Despite fiscal woes, don't count the U.S. out

A German TV journalist holds an American flag as he presents the latest stock market news in front of the German share price index DAX board at the German stock exchange in Frankfurt, November 5, 2008.

NEW YORK (Reuters) - The turmoil in Europe over Greece's debt woes has sparked a few fears that market turbulence looms over the United States because of its growing federal deficit.

Still, market strategists and analysts at this week's Reuters Investment Outlook Summit in New York said the U.S. outlook is brighter than in Europe because the United States has more wherewithal -- a stronger economy, better demographics and a fiat currency.

That doesn't mean, however, that at some point over the next several years investors do not put federal deficits, or even state and local government finances, in their sights. Such a move might force officials to seriously address fiscal imbalances.

"Eventually the credit vigilantes are going to start paying attention to the funding situation of the United States, both federal government and cities and states," said Tom Lee, chief U.S. equities strategist at JPMorgan Chase & Co.

But the United States can defend its AAA credit rating for longer than many suspect, Lee said. Market discipline will likely stop the federal deficit from growing to double or triple the size of U.S. gross domestic product, he said.

Lee's reference to the size of federal indebtedness in relation to economic output is important. Research by Harvard economist Kenneth Rogoff shows that debt levels greater than 90 percent of GDP have been precursors for economic meltdowns, severe recessions or even depressions.

Total U.S. public debt was about $12.77 trillion as of March 31, or about 96 percent of seasonally adjusted GDP of $13.25 trillion at the end of the first quarter.

Bill Gross, the influential bond manager at Pimco, said in a recent letter to shareholders that common sense indicates U.S. debt levels are getting close to unsustainable. The growth needed to service such a debt load is insufficient if interest rates head higher, he wrote.

DEFICIT SPENDING

Yet suggestions that the United States cannot meet its obligations and could turn into a basket-case economy are off the mark, said Richard Bernstein, a widely watched chief investment strategist at Merrill Lynch & Co before he left to start Richard Bernstein LLC in 2009.

Deficit spending during economic slowdowns is necessary, he said. While the fiscal outlook might seem tough, predicting the future of the economy is harder, he said. A case in point is the U.S. recession in the early 1990s when the housing market was in a deep downturn and the savings & loan crisis raged.

"We were running what people thought were huge budget deficits," Bernstein said. "If I had said to you that within the next nine years the United States would be running a budget surplus, you would have thought I was insane...

"My point is simply that it's very hard to say that there is a fiscal Armageddon at the trough of a cycle. I am not sure that is the right way to approach the analysis."

Concerns about European growth and how that may impact the world are not unfounded, said Abby Joseph Cohen, senior investment strategist at Goldman Sachs and another widely watched analyst on Wall Street.

"Many people have wondered aloud, 'Well, as the countries in Europe move to address their short-term deficit issues, will they be slowing down GDP growth, and won't that be counterproductive?'" Cohen told the Summit.

A 20 percent decline in the value of the euro since December in recent months, however, will enhance demand for European exports and make imports in Europe more expensive.

"There is already this very interesting counterforce in terms of the weaker euro, because the weaker euro by itself is stimulative," Cohen said.

David Riley, group managing director for sovereign and international public finance at Fitch Ratings Ltd in London, said he did not think U.S. state and local government debt, which is about 13 percent of GDP, is a critical issue.

"The action on the public finances in the U.S. is primarily at the federal level, and that's where the adjustments are primarily going to have to take place," Riley said.

To be sure, some states or cities may come under strain, Riley said, a point echoed by Maria Fiorini Ramirez, an economist who runs her own firm. She cited the last Catholic general hospital in New York City, which was forced into bankruptcy in April, as an example.

"The risk is more with individual entities," said Ramirez. "I'll just give you an example that comes off the top of my head -- St. Vincent's Hospital. They had $850 million of debt they couldn't pay. They closed down the hospital."

St. Vincent's stands as a potential harbinger of change in the U.S. healthcare industry as cash-strapped governments that once stood behind community hospitals are forced to confront fiscal imbalances that have festered for years.

(Editing by Padraic Cassidy)