Era of Globalization Arose After

¶ … era of globalization arose after World War Two as a result of the Bretton Woods Conference. Since that point, nations have worked to lower trade barriers. The underlying principle is that by lower trade barriers growth with be stimulated. This in turn is based on the concept of comparative advantage, wherein if nations pursue their relative specialties the cost of all goods will decrease and the production of goods will increase on aggregate.

Since Bretton Woods, trade barriers have been gradually reduced. However, the flows of different types of capital have not been reduced equally. For example, while goods can travel freely across the U.S.-Mexico border, human capital cannot, which has led to the current immigration "problem." The good that has the most freedom to move is financial capital. The different degrees of flow of different types of capital have contributed to the current global economic crisis.

The reduction of trade barriers has led to sharp increases in global trade. Goods from China, previously subject to a myriad of duties and tariffs, now travel with only limited restrictions to the American market. China is a low cost producer, aided in part to government interference in the dollar-yuan exchange rate. This gives China a comparative advantage in a wide number of goods. The result is that the United States built up a substantial deficit in its trade with China (Roach, 2006). The same situation has occurred with a number of other different countries as well. As trade barriers have fallen, the U.S. trade deficit has increased.

One of the outcomes of this deficit is that other countries hold substantial reserves of U.S. dollars. These countries -- their governments and their banks -- have therefore had a need for dollar denominated securities in which to invest. As treasury securities became increasingly scarce throughout the past decade, these foreign investors moved to the next best thing. In this case, that appeared to be AAA-rated mortgage-backed securities. As a result, foreign investors became exposed to risk in the domestic U.S. housing market. When that market collapsed -- the securities were far from having genuine AAA strength -- a wide number of foreign institutions lost money.

Under normal circumstances, with minimal international capital flows, U.S. banks would have borne the full impact of the MBS market. Foreign institutions would have had little ability to purchase these securities. Indeed, they have been forced to sell their excess dollars, reducing their nation's currency exchange advantages, bringing global capital flows back towards equilibrium.

However, the international market for capital flows has been deregulated substantially over the past several years. The IMF cited a variety of recent initiatives for the rapid spread of the crisis around the world. These included not only the new structured investment products but the increasingly close links between the world's major banks. These links have been forged in an era where capital can flow around the world virtually unimpeded (Frank, 2008).

Banks in one country are able to invest their dollars rather than sell them. In this case, the investments were of poor quality. Compounding the issue is that other investments backed by U.S. institutions began to lose worth as the ability of those financial institutions to meet their obligations became compromised by subprime exposure. This is one of the main reasons why the government bailed out AIG. Banks around the world owned AIG-backed securities and if those securities were subject to default the global financial system could have collapsed.

The rise in international trade is intended to create more wealth more quickly that what has been achieved before. The international trade in goods has created substantial wealth transfers, resulting in countries around the world having significant exposure to the U.S. economy. Nations like China have essentially built their wealth on American credit. Increased exposure, however, results in increased risk. Freedom of trade does not inherently bring an increase in wealth; it brings an increase in volatility.

Thus, as global barriers to trade in goods and capital have fallen, volatility in the global economy has increased. During the Great Depression -- the best corollary we have to the current situation -- many nations recovered quickly relative to the United States. Some nations had other problems that hampered them -- Germany, for example -- but in general the spread of the crisis around the world was minor and short-lived. There was little impact outside of North America and Western Europe. Today's crisis is global in scope. No longer are regional crises confined to their home regions.