Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail

by Ray Dalio

To summarize, around the upward trend of productivity gains that produce rising wealth and better living standards, there are cycles that produce prosperous periods of building in which the country is fundamentally strong because there are relatively low levels of indebtedness, relatively small wealth, values, and political gaps, people working effectively together to produce prosperity, good education and infrastructure, strong and capable leadership, and a peaceful world order that is guided by one or more dominant world powers.

These are the prosperous and enjoyable periods. When they are taken to excess, which they always are, the excesses lead to depressing periods of destruction and restructuring in which the country’s fundamental weaknesses of high levels of indebtedness, large wealth, values, and political gaps, different factions of people unable to work well together, poor education and infrastructure, and the struggle to maintain an overextended empire under the challenge of emerging rivals lead to a painful period of fighting, destruction, and then a restructuring that establishes a new order, setting the stage for a new period of building.

Because these steps unfold in a logical sequence of timeless and universal cause/effect relationships, it is possible to create a health index of where a c...

Since all of these factors, both ascending and descending, tend to be mutually reinforcing, it is not a coincidence that large wealth gaps, debt crises, revolutions, wars, and changes in the world order have tended to come as a perfect storm.

The Big Cycle of an empire’s rise and decline looks like the following chart. The bad periods of destruction and restructuring via depression, revolution, and war, which largely tear down the old system and set the stage for the emergence of a new system, typically take about 10 to 20 years, though variations in the range can be much larger. They are depicted by the shaded areas.

They are followed by more extended periods of peace and prosperity in which smart people work harmoniously together and no country wants to fight the world power because it’s too strong. These peaceful periods last for about 40 t...

As previously explained, the last major period of destroying and restructuring happened in 1930–45, which led to the period of building and the new world order that began in 1945 with the creation a new global monetary system (built in 1944 in Bretton Woods, New Hampshire) and a US-dominated system of world governance (locating the United Nations in New York and the World Bank and the International Monetary Fund in Washington, DC).

The new world order was the natural consequence of the US being the richest country (it then had two-thirds of the world’s gold stock and gold was then money), the dominant economic power (it then accounted for about half of world production), and the strongest military (it then had a monopoly on nuclear weapons and the strongest conventional forces).

At the time of my writing, it is now 75 years later, and the major old empires, which are also the major reserve currency empires, are classically approaching the end of a long-term debt cycle when there are l...

Politically fragmented central governments have recently tried to fill in their financial holes by giving out a lot of money that they are borrowing, while central banks have tried to help by print...

All this is happening when there are big wealth and values gaps and a rising world power that is competing with the leading world power in trade, technology development, capital markets, and geopolitics. And on top of all ...

In the last chapter I described the Big Cycle in a tiny nutshell. In this and the other chapters that follow in Part I, I will flesh out how I see the perpetual-motion machine working. In this chapter, I will review the most important determinants and summarize how I put them into my “model.”

As the saying goes, and most people agree, “history rhymes.” It “rhymes” because its most important events repeat, though never in exactly the same way. That is because, while the cause/effect relationships behind those events are timeless and universal, all things evolve and influence each other in different ways.

By studying many analogous events in different times and places, their underlying causes and effects become clearer. I have learned that history’s continuously evolving story transpires like a perpetual-motion machine that is driven by c...

All peoples throughout history have had systems or orders for governing how they deal with each other. I call the systems within countries “internal orders,” those between countries “external orders,” and those that apply to the whole world “world orders.” These orders affect each other and are always changing. Such orders have always existed at every level—within families, companies, cities, states, and countries, as well as internationally. They determine who has what powers and how decisions are made, including how wealth and political control are divided.

The way I see it, at any moment in time there are both 1) the existing set of conditions that include the existing domestic and world orders and 2) timeless and universal forces that cause changes in these conditions.

Everything that has happened and everything that will happen has had and will have determinants that make it happen. If we can understand those determinants, we can understand how the machine works and anticipate what will likely be coming at us next.

Most people don’t see things that way. Most people believe the future is unknowable and that destiny doesn’t exist. To be clear, while having a perfect model that gives a nearly perfect picture of that predestined future would be great, I don’t expect my model to come close to that. My goal is simply to have a crude yet evolving model that gives me a leg up relative to the competition and relative to the position I would be in if I didn’t have the model.

To build this model, I looked at history quantitatively as well as qualitatively because 1) by measuring conditions and their changes, I can more objectively determine the cause/effect relationships behind them, develop a likely range of expectations, and systemize my decision making accordingly but 2) I can’t measure everything quantitatively.

Stage 5: People and Their Countries Are Poor and They Think of Themselves as Poor. This is when the gaps described in Stage 4 cease to exist and the reality of the country’s situation is hitting home. After bubbles burst and deleveragings occur, private debts grow, while private sector spending, asset values, and net worths decline in a self-reinforcing negative cycle. To compensate, government debt and government deficits grow, and central bank “printing” of money typically increases. Central banks and governments cut real interest rates and increase nominal GDP growth so that it is comfortably above nominal interest rates in order to ease debt burdens.

As I explained comprehensively in my book Principles for Navigating Big Debt Crises, there are four levers that policy makers can pull to bring debt and debt-service levels down relative to the income and cash flow levels required to service debts: 1. Austerity (spending less) 2. Debt defaults and restructurings 3. Transfers of money and credit from those who have more than they need to those who have less than they need (e.g., raising taxes) 4. Printing money and devaluing it

Austerity is deflationary and doesn’t last long because it’s too painful. Debt defaults and restructurings are also deflationary and painful because the debts that are wiped out or reduced in value are someone’s assets; as a result, defaults and restructurings are painful for both the debtor who goes broke and has their assets taken away and for the creditor who loses wealth when the debt is written down. Transfers of money and credit from those who have more than they need to those who have less than they need (e.g., raising taxes to redistribute wealth) is politically challenging but more tolerable than the first two ways and is typically part of the resolution.

Compared to the others, printing money is the most expedient, least well-understood, and most common big way of restructuring debts. In fact, it seems good rather than bad to most people because: It helps to relieve debt squeezes. It’s tough to identify any harmed parties that the wealth was taken away from to provide this financial wealth (though they are the holders of money and debt assets). In most cases it causes assets to go up in the depreciating currency that people measure their wealth in, so it appears that people are getting richer. This is what has been happening during the coronavirus crisis as central governments and banks send out large amounts of money and credit. Note that you don’t hear anyone complaining about the money and credit creation; in fact, people say that governments would be cheap and cruel if they didn’t provide a lot more of it. Hardly anyone acknowledges that governments don’t actually have this money to give out.

Governments aren’t rich entities with piles of money lying around. They are just their people collectively, who will ultimately have to pay f...

Stage 6: Then the flight back into hard money. When taken too far, the overprinting of fiat currency leads to the selling of debt assets and the earlier-described “bank run” dynamic, which ultimately reduces the value of money and credit, which prompts people to flee out of both the currency and the debt. History teaches us that people typically turn to gold, silver, stocks that maintain their real value, and currencies and assets in other countries not having these problems.

Some people think that there has to be an alternative reserve currency to go to for this flight to happen, but that’s not true as the same dynamic of the breakdown of the monetary system and the running to other assets has happened in cases in which there was no alternative currency (e.g., in dynastic China and during the Roman Empire).

There are a lot of things people run to when money is devalued, including rocks (used for construction) in Germany’s Weimar Republic. The debasement of the currency leads people to run from it and...

When the devaluations and defaults become so extreme that the money and credit system breaks down, necessity generally compels governments to go back to some form of hard currency to rebuild people’s faith in the value of money as a storehold of wealth.

To review, holding debt as an asset that provides interest is typically rewarding early in the long-term debt cycle when there isn’t a lot of debt outstanding, but holding debt late in the cycle, when there is a lot of debt outstanding and it is closer to being defaulted on or devalued, is risky relative to the interest rate being given. So, holding debt is a bit like holding a ticking time bomb that rewards you while it is still ticking and blows you up when it stops. And as we’ve seen, that big blowup (i.e., big default or big devaluation) happens something like once every 50 to 75 years.

These cycles of building debts and writing off debts have existed for thousands of years and in some cases have been institutionalized. For example, the Old Testament describes a year of Jubilee every 50 years, in which debts were forgiven. Knowing that the debt cycle would happen on that schedule allowed everyone to act in a rational way to prepare for it.

Ironically, the closer most people are to the blowup, which is also when the claims outstanding are largest relative to the amount of hard money and tangible wealth there is, the riskier the situation is but the safer people tend to feel. That is because they have held the debt and enjoyed the rewards of doing so. The longer it has been since the last blowup, the more people’s memories of it have faded—even as the risks of holding the debt rise and the rewards for holding it decline.

For thousands of years, there have always been three types of monetary systems: Type 1: Hard money (e.g., metal coins) Type 2: Paper money (claims on hard money) Type 3: Fiat money

Hard money is the most restrictive system because money can’t be created unless the supply of the metal or other intrinsically valuable commodity that is the money is increased.

Money and credit are more easily created in the second type of system, so the ratio of the claims on hard money to the actual hard money held rises, which eventually leads to a run on the banks. The result is a) defaults, when the bank closes its doors and depositors lose their hard assets, and/o...

In the third type of system, governments can create money and credit freely, which works for as long as people continue to have confidence in the c...

Throughout history, countries have transitioned across these different types of systems for logical reasons. When a country needs more money and credit than it currently has, whether to deal with debts, wars, or other problems, it naturally moves from Type 1 to Type 2, or Type 2 to Type 3, so that it has more flexibility to print money. Then creating too much money and debt depreciates their value, causing people to get out of holding d...

Since this typically takes place when there is wealth conflict and sometimes war, there is also typically a desire to get out of the country. Such countries need to re-establish confidence in their currency as a storeh...

The following diagram conveys these different transitions. There are many historical examples, from the Song Dynasty in China to Weimar Germany, of countries making the full transition from constrained types of monetary systems (Type 1 and Type 2) to fiat money (Type 3),...

This big cycle typically plays out over something like 50 to 75 years; its ending is characterized by a restructuring of debts and the monetary system itself.

The abrupt parts of these restructurings—i.e., the periods of debt and currency crisis—typically happen quickly, lasting only a few months to up to three years, depending on how long it takes the government to act.

However, their ripple effects can be long-lasting, for example, when a currency ceases...

Within each of these currency regimes there are typically two to four big debt crises—i.e., big enough to cause banking crises and debt write-downs or devaluations of 30 percent or more—but not big enough to break the currency system. Because I have invested in many countries for nearly half a century, I have experienced dozens of them. They all run the sa...