Europe's debt woes may be warning for U.S.

WASHINGTON (Reuters) - Spreading European debt woes may be a wake-up call for the United States, which could eventually face a crisis of its own if U.S. leaders fail to summon the political will to tackle growing budget deficits.

President Barack Obama has been urging Greece and Spain to make tough decisions and pursue reforms to restore market confidence. He and his advisers also prodded Europe to take bold action to calm financial markets.

But Washington has budget problems, too. The worst recession since the Great Depression of the 1930s has saddled the United States with a deficit of $1.4 trillion (950.5 billion pound) or roughly 10 percent of the economy's size.

Fiscal pressures will grow as the ageing population drives up spending on government health and retirement benefits.

For now, investors are lapping up U.S. debt, fleeing other more troubled borrowers. But if investors conclude the pace of borrowing is unsustainable, the United States could face the kind of predicament plaguing Greece, Spain and other nations.

"We know that we have large fiscal problems," said Douglas Holtz-Eakin, who served as an economist in President George W. Bush's administration. "I think there is a growing awareness that something has to happen. I don't see any genuine willingness to do it this year."

The White House is well aware of the risks. Budget chief Peter Orszag said on Wednesday Europe's problems show the need for the United States to move sooner rather than later to get its fiscal house in order.

"We want to make sure we never wind up facing the sorts of choices that Greece now faces," Orszag told Reuters Insider television in an interview.

CONSENSUS MAY BE ELUSIVE

There is a danger Washington's polarized atmosphere makes it more difficult to get congressional consensus on the kind of strong action needed to bring the deficit under control.

That is one reason why Obama, a Democrat, created a bipartisan commission to make recommendations for reining in the deficits. Seeking to shield the panel from the politics of this congressional election year, Obama asked its members to report back by December 1 -- a few weeks after the election.

Still, some Republicans have already accused Obama of using the commission to seek political cover for tax increases, while some liberal groups have said cuts in programs like Social Security should be taken off the table.

The United States, which benefits from its status as the world's largest economy and from the dollar's traditional role as a safe haven currency, has more leeway than Greece to run large budget deficits.

But a nightmare scenario could play out in which U.S. borrowing costs surge and the government is forced to slash spending at a time of economic weakness.

For now, flight from European debt securities towards short-term U.S. Treasuries is benefiting the United States by holding down interest rates.

But the mood of financial markets could shift suddenly, leading to a spike in interest rates, warned Holtz-Eakin, who advises lawmakers on fiscal and economic issues.

Allen Sinai, chief economist for Decision Economics Inc in Boston, said the United States could see a crippling legacy from the massive monetary and fiscal pump-priming that U.S. authorities undertook to counter the recession.

Necessary as the steps were to keep the U.S. and global economies from falling further, they came too late to halt the slowdown and steep declines in economic activity.

Sinai sees a U.S. unemployment rate approaching 10 percent as a "political powder keg" but also says U.S. indebtedness has risen so swiftly that policymakers' options are limited.

"Fiscal policy will be constrained by a U.S. sovereign debt problem -- record-high federal budget deficits and gross public debt relative to GDP (gross domestic product) that have set up conditions for a sovereign debt crisis," Sinai said.

While concern about the potential for serious problems in the long term is widespread, some analysts note there are differences between the problem countries like Greece face and those coming into focus in Washington.

James Horney, director of federal fiscal policy for the Centre on Budget and Policy Priorities, said that meant policymakers should not lose sight of the need to focus on reviving the economy's vitality before slashing budgets.

"Big spending cuts implemented over the next few years are inadvisable because it will simply undermine efforts to revive a flagging economy," Horney said. "Absolutely we're going to need more revenues and it's going to take a combination of higher revenues and leaner spending to get control again."

(Writing by Caren Bohan and Glenn Somerville; Editing by Simon Denyer and John O'Callaghan)