Unformatted text preview: FIRST ANCHOR BOOKS EDITION, APRIL 2000
[email protected], 2000 by Thomas L. Friedman
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Published in the United States by Anchor Books, a division of Random House, Inc., New
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Copyright @2000 The Economist Newspaper Group, Inc. Reprinted by permission.
Further reproduction prohibited. . Excerpt from the musical Ragtime,
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Inc. Reprinted by permission. Library of Congress Cataloging-in-Publication Data
Friedman, Thomas L. The Lexus and the olive tree / by Thomas L. Friedman -1st Anchor
Books ed. p. cm.
Originally published: New York: Farrar, Straus Giroux, @ 1999.
Includes bibliographical references and index. ISBN 0-385-49934-5
International economic relations. 2. Free trade. 3. Capitalism-Social aspects. 4.
Technological innovations--Economic aspects. 5. Technological innovations--Social
aspects. 6. Intercultural communication. 7. United States-Foreign economic relations.
8. Globalization I. Title.
Book design by Bob Bull Printed in Canada 10 9 8 7 6 5 4 3 2 1
THOMAS L. FRIEDMAN
The Lexus and the Olive Tree
Thomas L. Friedman is one of America's leading interpreters of world affairs. Born in
Minneapolis in 1953, he was educated at Brandeis University and St. Anthony's College,
Oxford. His first book, From Beirut to Jerusalem, won the National Book Award in 1988.
Mr. Friedman has also won two Pulitzer Prizes for his reporting for The New York Times
as bureau chief in Beirut and in Jerusalem. He lives in Bethesda, Maryland, with his wife,
Ann, and their daughters, Orly and Natalie.
Foreword to the Anchor Edition ix
Opening Scene: The World Is Ten Years Old xi
Part One: Seeing the System
1. The New System 3
2. Information Arbitrage 17
3. The Lexus and the Olive Tree 29
4. …And the Walls Came Tumbling Down 44
5. Microchip Immune Deficiency 73
6. The Golden Straitjacket 101
7. The Electronic Herd 112
Part Two: Plugging into the System
8. DOScapital 6.0 145
9. Globalution 167
10. Shapers, Adapters and Other New Ways of Thinking About Power 194
11. Buy Taiwan, Hold Italy, Sell France 212 12. The Golden Arches Theory of Conflict Prevention 248
13. Demolition Man 276
14. Winners Take All 306
Part Three: The Backlash Against the System
15. The Backlash 327
16. The Groundswell 348
Part Four: America and the System
17. Rational Exuberance 367
18. Revolution Is U.S. 379
19. If You Want to Speak to a Human Being, Press 1 406
20. There Is a Way Forward 434
Foreword to the Anchor Edition
Welcome to the paperback edition of The Lexus and the Olive Tree. Readers of the
original hardback version of the book will notice that several things have changed in this
new version. But what has not changed is the core thesis of this book: that globalization
is not simply a trend or a fad but is, rather, an international system. It is the system that
has now replaced the old Cold War system, and, like that Cold War system, globalization
has its own rules and logic that today directly or indirectly influence the politics,
environment, geopolitics and economics of virtually every country in the world.
So what has changed? I have reorganized the early chapters to make my core thesis a
little easier for the reader to identify and digest, and I have used the year since the book
was originally published in April 1999 to gather more evidence and to update and expand
the book with all the technological and market innovations that are enhancing globalization even further. I have also re-examined some of the more controversial subtheses
of this book. One is my Golden Arches Theory-that no two countries that both
have McDonald's have ever fought a war against each other since they each got their
McDonald's. I feel the underlying logic of that theory is stronger than ever, and I have
responded to those who have challenged it in the wake of the Kosovo war. Another
change is that the chapter originally entitled "Buy Taiwan, Hold Italy, Sell France" is
now broken into two parts. The new chapter, called "Shapers, Adapters and Other New
Ways of Thinking About Power," builds on a question I raised in the first edition: if
economic power in the globalization system was first based on PCs per household in a
country, and then on degree of Internet bandwidth per person in a country, what comes
next? This chapter tries to answer that question by looking at evolving new ways of
measuring economic power in the globalization era. Finally, I have tried to answer some
of the most oft-asked questions I got from readers of the first edition: "Now that you have
described this new system, how do I prepare my kids for it?" and "Is God in
cyberspace?"-which is another way of saying, "Where do moral values fit in?"
The new world order is evolving so fast that sometimes I wish this were an electronic
book that I could just update every day. My more realistic hope is that when the day
comes years from now when this book can no longer reside on the Current Affairs shelf
in bookstores, it will find a comfortable home in the History section - remembered among
the books that caught the start, and helped to first define, the new system of globalization
that is now upon us.
Thomas L. Friedman Bethesda, Md.
Opening Scene: The World Is Ten Years Old
It's aggravating - we have nothing to do with Russia or Asia. We're just a little domestic business trying to grow, but we're being prevented because of the way those
governments run their countries.
- Douglas Hanson, CEO of Rocky Mountain Internet, Inc., speaking to The Wall Street
Journal after the 1998 market meltdown forced him to postpone a $175 million junk
On the morning of December 8,1997, the government of Thailand announced that it was
closing 56 of the country's 58 top finance houses. Almost overnight, these private banks
had been bankrupted by the crash of the Thai currency, the baht. The finance houses had
borrowed heavily in U.S. dollars and lent those dollars out to Thai businesses for the
building of hotels, office blocks, luxury apartments and factories. The finance houses all
thought they were safe because the Thai government was committed to keeping the Thai
baht at a fixed rate against the dollar. But when the government failed to do so, in the
wake of massive global speculation against the baht-triggered by a dawning awareness
that the Thai economy was not as strong as previously believed the Thai currency
plummeted by 30 percent. This meant that businesses that had borrowed dollars had to
come up with roughly one-third more Thai baht to pay back each $1 of loans. Many
businesses couldn't pay the finance houses back, many finance houses couldn't repay their
foreign lenders and the whole system went into gridlock, putting 20,000 white-collar
employees out of work. The next day, I happened to be driving to an appointment in
Bangkok down Asoke Street, Thailand's equivalent of Wall Street, where most of the
bankrupt finance houses were located. As we slowly passed each one of these fallen firms,
my cabdriver pointed them out, pronouncing at each one: "Dead! . . . dead! . . . dead! . . .
dead! . . . dead!"
I did not know it at the time - no one did - but these Thai investment houses were the first
dominoes in what would prove to be the first global financial crisis of the new era of globalization - the era that followed the Cold War. The Thai crisis triggered a general
flight of capital out of virtually all the Southeast Asian emerging markets, driving down
the value of currencies in South Korea, Malaysia and Indonesia. Both global and local
investors started scrutinizing these economies more closely, found them wanting, and
either moved their cash out to safer havens or demanded higher interest rates to
compensate for the higher risk. It wasn't long before one of the most popular sweatshirts
around Bangkok was emblazoned with the words "Former Rich."
Within a few months, the Southeast Asian recession began to have an effect on
commodity prices around the world. Asia had been an important engine for worldwide
economic growth-an engine that consumed huge amounts of raw materials. When that
engine started to sputter, the prices of gold, copper, aluminum and, most important, crude
oil all started to fall. This fall in worldwide commodity prices turned out to be the
mechanism for transmitting the Southeast Asian crisis to Russia. Russia at the time was
minding its own business, trying, with the help of the IMF, to climb out of its own selfmade
economic morass onto a stable growth track. The problem with Russia, though, was
that too many of its factories couldn't make anything of value. In fact, much of what they
made was considered "negative value added." That is, a tractor made by a Russian factory
was so bad it was actually worth more as scrap metal, or just raw iron ore, than it was as a
finished, Russian-made tractor. On top of it all, those Russian factories that were making
products that could be sold abroad were paying few, if any, taxes to the government, so
the Kremlin was chronically short of cash.
Without much of an economy to rely on for revenues, the Russian government had
become heavily dependent on taxes from crude oil and other commodity exports to fund
its operating budget. It had also become dependent on foreign borrowers, whose money
Russia lured by offering ridiculous rates of interest on various Russian governmentissued bonds.
As Russia's economy continued to slide in early 1998, the Russians had to raise the
interest rate on their ruble bonds from 20 to 50 to 70 percent to keep attracting the
foreigners. The hedge funds and foreign banks kept buying them, figuring that even if the
Russian government couldn't pay them back, the IMF would step in, bailout Russia and
the foreigners would get their money back. Some hedge funds and foreign banks not only
continued to put their own money into Russia, but they went out and borrowed even more
money, at 5 percent, and then bought Russian T-bills with it that paid 20 or 30 percent.
As Grandma would say, "Such a deal!" But as Grandma would also say, "If it sounds too
good to be true, it usually is!"
And it was. The Asian triggered slump in oil prices made it harder and harder for the
Russian government to pay the interest and principal on its T-bills. And with the IMF
under pressure to make loans to rescue Thailand, Korea and Indonesia, it resisted any
proposals for putting more cash into Russia - unless the Russians first fulfilled their
promises to reform their economy, starting with getting their biggest businesses and
banks to pay some taxes. On August 17, 1998, the Russian economic house of cards came
tumbling down, dealing the markets a double whammy: Russia both devalued and
unilaterally defaulted on its government bonds, without giving any warning to its
creditors or arranging any workout agreement. The hedge funds, banks and investment
banks that were invested in Russia began piling up massive losses, and those that had
borrowed money to magnify their bets in the Kremlin casino were threatened with
On the face of it, the collapse of the Russian economy should not have had much impact
on the global system. Russia's economy was smaller than that of the Netherlands. But the
system was now more global than ever, and just as crude oil prices were the transmission mechanism from Southeast Asia to Russia, the hedge funds-the huge unregulated pools of
private capital that scour the globe for the best investments - were the transmission
mechanism from Russia to all the other emerging markets in the world, particularly
Brazil. The hedge funds and other trading firms, having racked up huge losses in Russia,
some of which were magnified fifty times by using borrowed money, suddenly had to
raise cash to pay back their bankers. They had to sell anything that was liquid. So they
started selling assets in financially sound countries to compensate for their losses in bad
ones. Brazil, for instance, which had been doing a lot of the right things in the eyes of the
global markets and the IMF, suddenly saw all its stocks and bonds being sold by panicky
investors. Brazil had to raise its interest rates as high as 40 percent to try to hold capital
inside the country. Variations on this scenario were played out throughout the world's
emerging markets, as investors fled for safety. They cashed in their Brazilian, Korean,
Egyptian, Israeli and Mexican bonds and stocks, and put the money either under their
mattresses or into the safest U.S. bonds they could find. So the declines in Brazil and the
other emerging markets became the transmission mechanism that triggered a herdlike
stampede into U.S. Treasury bonds. This, in turn, sharply drove up the value of U.S. Tbonds,
drove down the interest that the U.S. government had to offer on them to attract
investors and increased the spread between U.S. T-bonds and other corporate and
emerging market bonds.
The steep drop in the yield on U.S. Treasury bonds was then the transmission mechanism
which crippled more hedge funds and investment banks. Take for instance Long-Term
Capital Management, based in Greenwich, Connecticut. LTCM was the Mother of All
Because so many hedge funds were attracted to the marketplace in the late 1980s, the
field became fiercely competitive. Everyone pounced on the same opportunities. In order to make money in such a fiercely competitive world, the hedge funds had to seek ever
more exotic bets with ever larger pools of cash. To guide them in placing the right bets,
LTCM drew on the work of two Nobel Prize - winning business economists, whose
research argued that the basic volatility of stocks and bonds could be estimated from how
they reacted in the past. Using computer models, and borrowing heavily from different
banks, LTCM put $120 billion at risk betting on the direction that certain key bonds
would take in the summer of 1998. It implicitly bet that the value of U.S. T-bonds would
go down, and that the value of junk bonds and emerging market bonds would go up.
LTCM's computer model, however, never anticipated something like the global
contagion that would be set off in August by Russia's collapse, and, as a result, its bets
turned out to be exactly wrong. When the whole investment world panicked at once and
decided to rush into U.S. T-bonds, their value soared instead of fell, and the value of junk
bonds and emerging market bonds collapsed instead of soared. LTCM was like a
wishbone that got pulled apart from both ends. It had to be bailed out by its bankers to
prevent it from engaging in a fire sale of all its stocks and bonds that could have triggered
a worldwide market meltdown.
Now we get to my street. In early August 1998, I happened to invest in my friend's new
Internet bank. The shares opened at $14.50 a share and soared to $27. I felt like a genius.
But then Russia defaulted and set all these dominoes in motion, and my friend's stock
went to $8. Why? Because his bank held a lot of home mortgages, and with the fall of
interest rates in America, triggered by the rush to buy T-bills, the markets feared that a lot
of people would suddenly payoff their home mortgages early. If a lot of people paid off
their home mortgages early, my friend's bank might not have the income stream that it
was counting on to pay depositors. The markets were actually wrong about my friend's
bank, and its stock bounced back nicely. Indeed, by early 1999 I was feeling like a genius again, as the Amazon.com Internet craze set in and drove my friend's Internet bank stock
sky high, as well as other technology shares. But, once again, it wasn't long before the
rest of the world crashed the party. Only this time, instead of Russia breaking down the
front door, it was Brazil's turn to upset U.S. markets and even dampen (temporarily) the
Internet stock boom.
As I watched all this play out, all I could think of was that it took nine months for the
events on Asoke Street to affect my street, and it took one week for events on the
Brazilian Amazon (Amazon.country) to affect Amazon.com. USA Today aptly summed
up the global marketplace at the end of 1998: 'The trouble spread to one continent after
another like a virus," the paper noted. "U.S. markets reacted instantaneously. . . People in
barbershops actually talked about the Thai baht."
It wasn't long, though, before Amazon.com started to soar again. pulling up all the
Internet stocks, which in turn helped pull up the whole U.S. stock market, which in turn
created a wealth effect in America, which in turn encouraged Americans to spend beyond
their savings, which in turn enabled Brazil, Thailand and other emerging markets to
export their way out of their latest troubles by selling to America. Amazon.com,
Amazon.country - we were all becoming one river.
If nothing else, the cycle from Asoke Street to my street, and from .Amazon.country to
Amazon.com and then back again to Amazon. country, served to educate all of us about
the state of the world today. The slow, fixed, divided Cold War system that had
dominated international affairs since 1945 had been firmly replaced by a new, very
greased, interconnected system called globalization. If we didn't fully understand that in
1989, when the Berlin Wall came down, we sure understood it a decade later. Indeed, on
October II, 1998, at the height of the global economic crisis, Merrill Lynch ran full-page
ads in major newspapers throughout America to drive this point home. The ads read: The World Is 10 Years Old. It was born when the Wall fell in 1989.
It's no surprise that the world's youngest economy - the global economy - is still finding
its bearings. The intricate checks and balances that stabilize economies are only
incorporated with time. Many world markets are only recently freed, governed for the
first time by the emotions of the people rather than the fists of the state. From where we
sit, none of this diminishes the promise offered a decade ago by the demise of the walledoff
world. The spread of free markets and democracy around the world is permitting
more people everywhere to turn their aspirations into achievements. And technology,
properly harnessed and liberally distributed, has the power to erase not just geographical
borders but also human ones. It seems to us that, for a 10-year-old, the world continues to
hold great promise. In the meantime, no one ever said growing up was easy.
Actually, the Merrill Lynch ad would have been a little more correct to say that this era of
globalization is ten years old. Because from the mid-1800s to the late 1920s the world
experienced a similar era of globalization. If you compared the volumes of trade and
capital flows across borders, relative to GNPs, and the flow of labor across borders,
relative to populations, the period of globalization preceding World War I was quite
similar to the one we are living through today. Great Britain, which was then the
dominant global power, was a huge investor in emerging markets, and fat cats in England,
Europe and America were often buffeted by financial crises, triggered by something that
happened in Argentine railroad bonds, Latvian government bonds or German government
bonds. There were no currency controls, so no sooner was the trans-Atlantic cable
connected in 1866 than banking and financial crises in New York were quickly being
transmitted to London or Pa...
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