Comment on the following statement:
“High budget deficits ultimately lead to foreign trade deficits.”
From S + TA ‑ TR = I + G + NX ==> S ‑ I = ‑ (TA ‑ G ‑ TR) ‑ (‑NX) = BuD - TD, that is, the difference between private domestic saving and private domestic investment is equal to the difference between the budget deficit and the trade deficit. In the early 1980's the size of the U.S. federal budget deficit increased sharply. Private domestic saving remained low and thus interest rates increased. High U.S. interest rates attracted funds from abroad, which drove the value of the U.S. dollar up, making U.S. goods less competitive on world markets. Thus the increase in the budget deficit in the 1980's was largely responsible for the increase in the trade deficit. However, an increase in the budget deficit does not necessarily increase the trade deficit, since the other two variables in this equation, namely private domestic investment and private domestic saving, may also be affected. As long as we can finance the increase in the budget deficit domestically, a trade deficit is not inevitable. Instead private domestic saving may increase or private domestic investment may be crowded out.