GLOBAL ECONOMY WEEKAHEAD-Digesting Obama's $1.75 trln deficit

WASHINGTON, March 1 - In the sometimes twisted logic of finance, a weak global economy may be good news for U.S. President Barack Obama and the record-setting $1.75 trillion deficit he has proposed.

In order to pay for salvaging debt-laden banks, propping up the economy, expanding health care and a host of other initiatives, Obama's budget envisions total net borrowing of nearly $2.6 trillion in the coming fiscal year. That works out to 17.9 percent of the country's total output.

Someone has to buy that debt, and the price they're willing to pay has consequences for just about anyone who wants to borrow money, whether to buy a car, a house or a factory.

The biggest customers for U.S. Treasury debt include world central banks, notably those of China and Japan, which together held a little under $1.3 trillion as of December.

So far, there does not appear to be a shortage of willing buyers, in part because the United States is still seen as the world's safest haven in times of economic turmoil. That has kept borrowing costs down, not only for the government, but also for loans with interest rates tied to Treasury bonds.

"The great irony is, as the global economy does start to recover and our deficits stay at $1 trillion-plus, then you've got a problem," said John Silvia, chief economist at Wachovia in Charlotte, North Carolina.

"You end up running into a problem because of your own success," he added.

Right now, success looks like a distant dream.

In the coming week, both the European Central Bank and the Bank of England are likely to lower short-term borrowing costs to try to revive their economies.

On Friday, the monthly U.S. employment report may show upward of 600,000 jobs were lost in February. That will keep investors on the defensive, and most likely content to keep gobbling up U.S. government debt.

But eventually, when the global slump ends and investors are once again willing to take on greater risk, the appeal of U.S. government bonds will fade.

In theory, even if the rest of the world balked at buying U.S. debt, the Federal Reserve could step in, print dollars and buy Treasuries. But the central bank is reluctant to do that, largely because of the risk that it would spawn inflation and put pressure on the dollar.

Fed Chairman Ben Bernanke and Treasury Secretary Timothy Geithner are both due to testify before Congress this week on Obama's budget proposal.

They can expect tough questions on how the government can afford to ramp up spending on borrowed money -- and how it can afford to ratchet back as quickly as Obama is planning.

ECONOMIC MIRACLE

Obama has pledged to halve the deficit by the end of his first term in office, in January 2013. Some of the reduction will come from his plan to cut spending on the Iraq war, but it also assumes the economy rebounds more quickly and strongly than most economists predict.

His administration has forecast a 3.2 percent jump in gross domestic product next year. That is at the high end of the Fed's forecast range of 2.5 percent to 3.3 percent, and well above the 2.1 percent that private economists predicted in the Blue Chip survey.

The budget pegs GDP above 4 percent in 2011, 2012 and 2013, also far more ambitious than most private economists expect. If growth fails to live up to those lofty expectations, it will be much harder for Obama to make the sort of budget cuts he is planning to bring down the deficit.

There are no good options for Obama. If he cuts spending on things like health care, it could anger voters who elected him on promises to help the middle class. Raising taxes, as he has proposed, will provoke complaints from Republicans that he is putting a drag on growth when the economy needs it most.

"We need stimulus ... but please show us how we can, over a three, four, five-year period, get back into a sustainable budgetary position with a reasonable flow of taxes," Paul Volcker, one of Obama's top economic advisers and a former Fed chairman, said at a congressional hearing last week. "That's a great challenge for President Obama."

Wachovia's Silvia said not only was it unrealistic to think Obama could rein in spending quickly, but tax revenues may not be as robust as the budget assumes.

That suggests debt issuance will remain high.

Eventually, heavy debt issuance may catch up with the United States, and the dollar will fall, said Lena Komileva, head of G7 market economics at Tullett Prebon in London.

That would hurt the value of dollar-denominated holdings around the world, and could even jeopardize the United States' top-tier AAA credit rating, she said.

"Ultimately, it looks insane that the U.S. government can commit to a prolonged period of very high issuance," she said. "It is a gamble. The speculation part of it is that the government can easily reverse this in the future. There's absolutely no guarantee."