Harvard economist: Economy looks alright, but Fed bubbles are about to pop

International uncertainty combined with the Federal Reserve’s feckless monetary policy in recent years is could be heading the world toward a massive dollar dump that would devastate the U.S. economy.

Martin Feldstein, Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research, writes of a likely financial meltdown in a recent column for project Syndicate.

According to the well-respected economic researcher, all Americans should be watching the economy closely for potential catastrophe in the year ahead.

One potential catalyst of global and U.S. market turmoil, according to the professor, is an increasingly unstable international political environment.

“Russia has been acting dangerously in Eastern and Central Europe. China’s pursuit of territorial claims in the East and South China Seas, and its policies in East Asia more generally, is fueling regional uncertainty. Events in Italy could precipitate a crisis in the Eurozone,” Feldstein writes.

Aside from outside causes of U.S. economic trouble,  the Harvard economists contends that the Fed’s easy money policies we’ve been warning you about for years could destroy the wealth of millions of Americans virtually overnight.

While stopping short of predicting asset price declines that would slash demand and shutter U.S. businesses, Feldstein notes that the current economic situation in the U.S. isn’t measurable by any historical norm.

From his commentary:

Equity prices, as measured by the price-earnings ratio of the S&P 500 stocks, are now nearly 60% above their historical average. The price of the 30-year Treasury bond is so high that it implies a yield of about 2.3%; given current inflation expectations, the price should be about twice as high. Commercial real-estate prices have been rising at a 10% annual pace for the past five years.

These inflated asset prices reflect the exceptionally easy monetary policy that has prevailed for almost a decade. In that ultra-low-interest environment, investors have been reaching for yield by bidding up the prices of equities and other investment assets. The resulting increase in household wealth helped to bring about economic recovery; but overpriced assets are fostering an increasingly risky environment.

To grasp how risky, consider this: US households now own $21 trillion of equities, so a 35% decline in equity prices to their historic average would involve a loss of more than $7.5 trillion. Pension funds and other equity investors would incur further losses. A return of real long-term bond yields to their historic level would involve a loss of about 30% for investors in 30-year bonds and proportionately smaller losses for investors in shorter-duration bonds. Because commercial real-estate investments are generally highly leveraged, even relatively small declines in prices could cause large losses for investors.

Feldstein is careful to note that his commentary is to serve as more of a warning than a prediction — but if the actions of billionaire investors like Warren Buffett and Bill Gates are any indicator, he isn’t the only one who sees a potential economic disaster in the nation’s near future.

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