True or False?
False. When assets can be freely bought and sold across international boundaries the statement is dead wrong! Balance of payments deficits are reductions in the stock of official foreign exchange reserves that occur because the domestic source component of the stock of base money is growing faster than the demand for base money. The authorities are forced to sell reserves to keep the domestic currency from depreciating. This will happen independently of whether the current account balance is positive or negative.
A negative current account balance, and corresponding positive capital account balance, implies that investment opportunities in the domestic economy exceed the country's ability to finance them with domestic savings. This has nothing to do with whether there is balance of payments equilibrium or whether the government is maintaining the exchange rate fixed or allowing it to float freely in response to market forces. Balance of payments disequilibria will arise whenever the rate of change in the demand for base money differs from the rate at which the government is expanding the domestic source component of base money. This may occur regardless of whether the current account is in surplus or deficit.