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Fed-inflated stocks a 'hall of mirrors': Jim Grant

The stock market is being led by the dangerous "monetary manipulation" of the Federal Reserve's $85-billion-a-month in quantitative easing bond purchases, Jim Grant—founder and editor of Grant's Interest Rate Observer—said Tuesday, as the central bank began its final meeting of the year.

"The stock market is now a tool of Fed policy," he said on CNBC's "Squawk Box".

"What the Fed is doing is an exercise in price control. This is 'stocks.gov' [and] 'bonds.gov,'" Grant said. "The clear and present risk of the stock market is we're living ... in a hall of mirrors" because the Fed's accommodative policy is distorting the calculations by which the market has been traditionally valued.

(Read more: Is a 'panic taper' the real risk to markets?)

Making that case, Grant explained that "clearer than the proposition that the stock market is too rich is the proposition that the stock market is being led, rather than leading itself, through the discovery of earnings and how to discount them."

"The Fed can change how things look. It can't change what way things are," he said.

As the central bank begins its two-day policy meeting Tuesday morning, investors are wondering whether this will be the month policymakers will start to scale back their quantitative easing bond-buying program. According to the latest CNBC Fed Survey, respondents on average don't see policymakers deciding to taper until February.

(Read more: Fed taper expected sooner: CNBC survey)

"Five years, and they are conjuring $85-billion-a-month, with which to buy securities, with which to enrich Greenwich, Connecticut, even more," Grant railed. "This is the policy of the one-tenth of one percent."

"You say, 'There's no inflation?' How about Wall Street? Stocks and bonds and art and Ferraris and farmland, assets are up," he said.

Paul Isaac, founder of $900 million hedge fund Arbiter Partners, agreed with Grant. "The fact that the stock market is as nervous as it is about the taper is an indication that other people implicitly have some concerns that valuation relationships will change if you move anyway from the highly stimulative monetary policy."

Hans Olsen, chief investment officer at Barclays Wealth and Investment Management, went further saying that the stock market is in bubble territory because of Fed QE. "It's not in a gross bubble, but it's no longer undervalued."

"You definitely have a bubble in bond territory" as well, he added, saying all of this is due to "the rise in the Fed's balance sheet," which is approaching $4 trillion.

Stocks are not especially overvalued by most measures, Grant countered, but added that segments of the market are in a bubble territory, such as the biotech sector.

This week's Fed meeting is Chairman Ben Bernanke's second to last. Janet Yellen, the Fed vice chair, is expected to be confirmed sometime this week to succeed Bernanke, who plans to step down Jan. 31 at the end of his second, four-year term.

By CNBC's Matthew J. Belvedere. Follow him on Twitter @Matt_SquawkCNBC.

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