Analysts: Growing budget deficits may endanger nation's economic health

WASHINGTON -- Like a person packing on pounds, the United States keeps adding to its flabby budget deficits, endangering the nation's economic health and the pocketbooks of ordinary Americans.

Here's the worry: Persistent deficits will lead to higher borrowing costs for consumers and companies, slowing economic activity.

As Uncle Sam seeks to borrow ever more to finance those deficits, rates on Treasury securities would rise to entice investors. That would push up other interest rates, such as home mortgages, many auto loans, some home equity lines of credit and some credit cards.

"That's the pocketbook risk to the American consumer," said Greg McBride, a senior financial analyst at Bankrate.com, an online financial service.

For businesses, rates on corporate bonds would climb. It would become more expensive to borrow to pay for new plants and equipment and other capital investments.

With a succession of budget deficits, "you do expect to see higher interest rates. Where we fight about this is over how big the effects are. But they are definitely there," said James Feyrer, assistant economics professor at Dartmouth College.

The government's budget deficit last year was $319 billion. While smaller than the record $413 billion in 2004, it still was the third-highest ever.

A White House budget official now predicts that the deficit in the current budget year will top $400 billion, pushed up by the costs of the Gulf Coast hurricanes. The red ink is expected to keep flowing for years.

The nonpartisan Congressional Budget Office forecasts deficits every year through 2015; that is as far out as the office projects. The White House forecast, which runs to 2010, also expects annual shortfalls.

Federal Reserve chairman Alan Greenspan, who retires Jan. 31 after 18-plus years at the central bank, repeatedly has urged Congress and the Bush administration to get the country's financial house in order.

Bloated budget deficits, if not curbed, could endanger the economy over the long term, Greenspan warned. Increased government borrowing would drive up interest rates and weigh down economic activity.

"In the end, the consequences for the U.S. economy of doing nothing could be severe," he said recently.

The looming retirement of 78 million baby boomers will put massive strains on the country's finances, Greenspan said.

In 2008, the oldest of the boomers will reach 62, the earliest age at which they can tap Social Security retirement benefits. Three years after that, in 2011, they will reach 65 and become eligible for Medicare.

Ben Bernanke, chosen by President Bush to succeed Greenspan, also believes the situation is troubling and that the deficits need to be controlled.

"Budget deficits are a problem," he said. "I think it's important to continue to reduce budget deficits."

The administration has a goal of cutting the deficit in half by 2009 and plans to do that by restraining spending. The president, meanwhile, is continuing to press Congress to make his tax cuts permanent.

Democrats mostly blame Bush's tax cuts for the government's red ink. The last time the government recorded a surplus was in 2001.

In a worst-case scenario, foreigners who finance the U.S. budget and trade deficits would sour on U.S. investments and unload their holdings. The prices of U.S. stocks and bonds could plunge. Interest rates, including those for mortgages, could soar. A financial crisis could confront the country.

Economists are troubled by the prospects of budget deficits as far as the eye can see and want to see them trimmed. But the size of the current budget deficits, while unwelcome, do not signal that a crisis is imminent, they said.

An important barometer is the size of the federal debt -- now about $8 trillion -- relative to the overall economy, as measured by gross domestic product. Under that measure, this debt accounts for around 63.2 percent of GDP, Bethune said.

"Generally speaking, when it is over 75 percent of GDP, then the yellow flag goes out. I would say 95 percent of GDP and over is definitely a red flag," Bethune said.

The government produces a budget deficit when its total spending exceeds its total revenues. Budget deficits cause the government to borrow more money by selling Treasury securities to domestic and foreign investors. That additional borrowing increases the government's debt.

Despite the recent string of large budget deficits, long-term interest rates in the U.S. have behaved well. In fact, relatively low long-term rates around the world have puzzled economists and spawned a number of theories. Some experts believe too little investment worldwide may be behind this; others believe too much savings is the reason.

From an economic point of view, there is more concern about higher borrowing costs over time crimping business investment and ultimately the production of goods and services, economists said.

"Low investment is bad. That's going to mean lower productivity and lower production in the future, which has a cost on society," said Erik Hurst, associate professor of economics at University of Chicago's Graduate School of Business.

People who save would benefit, assuming inflation stayed under control. If the deficits fanned inflation, then the Fed would need to boost interest rates, pushing a whole range of borrowing costs even higher.