I know, I should be focusing on politics these days, but I just can’t but marvel at the sheer lack of common sense of some of the world’s best asset managers. Bill Gross, a legendary bond trader at PIMCO, has not had his top game lately and he keeps sticking to the losing trade. As some of you may know Bill Gross has been an inflation fiend for years now, predicting soon-to-come inflation back in 2008. And then in 2010. And then in 2011. And then again now. You can check current inflation data here, as you can see it’s under 2% as of July 2012. But he’s been wrong so many times before why should we listen to him now? I guess one day he will be right, but as a matter of coincidence, not as a matter of insight and expertise. I’d give him a few more years though.

This is one of the best commentary that I saw arguing that inflation isn’t coming anytime soon. I just don’t understand why everyone is puzzled by it.

“What the economy really needs for a full recovery is time and stability. Once U.S. banks have cleaned house and rebuilt their balance sheets, once consumers have their debt under control and their home values have stopped falling, and once companies have to start putting their cash to work, spending will pick up.”

Perhaps this what sums up my thinking for the last 4 years – I just thought about the delevering of both banks and individual homeowners and as I looked at the landscape it became perfectly clear to me – and mind you I’m not an economist or a venerated bond trader, I’m just an average observer – that it will take a long time for a turnaround and consumer spending to pick up and thus the ultimate inflation. I’m just amazed that people like Bill Gross (who is not running for political office and has no reason to scare the public with upcoming inflation) can’t grasp such simple truth. Perhaps, he’s still talking his book, but I thought he already took his Treasury position down. Maybe he’s trying, like a broken clock, to be finally right in the upcoming years. The fact that inflation will come eventually doesn’t make him a prophet or an insightful and thoughtful economist. Every fool in the industry in 2006 knew that the market was gonna crash, the trick was to know when exactly and on what scale.

Here’s one quote from his article:

If the dancing has slowed down, then the reason is not just an overweight partner. It’s that the price of money (be it in the form of a real interest rate, a quality risk spread, or both) is too low. Our entire finance-based monetary system – led by banks but typified by insurance companies, investment management firms and hedge funds as well – is based on an acceptable level of carry and the expectation of earning it. When credit is priced such that carry is no longer as profitable at a customary amount of leverage/risk, then the system will stall, list, or perhaps even tip over.

So that’s his argument for the upcoming inflation? System is stalled that’s why the inflation is coming?

He then goes on to say that “by historical models 0% interest rates should inevitably lead to dynamic economic recovery”. But did those historical models account for the massive debt plaguing potential borrowers? He seem to focus on the one side of the equation – banks flush with cash with nowhere to put it – and the notion that too much cash in the system will lead to inflation. It sure will – if it’s spent. But who is there to spend it and on what? He himself said there’s no yield out there and the potential borrowers (who would spend it) are overleveraged. To me that’s the answer that the inflation is not coming anytime soon.

“But what about the Chinese?” – some would say. “Don’t they hold a trillion dollars of US Treasuries? What if they stop buying it?” That’s a good question. If the Chinese stop buying Treasuries, or start demanding a higher yield – that can certainly spur inflation. But why would they do it now? Why didn’t they demand a higher yield when the world was coming to an end in 2008, 2009 and every year since then? They had plenty of opportunity to demand a higher yield before and they didn’t. What’s to change that dynamic now?

 The solution to a heavily indebted borrower and consumer is a slow, step by step process of deleveraging. This will take years, perhaps even a decade. Underwater homeowners will not get a refi or a principal reduction because of the absence of mechanisms to do it on a massive scale, uncooperating servicers and banks unwilling to refinance. So the consumers will not go out and buy a 5^th plasma TV and stock up on other goods until their house values will meet their outstanding mortgage balance. So, if it’s not the American consumer and not the Chinese then who? Who will bring about the inflation that conservatives like Paul Ryan and bond masters like Bill Gross have been warning us for years? What will generate it?

Time will. Mortgage servicers are a bottleneck for foreclosure relief, and banks are the bottleneck to healthy lending. Money, received from the Fed for free, is sitting on banks’ balance sheets and the inventory of underwater mortgages has no way of resolution other than time. A long time.

That’s my trade and I’m sticking to it.