OTTAWA -- Canada could face “serious” economic consequences should the United States fail to address its bulging budget deficit, warns Finance Minister Jim Flaherty.

“The situation in the United States is serious in terms of the size of their deficit,” Mr. Flaherty said in an interview. “That is a persisting concern” for the Canadian economy, as the United States is by far Canada’s largest trading partner.

In the interview, Mr. Flaherty talked about the big issues that Canada faces in the next decade. His short-term focus remains on implementing the federal government’s $47-billion stimulus package, which was meant to mitigate the impact of the global financial crisis. The stimulus scheme and record-low interest rates appear to have worked in turning around the Canadian economy, with meagre growth last quarter – bringing an end to the recession — and more robust expansion expected this quarter.

Mr. Flaherty reiterated his pledge to bring the budget back to balance by the middle of the coming decade, without tax increases or cuts to transfers to provinces and individuals. He suggested the next budget, now expected in March, would contain new “guideposts” that would show the way to budget balance.

While Mr. Flaherty expressed confidence about Canada’s economic prospects this coming decade as the country taps new emerging markets, he also acknowledged one of the big threats – namely, the U.S. fiscal situation, which analysts describe as “horrendous.”

The U.S. deficit this year, estimated at US$1.4-trillion, will be at its highest level as measured as a percentage of GDP since the Second World War. Furthermore, the debt-to-GDP ratio in the United States is expected to surpass the 100% threshold in 2012. (In contrast, debt-to-GDP in Canada is expected to peak next year, at 79%.)

To address this, U.S. legislators must opt to either control spending growth or raise taxes — both of which could crimp U.S. demand, which is a key component of Canadian economic growth. Unless addressed, there is also the risk that long-term borrowing costs will surge upward, throwing the North American economy into another tailspin.

“This is a concern,” the Finance Minister said. “We want the U.S. economy to return to health [because] it is good for our economy. We need to see that once American governments, including U.S. states, are through the crisis that there be indications as to how they will manage this huge deficit – because it has consequences both within and [outside of] the United States.”

Mr. Flaherty added he has spoken with his U.S. counterpart, Treasury Secretary Timothy Geithner, and is of the opinion the White House will try to address its budget shortfall.

Mr. Flaherty isn’t the only person warning of Washington’s need to restore fiscal order. Last week, former U.S. Federal Reserve chairman, Alan Greenspan, said the country was on the path toward a “formidable” fiscal crisis unless tackled shortly.

Furthermore, a recent paper prepared for the U.S. National Bureau of Economic Research suggested Washington might try to deal with its monster debt by allowing inflation to rise, thereby eroding the real value of the debt held by creditors — of which China is at the top of the list. Inflating away debt was a tactic tried following the Vietnam War, but kicked off a nasty inflationary spiral that saw inflation surge in the United States from 1.4% in the early 1960s to 13% by the time the 1980s rolled around.

Perhaps knowing U.S. demand is set to be tepid as households repair balance sheets and fiscal measures hold back growth, the federal Conservative government has been aggressive in recent months, with Prime Minister Stephen Harper visiting India and China for the first time.

“We have tremendous opportunities” in foreign markets, Mr. Flaherty said, noting Ottawa is in free-trade talks with the European Union and South American nations.

pvieira@nationalpost.com