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This whole conversation of yours, gentlemen, seems rather silly.

Trade deficits don't cause currency devaluations, and vice versa. Rather, both figures reflect a complex interplay of economic funadmentals.

Basic trade theory tells us that a shift in economic fundamentals that will push up a country's trade deficit (for instance, a decreased domestic savings rate) will also, other things equal, tend to push down a country's currency. Why? Well, it's very simple. Whatever is causing the trade deficit is causing an increase in demand for imports relative to exports and domestic goods. This in turn increases demand for the foreign currency relative to domestic currency, since imports ultimately have to be paid for in foriegn currency.

So yes, other things equal, shifts in the trade ballance will usually be accompanied by shifts in the exchange rate. But it's not a causal link. The same thing that causes a change in the trade deficit tends to effect the exchange rate.

You also have to remember that there are many, many variables that determine the exchange rate. A simple two-variable graph like the one posted doesn't tell you anything, because it neglects all these other factors, like monatary policy, which will tend to confound your inferences.

Actually since the transition from fixed exchange rates to floating exchange rates there is no such thing as a trade deficit. Under the fixed exchange rate regime, everything being equal, a trade deficit would mean the flow of specie out of the country which would lower the money supply and cause economic activity to be reduced, a deflation would result, this would then lower prices which in turn would reduce imports and spur exports. Removing the dollar from gold convertibility cut that link and means of regaining equilibrium.

The ratio between imports and exports being changed routinely resulted in devaluations and revaluations because of the specie/gold flows to accomodate the deficits or surpluses. A deficit would lead to more dollars in the hands of foreigners than they wanted who would then demand gold and outflows would result. These outflows would cause a devaluation everything else being equal.

Your statement about the complex interplay of many factors is just a truism. Economic analysis requires attempting to isolate one variable at a time. Hence discussions of trade effects does not mean one should try and throw in the impact of tax policy or monetary policy at the same time. Their impacts can be determined later.

Econometic methods take one variable at a time to estimate an equation for testing.

Pardon me, but I got curious about what you are terming, a "causal link" since you said this:

Whatever is causing the trade deficit is causing an increase in demand for imports relative to exports and domestic goods. This in turn increases demand for the foreign currency relative to domestic currency, since imports ultimately have to be paid for in foriegn currency. So yes, other things equal, shifts in the trade ballance will usually be accompanied by shifts in the exchange rate. But it's not a causal link. The same thing that causes a change in the trade deficit tends to effect the exchange rate.

Wouldn't you call this an indirect causation nonetheless, rather than a mere sympathetic indicator?