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Why Smart Money Is Focusing on Inflation

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Warren Buffett is betting on inflation as Fed concludes meeting on monetary policy, Quantitative Easing 2.

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Deflation is in vogue on Wall Street but the smart money is starting to focus on inflation.

Warren Buffett, who needs no introduction, shortened the duration of bonds held by Berkshire Hathaway (BRK/A). For those who aren't studying for the CFA exam, the simplest definition of duration is how long in years it takes for a bond to be repaid. Bonds with high durations carry more risk and are more volatile then bonds with lower duration.

According to a filing from August 6, 21% of Berkshire's holdings in Treasuries, municipal debt, corporate debt, and foreign-government securities were due in one year or less. According to Bloomberg, on March 31 the portfolio was at 18% and at 16% during the second quarter of last year. This is an 8.5% advance of fixed-income securities due in one year or less, while bonds maturing after a year fell 8.6%.

Buffett's moves to the Berkshire portfolio shows he could be betting that interest rates will start to rise as inflation starts to creep up. In an inflationary environment, long-term securities get hit the hardest.

Buffet has been vocal about inflation in the past: Last year he asked Congress to guard against inflation as the US economy showed signs of returning to growth. In a New York Times op-ed from August 2009, Buffet said the government must address its "monetary medicine" that was injected into the systems after the financial crisis of 2008. However, inflation has fallen to a 44-year low despite the Federal Reserve doubling its balance sheet to $2.33 trillion.

Today the Fed will conclude its meeting on monetary policy, and most market participants are expecting the Fed to expand its balance sheet more and introduce Quantitative Easing 2.0. The whisper number is currently around $1 trillion, which would be used to buy securities and US treasuries.

In a 2002 speech, Bernanke said, "Under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

It's no wonder the smart money -- like Buffett and John Paulson -- is betting on inflation.

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