When ‘inflation’ is ‘low,’ unemployment ‘high,’ and the output gap is growing, the deficit is probably way too small. The economy is screaming for more net financial assets that only government deficit spending can provide. When unemployment is very low, prices rising, and excess capacity at a minimum the deficit is probably too high.
But solvency is never the issue. The economy is the issue.
During the last two recessions the economy did not improve in a meaningful way until after the deficit reached about 5% of GDP. This time around the deficit is now at about 5% of GDP and from the latest economic statistics it’s obvious that this time around a much higher deficit will be required to turn the economy. This is because the previous government surpluses of the late 1990’s deeply eroded savings, which, for all practical purposes, only a budget deficit can replenish.
Additionally, the large trade deficit that foreigners allow us to sustain, means we can have a budget deficit that much larger without increasing the risk of inflation.
Here’s how that works. When Americans purchase foreign goods and services, we use up some of our ‘purchasing power.’ That can mean we don’t have enough purchasing power left over to buy all of our own goods and services we can produce at full employment, UNLESS our government conducts sufficient deficit spending to make up for this shortfall.
So our negative trade balance allows us to enjoy either lower taxes or the benefits of higher government spending, so we can consume BOTH whatever we can produce AND whatever the foreign sector wants to send to us.
The economic fundamental at work is that exports are real costs and imports real benefits. Economically, scripture notwithstanding, it’s better to receive than to give!
Our well being depends on appropriate policy response. Current circumstances allow us to run much higher deficits to sustain sufficient aggregate demand to close our output gap. That means lower taxes or more government spending is in order to sustain output and employment.

How We Can All Benefit from the Trade Deficit

The current trade gap is a reflection of the rest of the world’s desires to save $US financial assets.
The only way the foreign sector can do this is to net export to the US and keep the $US either as cash or securities. So the trade deficit is not a matter of the US being dependent on borrowing offshore, as pundits proclaim daily, but a case of offshore investors desiring to hold $US financial assets.
To accomplish their savings desires, foreigners vigorously compete in US markets by selling at the lowest possible prices. They go so far as to force down their own domestic wages and consumption in their drive for ‘competitiveness,’ all to our advantage.
If they lose their desire to hold $US, they will either spend them here or not sell us products to begin with, in which case that will mean a balanced trade position. While this process could mean an adjustment in the foreign currency markets, it does NOT cause a financial crisis for the US.
The trade deficit is a boon to the US. There need not be a ‘jobs’ issue associated with it. Appropriate fiscal policy can always result in Americans having enough spending power to purchase both our own full employment output and anything the foreign sector may wish to sell us. The right fiscal policy works to optimize our output, employment, and standard of living.
Our steel industry, however, is an example of a domestic industry with important national security considerations. Therefore, I would propose that steel tariffs be eliminated and instead defense contractors be ordered to use only domestic steel. This will ensure a domestic steel industry capable of meeting our defense needs, with defense contractors paying a bit extra for domestically produced steel, while at the same time lowering the price for non- strategic steel consumption for general use.

Using a Labor Buffer Stock to Let Markets Decide the Optimum Deficit

To optimize output, substantially reduce unemployment, promote price stability, and use market forces to immediately promote health care insurance nationally, the government can offer an $8 per hour job to anyone willing and able to work that includes full Federal health care benefits.
To execute this program, the government can first inform its existing agencies that anyone hired at $8 per hour ‘doesn’t count’ for annual budget expenditures. Additionally, these agencies can advertise their need for $8 per hour employees with the local government unemployment office, where anyone willing and able to work can be dispatched to the available job openings. This job will include full benefits, including health care, vacation, etc. These positions will form a national labor ‘buffer stock’ in the sense that it will be expected that these employees will be prone to being hired away by the private sector when the economy improves. As a buffer stock program this is highly countercyclical- anti inflationary in a recovery, and anti deflationary in a slowdown. Furthermore, it allows the market to determine the government deficit, which automatically sets it at a near ‘neutral’ level.
In addition to the direct benefits of more output from more workers, the indirect benefits of full employment should be very high as well. These include increased family coherence, reduced domestic violence, reduced crime, and reduced incarcerations. In particular, teen and minority employment should increase dramatically, hopefully substantially reducing the current costly levels of unemployment.