the dollar was restored as a dependable currency for trade and international finance. The persistence of higher inflation would have stunted globalization.15

Historically, global trade and finance have flourished when a single nation acts as their promoter and protector by providing an open market for goods, a stable world currency and a military umbrella for commerce. Before World War I, Britain played the part. After the war, it was too weak to do so again. Globalization's subsequent foundering in the 1920s and 1930s proves that it depends on more than technology. It also needs a political and economic framework. After World War II, the United States provided that leadership. This first phase of globalization—then simply called "free trade"—was seen as a way to prevent another Depression (protectionism abetted the 1930s collapse) and combat communism (prosperity in Europe and Japan would strengthen democracy). The strategy succeeded. From 1950 to 1970, world trade grew roughly by a factor of five. Tariffs dropped dramatically. Before the war, U.S. tariffs averaged about 50 percent; now they're less than 5 percent. But this initial globalization need not have continued. By the late 1970s, rampaging inflation had weakened the U.S. economy and eroded American leadership. We can never know exactly what would have occurred if the erosion had continued, but we can speculate.16

Imagine what would have happened in the 1980s if America had remained plagued by stubborn inflation, frequent recessions and meager income gains. Even if the Soviet Union had collapsed (not a certainty), the United States wouldn't have been a good advertise ment for capitalism. America would have seemed an ailing giant. Indeed, a burgeoning scholarly and popular literature had already reached that conclusion. In The Rise and Fall of the Great Powers (1987),Yale historian Paul Kennedy made the argument by comparing the United States to other lapsed superpowers, particularly the Hapsburg and British empires. In Trading Places (1988), Clyde Prestowitz—an expert on Japan—argued that Japan had already overtaken the United States. It had higher savings rates and seemed to have assumed leadership in many critical industries (electronics, steel, autos). "[T]he American Century is over," Prestowitz wrote in the book's 1989 paperback edition, and "the trading of places by Japan and the United States ... has become a fait accompli."17

We forget how prevalent those views were. At home and abroad, the United States was portrayed as lagging in technology, living standards and economic growth. Only in the late 1980s and early 1990s, just as the Soviet Union collapsed, did it become clear that these widespread criticisms did not fit the evidence. People could see that America's economic vitality had been prematurely and erroneously discounted. The United States continued to be a hotbed of entrepreneurial enthusiasm. New companies (Wal-Mart, Microsoft, Apple Computer) thrived. And by standard economic indicators, the United States performed as well as or better than its main rivals, and the gap would widen. From 1992 to 2000, U.S. economic growth averaged 3.7 percent annually compared with 1.8 percent for Germany and 1.2 percent for Japan.18

Falling inflation also promoted globalization through the dollar. The world economy, like all successful economic systems, requires reliable money. For centuries, gold and silver coins served this role. In the late nineteenth century, the British pound—readily convertible into gold—also provided global money. After World War II, the dollar did. No other large country had a trusted currency, and gold was too scarce and unevenly distributed (in the late 1940s, the United States had 70 percent of the world supply) to restart the gold standard. It's not just the United States that uses dollars. More than half of Japan's exports are still priced in dollars, as are about 70 percent of its imports. For South Korea and Thailand, four-fifths of exports and imports involve dollars. Even for France and Germany—where the euro dominates—a third of exports are priced in dollars. But continuation of the dollar's central role was not inevitable. Recall why confidence in the currency ebbed in the late 1970s: Inflation cut its purchasing power; U.S. interest rates remained near or below inflation; U.S. stock prices lagged inflation. Why use unstable dollars for trade? Why hold them as a reserve or store of value?19

By reviving confidence in the dollar, Volcker and Reagan unconsciously transformed the global trading system. From 1980 to 1985, the dollar rose 62 percent against the deutsche mark, 5 percent against the yen and 112 percent against the French franc (France was having inflation problems of its own). The "strong" dollar thrust America's trade balances into a rising and almost continuous deficit— creating in the process a huge export subsidy for other countries to embrace globalization. At these levels, the dollar encouraged U.S. imports and discouraged U.S. exports. Although the dollar's value fluctuated in later years, the basic changes endured for about two decades. The dollar stayed strong, and large U.S. trade deficits per sisted. In 1980, U.S. trade was virtually balanced. By 1987, the deficit was $145 billion, or 3 percent of GDP. By 2005, it was $717 billion, or nearly 6 percent of GDP.*20

Though overlooked, this change powerfully promoted globalization. Because exports create jobs—a popular objective—the stronger dollar represented a bonanza for other countries. It improved the competitiveness of their exports, spurred economic growth and reduced the threat of imports, particularly American imports, to local jobs. As a result, it became easier for countries to endorse expanded trade even if that meant reducing their own trade barriers. From the jobs perspective, the game seemed fixed in their favor. As long as Americans didn't respond by adopting protectionist measures, the arrangement would encourage both trade and trade liberalization. That's generally what happened.t Americans toler

* A popular, but mistaken, view in the 1980s held that the trade deficits resulted from Reagan's budget deficits. Higher U.S. interest rates— allegedly caused by the budget deficits—attracted foreign money into the United States, lifting the dollar's exchange rate as foreigners sold their currencies and bought dollars. Later events discredited this theory. In the late 1990s, despite U.S. budget surpluses, the trade deficits widened. Foreign money flowed into the United States in the 1980s and 1990s because foreigners found American investments attractive. As for U.S. interest rates, a budget deficit or surplus is only one influence on them. Others include inflation, the stage of the business cycle, the supply and demand for credit, and investors' psychology.

t To be sure, there were contrary pressures. U.S. firms protested the high dollar in the early 1980s. The Reagan administration responded by persuading foreign exporters to adopt "voluntary" limits on auto, steel and machine-tool shipments. Later, the Reagan administration promoted a ated deficits, because a strong economy kept unemployment low and cheap imports satisfied consumers and helped restrain inflation. Global trade growth accelerated. Hurt by the U.S. recession, world exports grew only 11 percent from 1980 to 1985. From 1990 to 2000, they increased 85 percent.21

The restored dollar similarly transformed international finance by encouraging a breakdown of barriers to cross-border flows of money into stocks, bonds and bank loans. This was a fundamental change. In the late nineteenth century, large money flows between countries were common. But after World War II, most countries imposed capital controls—restrictions on inflows and outflows. Of course, capital flows never ceased completely. The Marshall Plan supplied Europe with $13.3 billion from 1948 to 1951 (todays value: more than $600 billion).* In general, the United States didn't impose capital controls, and dollars went abroad as foreign aid, military aid and the investments of U.S. multinationals. In the 1950s, these flows were regarded as essential to provide Europe and Japan with the dollars they needed to buy imports and rebuild war-torn industries. Other channels for global capital included the "Eurodollar" market—dollars held outside the United States. The Soviet Union started the market in 1954. The Soviets had earned dollars by selling gold, but they didn't want to deposit the dollars in the United States. So the dollars were deposited in London.22

depreciation of the dollar, notably at a September 1985 meeting of major countries at the Plaza hotel in New York. However, the dollar was already declining.

* It was named after the wartime army chief of staff and Truman's Secretary of State, General George C. Marshall.

Still, the strong prejudice against international capital flows was rooted in history. In the 1930s, capital movements aggravated the Great Depression. Investors had withdrawn bank deposits or sold securities, then converted paper currencies (say, British pounds or Austrian schillings) into gold that was shipped abroad. These outflows fed banking crises, as banks lost deposits and cut lending. After the war, these stinging memories discouraged free capital flows. Some countries accepted investments of multinational firms in factories or offices—so-called foreign direct investment (FDI)—because they created jobs. But FDI was a spotty exception to pervasive restrictions on cross-border money flows. In general, people saved and invested at home. Outside the United States, many countries' stock and bond markets were reserved for their citizens, and most people and companies couldn't easily move money abroad. If you were French, you saved in francs, which were invested in France.

No more. Capital controls have been widely dismanded (a major exception: China). In 1980, individuals and firms held $3.2 trillion worth of assets—stocks, bonds, bank deposits—outside their home countries, equal to about 27 percent of the world economy (global GDP). By 2003, that had increased to $47 trillion, equal to 130 percent of world GDP. In part, capital controls broke down because firms had greater needs to transfer funds across borders. But the strong dollar and mushrooming U.S. trade deficits were catalysts. Countries with large trade surpluses had to dispose of the excess dollars they earned. In Europe and Japan, the most appealing choice was often for dollars to be reinvested abroad, mostly in the United States. That would keep dollars off foreign exchange markets and mean that their own currencies remained undervalued for trade.

Governments in some countries (Japan, China) deliberately reinvested dollars in U.S. Treasury securities; other governments recycled dollars by allowing private investors (individuals, banks, insurance companies) to invest them abroad. Exporters earned dollars; investors bought them on foreign exchange markets and sent most of them to the United States.23

In these decades, the United States received a flood tide of foreign funds to acquire U.S. stocks, bonds, real estate and entire companies. This made it harder for other countries not to relax their controls: If Japanese could invest in America, why couldn't Americans invest in Japan? There were other pressures. Developing countries increasingly sought foreign investment, especially FDI in factories. Dismantling controls was tedious and technical. The changes occurred slowly, but the cumulative effect was massive. One survey of 10 advanced and 24 "middle income" countries (including Brazil, Singapore and Indonesia) found that 8 of the advanced countries and 19 of the middle-income countries significantly reduced controls from 1973 to 1996. In 1986, the European Union adopted the Single European Act, which committed members to removing controls by June 1990. From 1980 to 1990, annual FDI flows to developing countries went from $6 billion to $135 billion. As late as 1987, no private company from a developing country had sold bonds on international markets. In 2003, they floated almost $14 billion.24

So globalization did not result just from better technology and the end of the Cold War. Having a trustworthy global currency was also crucial. It promoted trade, cross-border money flows and confidence. In effect, the United States provided a service to the world in the form of global money, and the dollar's high exchange rate (re-

fleeting demand for the currency) enabled other countries to pay for the service. They sent us goods; we sent them dollars. That largely explained the huge U.S. trade deficits. If you try to visualize a hypothetical and alternate history—one with continued U.S. inflation and economic instability—the whole structure of global trade and finance would have evolved differently and more slowly. Higher inflation would have meant a weaker economy and depreciating dollar. American exports might have increased and imports diminished. But this would have reduced other countries' exports and dulled their appetite for trade. Instead of attracting huge foreign investments, the United States might have experienced outflows. Then, the government might have restricted how many dollars U.S. citizens and companies could take abroad. "If the dollar had continued to fall—as it had in the Carter years—we would have used capital controls to bottle up the pressures," said economist Barry Eichengreen of the University of California at Berkeley.* Other countries might have erected new controls.25

What kind of globalization would have resulted with an inflationary and wobbling United States is impossible to say. But trade and finance might have become politicized and regionalized, as

* The aim would have been to limit dollar sales on foreign exchange markets. In the 1960s, President Johnson restricted what U.S. banks and multinational firms could invest abroad in an effort to limit foreign government demand for gold at $35 an ounce. These controls, largely ineffective, were rescinded in the early 1970s after the dollar was devalued. In 1964, Congress also imposed an "interest equalization tax" on foreign bonds that paid higher rates than U.S. bonds. It aimed to deter purchases of foreign bonds and was ultimately repealed.

occurred in the 1930s. Most countries then faced a dilemma: Not being self-sufficient, they had to trade, but they feared that trade would aggravate unemployment. To resolve the dilemma, countries retreated into preferential trade blocs that provided essential imports while limiting other imports. To some extent, the strong dominated the weak. By the spring of 1938, Germany had bilateral trade agreements with twenty-five countries, including many of its close neighbors. These agreements often compelled its trading partners to accept terms generous to Germany (high prices for Germany's exports, low prices for their own exports). England favored trade with its empire and discriminated against others. A weak dollar and America might have similarly caused the world to splinter into regional blocs. But none of this happened. Instead, global capitalism spread, and American companies and workers now compete in a world in which technology, labor and capital are highly mobile. The pressures to maximize profits and minimize costs now play out on a global stage.26

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