WASHINGTON (BLOOMBERG) – Former United States treasury secretary Lawrence Summers warned of the risk of a “spontaneous deflating of financial markets” that have been pumped up by retail buying and exuberant investors.

There is “a lot of euphoria”, Mr Summers said at an American Council for Capital Formation webinar on Tuesday (Dec 14) – pointing, among other things, to cryptocurrencies, so-called meme stocks and technology shares. “Super-excited retail is usually a sign of trouble to come,” he added.

Mr Summers, who is a paid contributor to Bloomberg and a Harvard University professor, also saw potential signs of trouble in the actions of more seasoned investors. “There are many who are chasing yield by taking on extra risk,” he said. “Highly sophisticated endowments and pensions funds are behaving in that way. In so far as that is happening, it points to something that may or may not be sustainable.”

Stock prices slid on Tuesday as investors awaited Wednesday’s results of the US Federal Reserve’s final policymaking meeting of the year. Central bank officials are expected to double the pace of tapering the Fed’s bond-buying – to US$30 billion (S$41.1 billion) a month, wrapping up in March – while forecasting two interest rate hikes next year, according to economists surveyed by Bloomberg News.

Mr Summers, who has been warning of the dangers of elevated inflation for months, said it would be very hard for the Fed to rein in excessive price gains without also damaging the economy.

“The Fed will have a very difficult time organising a soft landing,” he said, noting the long and variable lags between monetary policy actions and their impact on the economy. “All the efforts at disinflation that we have had historically, where it was clearly established that inflation was too high and the Fed acted, have ended in recession.”

He called on the Fed to immediately stop buying mortgage-backed securities and wind up its purchases of Treasury debt “probably by the end of February”.

“I would be establishing a presumption that the Fed will do whatever is necessary to bring inflation under control, and that quite possibly that could involve four rate increases during the next year and more after that,” he said.