By Richard Cowan and Alistair Bell
WASHINGTON (Reuters) - The United States lurched into a new budget crisis on Friday as President Barack Obama and Republicans failed to agree on stopping broad spending cuts that could dampen economic growth and curb military readiness.
Put in place during a bout of deficit-reduction fever in 2011, the automatic cuts can only be halted by a deal between Congress and the White House.
As expected, talks at the White House on Friday were fruitless, meaning that government agencies will now begin to hack a total of $85 billion from their budgets between Saturday and October 1. Financial markets in New York shrugged off the stalemate in Washington.
Democrats predict the cuts, known as "sequestration," could soon cause air-traffic chaos, delays in food safety inspections and less aid to the homeless as hundreds of thousands of federal employees are forced to take furloughs.
The nation's largest employer with a civilian workforce of 2.7 million people, the U.S. government begun notifying staff to prepare for reduced hours and slashed paychecks.
New U.S. Defense Secretary Chuck Hagel said the cuts, half of which will fall on the Pentagon, put at risk "all of our missions.
While the International Monetary Fund warned that the belt-tightening could slow U.S. economic growth by at least 0.5 of a percentage point this year, that is not a huge drag on an economy that is picking up steam.
Many Republicans accuse the administration of overstating the effects of the cuts in order to pressure them into agreeing on a solution to the White House's liking.
Obama said the damage to the economy was genuine.
"Not everyone will feel the pain of these cuts right away. The pain though will be real. Beginning this week, many middle-class families will have their lives disrupted in significant ways," he told journalists after meeting Republican and Democratic congressional leaders.
At the heart of Washington's persistent fiscal crises is disagreement over how to slash the budget deficit and the $16 trillion national debt, bloated over the years by wars in Iraq and Afghanistan and government stimulus for the ailing economy.
Obama wants to close the fiscal gap with spending cuts and tax hikes, but Republicans do not want to concede again on taxes after doing so in negotiations over the "fiscal cliff" at the New Year.
"The discussion about revenue, in my view, is over. It's about taking on the spending problem," House of Representatives Speaker John Boehner said on leaving the meeting.
The full brunt of the automatic cuts will be borne over seven months. Congress can stop them at any time if the two parties agree on how to do so.
The across-the-board cutbacks were mandated by a deficit reduction law, structured to be so disruptive that Congress would ultimately replace them with more targeted savings. But partisan gridlock in Washington has prevented agreement on where to save.
OBAMA TO SIGN ORDER
Obama will now issue an order to federal agencies on Friday night to reduce their budgets. The White House budget office must send a report to Congress detailing the spending cuts.
Notices of "intent to furlough" have gone to many of the unions representing government employees.
Some 115,000 employees of the Department of Justice -including prosecutors and the FBI - were among the first to get the official word of furloughs in notices that started going out last week but were made public on Friday.
The government also sent letters to several governors advising them of cuts to services like the Head Start education program in California and military facilities in Virginia.
Unlike previous fiscal dramas, the sequestration fight is not rattling Wall Street.
U.S. stocks rose moderately on Friday, with the Dow Industrials closing up 35 points, as data showed manufacturing expanded at its fastest pace in 20 months in February. Despite the market being up more than 7 percent this year, and near a record high, the discord in Washington has not prompted traders to cash in gains.
"Most of us believe that sequestration is not something that will make us fall off the cliff, since the cuts will be worked in relatively slowly," said Bill Stone, chief investment strategist at PNC Wealth Management in Philadelphia.
Canadian Finance Minister Jim Flaherty expressed rare public frustration with the United States for lurching from crisis to crisis.
Flaherty said he was confident Canada would not suffer too badly from the fiscal troubles its biggest trading partner is suffering from. "It is regrettable, though, that the U.S. continues to move from crisis to crisis in fiscal terms," he told reporters.
Another influential minister in Canada's Conservative government, House Leader Peter Van Loan, took a swipe at the United States, saying it was up to its ears in debt because of big-spending, left-wing policies.
One reason for the inaction in Washington is that both parties still hope the other will either be blamed by voters for the cuts or cave in before the worst effects predicted by Democrats come into effect.
A Reuters/Ipsos poll released on Friday showed 28 percent of Americans blamed congressional Republicans for the sequestration mess, 18 percent thought Obama was responsible and 4 percent blamed congressional Democrats. Thirty-seven percent blamed them all, according the online poll.
The non-partisan Congressional Budget Office predicts 750,000 jobs could be lost in 2013, and federal employees throughout the country are looking to trim their own costs.
"The kids won't go to the dentist, the kids might not go to the doctor, we won't be spending money in local restaurants, local movie theaters," said Paul O'Connor, president of the Metal Trades Council, which represents 2,500 workers at the Portsmouth Naval Shipyard in Kittery, Maine.
After weeks of White House warnings about the cuts causing disruption, Obama acknowledged it might be a while before effects fully kicked in.
"We will get through this. This is not going to be an apocalypse," Obama said.
In the absence of any deal at all, the Pentagon will be forced to slice 13 percent of its budget between now and September 30.
In his first Pentagon news conference since he was sworn in on Wednesday, Hagel struck a more moderate tone than many other defense officials who have said the spending reductions would be devastating or could turn the U.S. military into a second-rate power.
"America ... has the best fighting force, the most capable fighting force, the most powerful fighting force in the world," he said. "The management of this institution, starting with the Joint Chiefs, are not going to allow this capacity to erode."
Most non-defense programs, from NASA space exploration to federally backed education and law enforcement, face a 9 percent reduction.
Moving to head off a new budget crisis later this month, Boehner said the Republican-led House would move a "continuing resolution" to fund government through the rest of the fiscal year, thus hopefully averting a government shutdown.
(Additional reporting by Steve Holland, Roberta Rampton, Deborah Zabarenko and Jeff Mason in Washington and David Ljunggren in Ottawa; Editing by Peter Cooney)
