Final answer:
A country can sustain trade deficits if it earns more from its foreign assets than it pays on its liabilities. Yet, historical precedents suggest that failure to invest borrowed funds in productivity can lead to financial crises. It's crucial for economies to manage risks strategically, including adapting to currency fluctuations.
Step-by-step explanation:
The statement "It is possible for a country with debt today to perpetually run trade deficits if the returns on its foreign assets is sufficiently high relative to its liabilities" refers to a scenario where a nation can sustain ongoing trade deficits as long as the investment income from its assets abroad is higher than the costs associated with its external liabilities.
Essentially, if a country earns more on its investments abroad than it pays out in interest and dividends on its foreign debt, it can continue to run a trade deficit without depleting its resources.
However, this delicate balancing act comes with risks. Historical examples show that countries running persistent trade deficits, such as some nations in Latin America and Africa during the 1970s and 1980s, can face severe financial crises if the borrowed funds are not utilized to enhance productivity and economic growth.
Without this growth, the necessary returns on foreign investments may not materialize, leading to difficulties in meeting obligations associated with external debt.
Risks can be mitigated if there is a strategic approach to increase productivity and if the economy can adapt to changing conditions, such as currency devaluation, which can make imports more expensive and reduce trade deficits by making exports more competitive.