Whoever wins this year's US presidential election will inherit a massive fiscal headache, and international investors may dump dollar assets if the deficit is not tackled, a former top US central banker said on Thursday.
The deficit was so big that faster economic growth could not eradicate it, and tax increases would be needed, said Alice Rivlin, a former vice chair of the US Federal Reserve.
Rivlin, speaking at a seminar in Singapore, was optimistic that a consensus would be reached among both US Republicans and Democrats that the deficit needed to be lowered.
Even if the US economy performed well, foreign investors would not be willing to sustain the current high rates of investment in the country if fiscal imbalances were left unchecked, said Rivlin, a director of the budget office in the Clinton administration.
"Particularly at the moment, a very large portion of Treasuries are held by Asian central banks. That might begin to seem like not such a good idea to Asian central bankers after a while if we can't get our affairs in order," she said.
Heavy reliance on foreign funding of the deficit posed a risk of recession if sentiment on the United States changed suddenly.
"Whoever wins the election has got a problem," Rivlin told an Institute of Policy Studies-Economic Society of Singapore seminar.
While President George W. Bush's tax cuts had helped when the US economy slipped into recession, they were inappropriate when the economy was recovering and needed to prepare for retirement of people born after the Second World War, she said.
The non-partisan Congressional Budget Office has forecast the budget deficit would rise to around $450 billion this year, more than four percent of GDP.
Rivlin said it was projected to rise to five to six percent of GDP over the next decade as baby boomers retired.
Her current work at the Brookings Institution showed it was not politically feasible to balance the budget through spending cuts alone, she said.
Bush wants to extend the tax cuts that he introduced in his first term, but has also indicated he wants to cut the deficit.
"He'd be in the position that his father (President George Bush) was in. I think it wouldn't be possible to balance the budget without going back on his tax cut promises," she said.
Democrat John Kerry also faced a problem of funding his spending programs, as he needed to find a revenue source other than his plan to take back tax cuts given to high-income earners.
Asia's central banks hold more than $2.15 trillion of foreign exchange reserves, far more than the rest of the world. The majority of these are thought to be held in US dollar assets such as Treasuries, reflecting the Asian policy of supporting the US dollar to keep regional exports competitive.
Less foreign investment would put pressure on the US dollar. Rivlin said a gradual weakening of the dollar could help boost US exports and improve the current account balance.
But there was a risk of a precipitous fall in the dollar that could lead to a spike in interest rates, rising inflation and possibly recession.
"That risk is an important addition to the list of general negatives that one might have," she said, without quantifying the risk.