Here's why we got to where we are. Since the late 1980s, the world has been moving toward a extraordinary degree of political stability. The end of the Cold War has ushered in a period with no major military competition among the world's great powers—something virtually unprecedented in modern history. It has meant the winding down of most of the proxy and civil wars, insurgencies and guerrilla actions that dotted the Cold War landscape. Even given the bloodshed in places like Iraq, Afghanistan and Somalia, the number of people dying as a result of political violence of any kind has dropped steeply over the past three decades.
Then there is the end of inflation. In the 1970s, dozens of countries suffered hyperinflation, which destroyed the middle class, destabilized societies and led to political upheaval. Since then, central banks have become very good at taming the monster, and by 2007 the number of countries with high inflation had dwindled to a handful. Only one, Zimbabwe, had hyperinflation.
Add to this the information and Internet revolutions, and you have a series of historical changes that have produced a single global system, far more integrated and faster-moving than ever before. The results speak for themselves. Over the past quarter century, the global economy has doubled every 10 years, going from $31 trillion in 1999 to $62 trillion in 2008. Recessions have become tamer than ever before, averaging eight months rather than two years. More than 400 million people across Asia have been lifted out of poverty. Between 2003 and 2007, average income worldwide grew at a faster rate (3.1 percent) than in any previous period in recorded human history. In 2006 and 2007—the peak years of the boom—124 countries around the world grew at 4 percent a year or more, about four times as many as 25 years earlier.
Many of these countries had more cash than they knew what to do with. China sits on a war chest of more than $2 trillion, while eight other emerging-market nations have reserves of more than $100 billion. They've all looked to the safest investment they could imagine—U.S. government debt. In buying so much debt, they drove down the interest rate Washington had to offer, which in turn made credit in America cheap. So the effect of all this money sloshing around the world was to subsidize Americans in their favorite activity: shopping. But it affected other Western countries as well, from Spain to Ireland, where consumers and governments loaded themselves up with debt.
Good times always make people complacent. As the cost of capital sank over the past few years, people became increasingly foolish. The world economy had become the equivalent of a race car—faster and more complex than any vehicle anyone had ever seen. But it turned out that no one had driven a car like this before, and no one really knew how. So it crashed.
The real problem is that we're still driving this car. The global economy remains highly complex, interconnected and im-balanced. The Chinese still pile up surpluses and need to put them somewhere. Washington and Beijing will have to work hard to slowly stabilize their mutual dependence so that the system is not being set up for another crash.