Heed the Red Flags Over Red Ink

Federal Reserve chief Ben Bernanke delivered a crucial message to Congress and the White House this week: Cut the budget deficit or run the heightened risk of another financial crisis.

Bernanke's warning came three days after the federal government announced that it had racked up a record $1.4 trillion deficit in fiscal year 2009. That's more than three times the size of the previous year's $459 billion deficit.

The explosion of red ink was triggered, of course, by this year's deep recession and the government's frantic efforts to mitigate the damage by pumping truckloads of dollars into the economy. But even as the recession appears to be receding, the flood of deficit spending continues. In September, the deficit hit $46.6 billion — a record for the month.

To their credit, President Barack Obama and Treasury Secretary Timothy Geithner are saying the right things about trimming the deficit. Each insists it will be a top priority for the administration in the near future.

But other forces could very well undermine any effort to cut spending. The crashing value of the dollar, off almost 15 percent from its March high, is tied in part to the nation's soaring deficit.

The weak dollar in turn has propped up oil prices, which are climbing despite soft demand and ready supplies. A spike in energy prices next year could slow or even reverse the economic recovery.

The Obama administration's legislative priorities also are likely to ensure that the deficit remains at or near record levels for years to come. The president and his allies in Congress claim that health-care reform, which could include a new entitlement program, will actually help them cut spending in the future. To believe that is to ignore history.

The model for new federal entitlements has been to repeatedly expand benefits while continuing to rely on insufficient streams of revenue. Washington never has been able to figure out how to make work the concept of spending some now to save more in the future. That's because Congress almost invariably pours additional dollars into the programs it creates.

Two factors that the U.S. economy has going for it at the moment are low interest rates and mild inflation. Failure to tame the deficit increases the likelihood that both inflation and interest rates will surge, and substantially so. And, as Bernanke knows, that scenario could stagger the economy for years to come.

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