Another bubble is building in the U.S. economy - this time in bonds - that likely will do significant damage to investors in stock, farmland and other holdings affected by long-term interest rates, a key economic adviser to several presidents said Thursday in Colorado Springs.
"I am afraid we are creating an asset-price bubble again because of low interest rates. An asset-price bubble caused the last recession. Long-term interest rates should be higher and will eventually rise, and there will be losses," said Martin Feldstein, who served as chairman of the Council of Economic Advisers under President Ronald Reagan, headed the National Bureau of Economic Research for 30 years and is now an economics professor at Harvard University.
"I think this is a bubble that will cause a lot of pain," he said.
Feldstein also said he expected U.S. economic growth to be "quite weak" this year as a result of automatic federal spending cuts that began March 1 and tax increases enacted at the beginning of the year as part of a deal between the Obama administration and Republicans in Congress to avert the so-called "fiscal cliff" of expiring tax cuts. He made the comments during the general meeting of the Washington, D.C.-based American Iron and Steel Institute, a trade group for 24 steelmakers and 123 suppliers and customers, at Broadmoor Hall.
The automatic budget cuts and tax increases will trim at least 1.1 percentage points from the nation's economic growth rate, which could end up being less than 1 percent this year and offset much of the benefit from an improving housing industry, a booming stock market and expansion of the nation's energy industry, Feldstein said. A continuing recession in Europe, slowing economic growth in Asia that is expected to reduce exports and lackluster growth in consumer spending from stubbornly high unemployment also will be drags on economic growth, he said.
Feldstein criticized the Federal Reserve's efforts to keep long-term interest rates low as ineffective in stimulating economic growth, contributing to the bubble he warned about and fueling future inflation after the economy has begun to recover. He is worried the nation's central bank will wait too long into an economic recovery to raise interest rates, allowing inflation to gain momentum and making it more difficult to bring it back under control. He remains concerned that growing federal deficits and debt will eventually force interest rates higher.
He recommended reducing federal income tax breaks to increase revenue and reducing the growth in federal health care benefits for the elderly, but said a continued stalemate between a Democratic president and Senate and a Republican House is likely to continue for several more years, resulting in continued growth in the federal government's debt. Feldstein also said he doesn't expect much improvement this year in the European or Asian economies, especially since plans to reduce deficits and government debt have been shelved in several European countries.
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