Economic instability

The decisive event in the collapse of the integrated economy of the late 19th and early 20th

centuries was the Great Depression in the United States and the financial and exchange rate

crises that rolled across the world in the 1930s.

In developing countries, financial and exchange rate crises have come with depressing frequency over the past two decades. Substantial financial and exchange rate crises also erupted among the other advanced economies in the 1980s and early 1990s. Japan is still struggling with the aftermath of its bubble economy, while the United States has also suffered a huge stock market bubble, which reached its maximum extent in 2000.

All these are signs of significant financial instability. Yet it is almost impossible to

believe that the outcome will be another 1930s. The move to floating rates has significantly reduced the risk of such crises.

The strangest and most disturbing feature of the world economy—its dependence for

macroeconomic stability on explosive rises in US current account deficits. Being the world’s borrower of last resort and the world’s most creditworthy debtor and the issuer of the world’s most trusted currency, of course, it is better placed to play this role than any other country. But there is a risk that the rest of the world may decide that its holdings of dollar claims are excessive and, too vulnerable to the depreciation that must occur if the US current account deficit is to fall sharply as a share of GDP and the odds increase with each passing year, thus the world can face the collapse of the integrated economy.