Buffett's Brazilian windfall

NEW YORK (Fortune) -- A surprising bet on Brazil's currency made Berkshire Hathaway shareholders some real money last year.

Omaha-based Berkshire makes money by writing insurance policies and investing its take in stocks and bonds, and by owning companies ranging from utilities to retail stores. But in recent years the firm, run by billionaire investor Warren Buffett, has found a very profitable sideline: buying foreign currencies in a wager that the value of the dollar will fall.

Those bets continued to pay off in 2007, but with a twist. Where Berkshire (BRKA, Fortune 500) previously has taken positions in multiple currencies, all of its $100 million in pretax direct foreign-currency gains last year came from a single holding, the Brazilian real.

"Not long ago, swapping dollars for reals would have been unthinkable," Buffett admits on page 16 of Berkshire's annual report, which was posted Friday afternoon on the company's Web site at berkshirehathaway.com. "After all, during the past century five versions of the Brazilian currency have, in effect, turned into confetti."

But since 2002, Buffett continues, it has been the once-mighty dollar that has been shredded. The problem, Buffett says, is that "Americans like buying products made elsewhere more than the rest of the world likes buying products made in the U.S." As a result, he adds, the United States ends up shipping some $2 billion in assets and repayment promises to overseas trading partners every day. Over time, sending out all these IOUs puts pressure on the dollar.

As a result, the dollar lost half its value against the real between 2002 and the end of 2007 - and it could have been worse, Buffett says. "During much of this period the Brazilian government was actually holding down the value of the real," Buffett writes, "and supporting our currency by buying dollars in the market."

Of course, the real hasn't been the only currency that has gained at the expense of the dollar. Buffett says Berkshire shareholders have earned $2.3 billion, on a pretax basis, over the past six years on holdings of foreign currencies such as the euro, the Australian and Canadian dollars, the British pound and the South Korean won.

But the timing of Buffett's bet on the real was impeccable. The real has jumped 26% over the past 12 months, Bloomberg reported, marking the biggest gain against the dollar among major currencies. And while it's not clear whether Berkshire's real position remains open, the trade has certainly remained profitable. The real is up 6.7% against the dollar this year, even after Thursday's decline in the real broke a string of eight consecutive daily gains against the dollar.

None of this is to say Buffett is pessimistic on the future of the United States. "Despite our country's many imperfections and unrelenting problems of one sort or another, America's rule of law, market-responsive economic system and belief in meritocracy are almost certain to produce ever-growing prosperity for its citizens," he writes on page 17.

But, as he has in the past, Buffett urges legislators to recognize the nation's trade deficit is "unsustainable" and to respond by adopting policies that will "materially reduce [current imbalances] sooner rather than later." Otherwise, he warns, the daily flow of dollars into the hands of U.S. trading partners "may produce global indigestion of an unpleasant sort."

That could make for a real nasty hangover.

(A member of FORTUNE's staff, senior editor at large Carol Loomis, edits the chairman's letter in Berkshire Hathaway's annual report.)