While the improving U.S. economy remains the engine of growth for the world economy, an underlying trend involving "huge imbalances and risks" should be cause for serious alarm, Paul Volcker warned Feb. 11 during a speech on campus. Americans have virtually no savings, the former chairman of the Federal Reserve said, and the nation is consuming more than it is producing. Furthermore, Social Security and Medicare are threatened by the retirement of millions of baby boomers and skyrocketing health care costs. More broadly, he continued, the world economy is lopsided.

"Altogether, the circumstances seem as dangerous and intractable as I can remember," Volcker said during a keynote address at the second annual summit of the Stanford Institute for Economic Policy Research. "But no one is willing to understand [this] and do anything about it."

Volcker spoke at the end of a daylong conference that attracted about 450 corporate leaders, entrepreneurs, policymakers and academics. The event included discussions on the stability of the global economy, the U.S. economic outlook and the role of the Internet in helping to level the competitive playing field worldwide. The conference also featured sessions on outsourcing, Medicaid and Medicare, technology policy and the Sarbanes-Oxley Act, which was implemented in 2002 to restore investor confidence in corporate America following a series of bankruptcies and far-reaching accounting scandals.

During a morning session, William J. Perry, a former secretary of defense and a senior fellow at the Stanford Institute for International Studies, gave a chillingly stark assessment of the crisis of terrorism that was reinforced by George Shultz, a former secretary of state.

"I fear that we're headed toward an unprecedented catastrophe where a nuclear bomb is detonated in an American city," Perry said. "The bomb will not come in a missile at the hands of a hostile nation. It will come in a truck or a freighter at the hands of a terror group."

Perry, who holds the Michael and Barbara Berberian Professorship, said the "awesome military capability" of the United States has had unintended consequences in that it has increased the incentive for a hostile power, unable to compete in conventional warfare, to acquire weapons of mass destruction and launch terror attacks against America. U.S. military superiority is not particularly effective against such tactics, he said. "There exist terror groups, of which al Qaeda is the most prominent, that have the mission, the intent to kill Americans," Perry said. "They have the capability to do so; they have the resources to do so." A truly nightmare scenario would involve a terror group using nuclear weapons acquired clandestinely, he said: "After 9/11 that threat seems all too real."

Such a catastrophe is preventable, but the United States is not taking the necessary measures to avert it, Perry warned. Important steps should include a major expansion of the Nunn-Lugar Cooperative Threat Reduction Program with the support the G-8 group of industrialized nations. The program was created in 1991 to reduce the threat posed by the legacy of the Soviet nuclear arsenal and succeeded in dismantling and destroying weapons in Kazakhstan, Ukraine and Belarus. Furthermore, Perry said, a clear strategy of "coercive diplomacy" should be used against North Korea and Iran, followed by a major diplomatic initiative to convince other nuclear powers that the threats posed by terrorists are real and not just directed at Americans. "While America must show real leadership in dealing with this problem, [it] cannot deal with it alone," he said.

Shultz, the Thomas W. and Susan B. Ford Distinguished Fellow at the Hoover Institution, said the United States faces a huge problem in combating Islamic radicals intent on using terror to achieve their goals. "Eventually, what they want is to change the way the world works by creating a unified Islamic theocratic state," he said. "It's a worldwide agenda."

Shultz argued that the United States must help supporters of mainstream Islam understand the fundamental nature of the problem so they will take action against the radicals themselves.

"That's why Iraq is of such overwhelming importance," he said. "Here we have a country in the heart of the Middle East where there is a chance. If Iraq can emerge as a sensibly governed country--that's a gigantic event in the Middle East and in this war on terror. Our enemies recognize that just as well as we do, and that's why we're having so many problems."

Other measures that Shultz said should receive greater support include efforts to set up independent media in countries such as Iraq, as well as a revival and expansion of the U.S. diplomatic service, which he said was allowed to atrophy after the end of the Cold War. "We have developed an awesome military capability," he said. "We need a diplomatic capability that is as every bit as good." Shultz also stressed the need to reduce U.S. dependence on foreign oil. "We are out of our cotton-picking minds not to be doing much, much more to figure out how to use much, much less oil," he said to applause from the audience.

In the afternoon, Thomas Friedman, a columnist at the New York Times, also called for greater efforts to develop alternative energy supplies. This should be the "moon shot of our generation," he said.

Friedman discussed how the convergence of personal computers, cheap telecommunication and workflow software has changed the way the world works. In his upcoming book, The World Is Flat: A Brief History of the 21st Century, Friedman explained that the world has shrunk to the point where individuals, not countries or companies, are increasingly able to think and act globally. "And it's not just a bunch of white Westerners," he said. "It's going to be driven by individuals of every color of the rainbow."

Friedman told the audience that these technological advances quietly unfolded just as the 9/11 terror attacks, the Enron collapse and the dot-com bust grabbed America's attention. "People thought globalization was over but actually it turbo-charged globalization; it drove it overseas," he said. "9/11 completely distracted our administration, and then there was Enron. We have hit a fundamentally transformative moment and no one is talking."

In this new scenario, people anywhere in the world will be able to "innovate and not emigrate" if they have the required skills, Friedman said. This means that engineers in India and China will be able to compete on a level playing field with people in this country. "When the world goes flat, everything changes," he said.

To address this challenge, Friedman said the United States must radically improve science, mathematics and engineering education and encourage young people to enter these fields. "We're not doing that," he said. "In the next two years, five years, it won't matter. In 15 years, which is the time it takes to build an engineer, it will matter. We will not be able to sustain our standard of living."

Earlier this month, the so-called EU Three--Britain, France and Germany-- achieved an important victory for global security, convincing Iran to suspend its uranium enrichment and plutonium reprocessing activities pending further negotiation on its nuclear question. Though Iran claims that it does not desire a nuclear bomb, the West has long been skeptical of the oil-rich state's contention that it seeks a nuclear fuel cycle for energy purposes alone. Europe and the United States (and of course Israel) will sleep better knowing that Tehran is not pursuing enrichment activities, whatever their alleged purpose.

But the EU3 agreement, which fails to discuss consequences for Iran if it breaks the deal, is vulnerable to being undermined not only by Iran but also by the United States; both have already raised eyebrows in the wake of the accord. Iran raced to produce uranium hexafluoride, a gas that can be enriched into bomb fuel, before it began to observe the temporary suspension on Monday. And both President George W. Bush and outgoing Secretary of State Colin Powell have publicly aired their suspicions that Iran will continue its drive for nuclear weapons under cover of the deal.

At the moment, administration hawks are pressing to confront the mullahs at the United Nations Security Council, where economic sanctions could be considered; calls for using force and for regime change are likely to follow.

Military action is inadvisable at this point, because of a dearth of solid intelligence and the secretive, geographically diffuse nature of Iran's nuclear sites. If the issue reaches the Security Council with the United States and Europe continuing along divergent paths, the inevitable deadlock will deal a severe and lasting blow to international security. Therefore, the agreement must be fortified to keep the Iranians honest, the Europeans effectively engaged and the U.S. hawks bridled.

This can be achieved through a U.S.-European accord laying out trigger mechanisms for specified consequences if Iran violates certain benchmarks. For example, if Iran fails to allow inspectors the access accorded by the Nuclear Nonproliferation Treaty's additional protocol--which Iran is provisionally observing pending ratification--or resumes enrichment and centrifuge-building activities, it could face severe economic sanctions, censure by the Security Council (necessitating cooperation from Russia and China), or in the event of hostility, a forceful response.

We don't know yet whether Tehran will play by the rules. The regime has mastered the art of behaving badly and then seeking rewards for getting back into line. To date, the Europeans have played into its hands, offering carrots for compliance without wielding sticks to punish violations.

Therefore, the Bush administration's apparent comfort with a military option can serve as an important deterrent against Iranian cheating, arming the EU3 agreement with teeth that it would not otherwise have. Iran desires economic incentives but does not yet desperately need them; without a credible threat of U.S.-backed sanctions imposed by the international community, the mullahs can simply decide one day that the restrictions have ceased to be worth their while, and break any deal as though it were merely a business contract.

For the United States, accepting the EU3's carrot-based approach (provided the benchmarks are added) will show the world that it still supports negotiated diplomacy and multilateralism, even in cases where military threats loom. Participating in this framework will also send a message to Iran that the United States is not ruling out renewed relations. This would resonate with the largely pro-American Iranian populace, who despise their regime and are seeking inroads to break free of it.

But if the United States instead presents itself as a unilateralist maverick, it will hinder its own interests; the only thing Iranians disdain more than the mullahs is outside meddling with their deeply nationalistic desire for self-determination. The more overtly hostile the United States acts toward Iran, the more the mullahs are able to spin America's posture to alienate Iranians against the "Great Satan."

The way to keep the Iranian regime in check while speeding its demise is to insure the nuclear agreement through benchmarks and triggers, and then give the mullahs exactly what they ask for in terms of increased access to international institutions like the World Trade Organization.

Such carrots can also be Trojan Horses, allowing the forces of democratic reform within Iran to blossom by enabling pro-democracy elements to make global connections. The U.S. and Europe should saddle up those horses together.