SCENARIOS: What's at stake with trillion-dollar U.S. deficits

(Reuters) - President-elect Barack Obama has said trillion-dollar U.S. budget deficits could stretch into the coming years -- a prospect that some worry could wreak havoc on the dollar, interest rates and the country's top-notch credit rating.

The non-partisan Congressional Budget Office has also said the U.S. budget deficit will swell to a record $1.186 trillion in fiscal-year 2009 and come in at $703 billion in the 2010 fiscal year, which begins October 1, 2009.

The actual budget gaps for both years may be significantly wider as Washington prepares to jolt the economy with stimulus spending that could total $775 billion over two years.

Obama has promised a massive program of new public spending and tax cuts to pull the economy out of the current recession, likely to be the longest since the Great Depression.

The cost of ending the recession will be enormous deficits, potentially mortgaging the well-being of future generations, though some note that the United States has had to resort to huge borrowing when faced with such difficulties in the past.

Former Labor Secretary Robert Reich, an Obama transition adviser, said Congress should not be wary of borrowing to pay for a stimulus, pointing out that U.S. debt at the end of the World War Two was more than 100 percent of gross domestic product.

The U.S. public debt is currently around 40 percent of GDP. Still, the trillion-dollar deficit milestone has forced some to consider how things could go wrong.

The following are several scenarios that could result from runaway budget deficits:

FALLING U.S. CREDIT RATINGS:

A string of trillion-dollar deficits could undermine investors' faith that the U.S. government always pays its debts and put in danger the country's triple-A credit ratings. This could lead foreign investors to shun U.S. Treasuries, the bonds the government sells on the open market to finance its borrowing. Treasuries are currently expensive by historic standards since the financial and economic turmoil of the past year has boosted their global appeal as a safe-haven investment. Serious danger to U.S. credit ratings could send the debt market downward and burst what some are calling a bond-market bubble.

SKY-HIGH INTEREST RATES:

A loss of faith in U.S. government bonds would send interest rates throughout the economy soaring since Treasuries serve as the benchmark for loans in the private sector. A rout in that market would dramatically lift the cost of borrowing for buying homes, cars and paying for university education. If it happens any time soon, this in turn would jeopardize the Federal Reserve's efforts to stabilize the ailing economy.

DUMP THE DOLLAR:

A crisis of confidence in U.S. debt would devastate the dollar. The world's reserve currency, the greenback is used globally by countries and companies to pay for a wide range of basic commodities, most notably oil. If investors dumped U.S. debt, they could do the same with the dollar. A dollar crisis might end its status as the preeminent currency of world commerce, deeply undermining its value and further raising the cost of borrowing for the United States.

SOARING INFLATION:

A plummeting dollar and sky-rocketing interest rates could push the inflation rate through the roof. The United States imports far more than it exports and would be hard pressed to pay for oil and manufactured goods it buys from abroad with the greenback's value withering. Currently, though, rapidly falling prices, or deflation, appears to be a much more imminent problem than the more distant prospect of inflation.

FALLING GLOBAL STATUS:

A dollar and debt crisis would undoubtedly undermine the global standing of the United States, much of which is based on the fact that it is the world's largest economy. If the United States lost the international reserve currency and the faith of global investors, little else might be left and the beacon of free-market capitalism might also dim.

(Additional reporting by John Crawley, Lisa Lambert, Richard Cowan and Jeremy Pelofsky in Washington; editing by Gary Crosse)