The multibillion-dollar bailouts handed out by the US Government will bring on an “onslaught of inflation”, Warren Buffett, the legendary investor, said in his keenly awaited annual letter to shareholders.

Mr Buffett, whose Berkshire Hathaway company last year reported only the second year of negative returns in its 44-year history, predicted that the economy would remain a shambles this year and “probably well beyond”.

President Obama signed off a $787 billion (£550 billion) stimulus package to revive America's economy this month. The President has also said that he expects to spend more than the $700 billion allocated to bail out the ailing banking sector.

“Economic medicine that was previously meted out by the cupful has recently been dispensed by the barrel,” Mr Buffett said. “These once unthinkable dosages will almost certainly bring on unwelcome after-effects. Their precise nature is anyone's guess, though one likely consequence is an onslaught of inflation.”

Gross domestic product figures revealed by the US Commerce Department last week showed that America's output shrank at an annual rate of 6.2 per cent in the last quarter of 2008, the biggest contraction since 1982. The annual inflation rate, however, disappeared in January for the first time in 50 years, with only a rise in the consumer price index saving America from deflation.

Britain's bank bailout is expected to add as much as £1,500 billion to public sector liabilities — through direct capital injections, loans and guarantees.

Once companies become dependent on state assistance, it can be difficult to de-nationalise them, Mr Buffett argued. “Weaning these companies from the public teat will be a political challenge.”

Known as the Sage of Omaha for his ability to make millionaires of ordinary investors in his company, Mr Buffett said that Berkshire Hathaway's per-share book value fell by 9.6 per cent in 2008, reflecting a decline of $11.5 billion in the company's net worth. The company beat the S&P 500 index, which experienced a 37 per cent decline. “Investors of all stripes were bloodied and confused, as much as if they were small birds that had strayed into a badminton game,” he said. With reference to the paltry yields on Treasury bonds, he said: “When the financial history of this decade is written, it will surely speak of the internet bubble of the late 1990s and the housing bubble of the early 2000s. But the US Treasury bond bubble of late 2008 may be regarded as almost as extraordinary.”

Mr Buffett admitted to having done “some dumb things” during last year. He increased the company's investment in ConocoPhilips, the Houston-based oil company, when gas and oil prices were near their peak and Conoco's shares were priced between $72 and $90 each. The subsequent fall in the commodities cost Berkshire Hathaway “several billion dollars”. Conoco closed at $37.50 per share on Friday.

“I still believe the odds are good that oil sells for far higher in the future than the current $40-$50 price. But so far I have been dead wrong,” Mr Buffett said. He also made an 89 per cent loss on two unnamed Irish banks in which he invested $244 million last year.

But he was happy with his insurance business. Berkshire Hathaway owns Geico, an American insurer, which he said was growing, mainly because of the present emphasis on value motor insurance. “Tony and I feel like two hungry mosquitoes in a nudist camp,” Mr Buffett wrote. “Juicy targets are everywhere.”

He fuelled speculation that Ajit Jain, the former McKinsey & Co consultant who heads Berkshire Hathaway's reinsurance business, is his heir-apparent. Mr Buffett heaped praise on Mr Jain, who joined the company in 1986, saying: “There isn't anyone like Ajit.”

Mr Buffett was also pleased with his $14.5 billion investment last year in fixed-income securities issued by Wrigley, Goldman Sachs and General Electric, which were returning yields that made the deals “more than satisfactory”. Since Mr Buffett took over Berkshire Hathaway, which had been a family-run textile maker, 44 years ago, the book value of its shares has risen from $19 each to $70,530.

The Sage of Omaha speaks

Warren Buffett on banks losing money on derivatives:

“Only companies having problems that can infect the entire neighbourhood - I won't mention names - are certain to become a concern of the State ... From this irritating reality comes the First Law of Corporate Survival for ambitious CEOs who pile on leverage and run large and unfathomable derivatives books: modest incompetence simply won't do; it's mindboggling screw-ups that are required.”

Buffett on the dangers of history-based financial models:

“Constructed by a nerdy-sounding priesthood using esoteric terms such as beta, gamma, sigma and the like, these models tend to look impressive. Too often, though, investors forget to examine the assumptions behind the symbols. Our advice: beware of geeks bearing formulas.”

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