Kaufman: $800 billion U.S. budget deficits now "the norm"

NEW YORK (Reuters) - U.S. federal budget deficits of as much as $800 billion, double the current level, will be the "norm" following a proposed financial system bailout, said veteran Wall Street economist Henry Kaufman on Wednesday.

"The credit crisis is in full bloom. It is by far the worst in the post-World War II period," Kaufman said. As a result of measures to address the crisis, "the new volume of U.S. government financing will continue to balloon for the next several years, no matter who wins the presidential election.

"U.S. budget deficits of $700 billion to $800 billion will be the norm. Federal tax revenues will slow appreciably and federal spending increase," Kaufman said, who was delivering prepared remarks before the World Leadership Forum of the Foreign Policy Association in New York.

The U.S. budget deficit is forecast to be about $407 billion this year, near its 2004 record of $413 billion, according to the Congressional Budget Office.

"The government takeover of Fannie Mae and Freddie Mac will make additional demands on U.S. Treasury financing, and so will the just-announced mammoth bailout program," said Kaufman, the president of the financial consulting firm Henry Kaufman & Co Inc.

As the U.S. government buys lower-quality fixed-income assets and issues more Treasury debt, "yields on all obligations eventually will increase, and yield spreads between high- and low-quality will narrow somewhat," Kaufman said.

Analysts expect the government to ramp up debt issuance substantially to pay for the bailout which will initially increase the pool of marketable U.S. Treasury securities outstanding by about 15 percent.

Despite that massive slew of anticipated fresh dollar-denominated issuance and the inflation risks and threats to the U.S. dollar this may pose, Kaufman does not expect the dollar's hegemony as the global reserve currency to be toppled.

"The U.S. dollar will remain the key reserve currency for the foreseeable future," he said, because its main challenger, the euro, faces slowing economic growth, corporate profit constraints and overly leveraged financial institutions.

In the United States, "our economy will see yet another round of financial consolidation that will contribute to future systemic risks," he said.

Many smaller banks may get taken over, he warned.

"As smaller and medium-sized financial institutions are absorbed by larger ones in the coming months -- mainly because smaller institutions do not have access to the open credit markets they need in order to replenish their weakened capital positions -- the large financial conglomerates at the forefront of debt creation will further consolidate their dominance," he said.

As that consolidation occurs, big financial institutions "will become financial utilities that will significantly circumscribe their activities," a development which Kaufman foresaw more than a decade ago, he said.

Kaufman became well known for correctly forecasting higher inflation and interest rates when he was chief economist with Salomon Brothers in the 1970s and 1980s.

(Reporting by John Parry; Editing by Tom Hals)