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

by Ray Dalio

… strong education, which is not just teaching knowledge and skills; it also includes teaching… … strong character, civility, and work ethic development. These are typically taught in families, schools, and/or religious institutions. If done well, this provides a healthy respect for rules and laws and order within society, leads to low corruption rates, and is effective in encouraging people to work together to improve productivity. The better the country does this, the more there will be a shift from producing basic products to… … innovating and inventing new technologies. For example, the Dutch were superbly inventive—at their peak they came up with a quarter of all major inventions in the world. One of these were ships that could travel around the globe to collect great riches. They also invented capitalism as we know it. Innovation is generally enhanced by being… … open to the best thinking in the world to be able to learn the best ways of doing things and by… … the workers, the government, and the military all working well together.

As a result of all of these things, the country… … becomes more productive and… … more competitive in world markets, which shows up in its… … share of world trade rising. You can see this happening today as the US and China are now roughly comparable in both their economic outputs and their shares of world trade. As a country trades more globally, it must protect its trade routes and foreign interests and it must be prepared to defend itself from attack so it develops great military strength.

If done well, this virtuous cycle leads to… … strong income growth, which can be used to finance… … investments in infrastructure, education, and research and development. The country must develop systems to incentivize and empower those who have the ability to make or get wealth. In all of these past cases, the most successful empires used a capitalist approach to incentivize and develop productive entrepreneurs. Even China, which is run by the Chinese Communist Party, uses a state-capitalism approach to incentivize and enable people. To do that incentivizing and financial enabling well, the country… … has to have developing capital markets—most importantly its lending, bond, and stock markets. That allows people to convert their savings into investments to fund innovation and development and share in the successes of those who are making great things happen. The inventive Dutch created the first publicly listed company (the Dutch East India Company) and the first stock market to fund it. These were integral parts of their machine that produced a lot of wealth and power. As a natural consequence, all of the greatest empires developed the world’s leading financial center for att...

This series of cause/effect relationships leading to mutually supportive financial, political, and military powers has gone together for as long as there has been recorded history. All of the empires that became the...

When debts become very large, and there is an economic downturn and the empire can no longer borrow the money necessary to repay its debts, this creates great domestic hardships and forces the country to choose between defaulting on its debts and printing a lot of new money. The country nearly always chooses to print a lot of new money, at first gradually and eventually massively. This devalues the currency and raises inflation. Typically at those times when the government has problems funding itself—at the same time as there are bad financial and economic conditions, and large wealth, values, and political gaps—there are great increases in internal conflict between the rich and poor and different ethnic, religious, and racial groups. This leads to political extremism that shows up as populism of the left or of the right. Those of the left seek to redistribute the wealth while those of the right seek to maintain the wealth in the hands of the rich. This is the “anti-capitalist phase,” when capitalism, capitalists, and the elites in general are blamed for the problems.

Typically during such times taxes on the rich rise, and when the rich fear their wealth and well-being will be taken away, they move to places, assets, and currencies they feel safer in. These outflows reduce the country’s tax revenue, which leads to a classic self-reinforcing, hollowing-out process.

When the flight of wealth gets bad enough, the country outlaws it. Those seeking t...

These turbulent conditions undermine productivity, which shrinks the economic pie and causes more conflict about how ...

Populist leaders emerge from both sides and pledge to take control and bring about order. That’s when democracy is most challenged because it fails to control the anarchy and because the move to a strong populist...

As conflict within the country escalates, it leads to some form of revolution or civil war to redistribute wealth and force the big changes. This can be peaceful and maintain the existing internal order, but it’s more often violent and changes the order. For example, the Roosevelt revolution to redistribute wealth was relatively peaceful, while the revolutions that changed the domestic orders in Germany, Japa...

Wars are terribly costly. At the same time, they produce the necessary tectonic shifts that realign the world order to the new reality of wealth and power. When those holding the reserve currency and debt of the declining empire lose faith and sell them, that marks the end of its Big Cycle.

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 country stands by looking at these measures. When the measures are strong/good, the condition of the country is strong/good and the period ahead is much more likely to be s...

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).

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 large debts and typical monetary policies don’t work well. 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 printing a lot of money (i.e., monetizing government debt). 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 this, as of this writing we have a pandemic to contend with. Simultaneously, great human thinking, working with computer intelligence, is creating great ways of addressing these challenges. If we can all deal with each other well, we will certainly get past this difficult time and move on to a new prosperous period that will be quite different. At the same time, I am equally confident that there will be radical changes that will be traumatic for many people.

humanity is evolving its ways of thinking and increasing productivity in more dramatic ways than ever before—even more dramatically than the discovery and usage of the scientific method. We are doing this through the development of artificial intelligence, which is an alternative way of thinking via an alternative brain that can make discoveries and process them into instructions of what should be done. Humanity is essentially creating an alternative species that has enormous capacity to see past patterns and process many different ideas very quickly, has little or no common sense, has trouble understanding the logic behind relationships, and doesn’t have emotions. This species is simultaneously smart and stupid, helpful and dangerous. It offers great potential and needs to be well-controlled and not blindly followed.

In 2008, it took two months from the crash to the printing of money; in 2020, it took just weeks.

We show where key indicators were relative to their history by averaging them across the cases. The chart is shown such that a value of 1 represents the peak in that indicator relative to history and 0 represents the trough. The timeline is shown in years with 0 representing roughly when the country was at its peak

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.

To deal with the realities that are coming at me, my process is to… Interact with this machine and try to understand how it works Write down my observations of its workings, along with the principles I have learned for dealing with them Backtest those principles through time Convert the principles into equations and program them into a computer that helps me with my decision making Learn from my experiences and my reflections on my experiences, so I can refine my principles Do that over and over again

The human player is more inventive, more lateral in thinking, and better able to reason, while the computer can calculate more data faster, is better able to identify patterns, and is much less emotional. This never-ending process of learning, building, using, and refining in partnership with computers describes what I do, except my game is global macro investing, not chess.

In this chapter, I will share my description of the workings of the perpetual-motion machine that drives the rises and declines of empires and their reserve currencies as I have come to understand it thus far, giving you a glimpse into how I play my game. While I’m sure my mental model is wrong and incomplete in any number of ways, it is the best one that I have now and it has proven invaluable to me.

Just as we can see the arc of the human life cycle from birth to death and how one generation impacts the next, we can do the same with countries and empires.

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.

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.

Since everything that happened and will happen was and is due to the interactions of the parts of this perpetual-motion machine, one can say that everything is predestined.

I believe that, if we had a perfect model that took every cause/effect relationship into consideration, we could perfectly forecast the future—that the only thing that stands in the way is our inability to model all those cause/effect dynamics. While that might or might no...

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.

Determinants lead to effects that become subsequent determinants that produce subsequent effects that become linked together in many cases. So we can look at each case and see what happened (the effect) and what made it happen (its determinants).

The determinants are both what exists and the energy that produces changes; like energy and matter, at the end of the day they’re the same. They create new circumstances and new determinants that create the next changes.

In the last chapter, I introduced you to what I believe are the three big cycles and the eight most important determinants of the rises and declines of empires and their currencies. Because thinking about all of these determinants and their interactions is complex, I suggest that you keep the three big cycles in mind as the most important things to watch: 1) the cycle of good and bad finances (e.g., the capital markets cycle), 2) the cycle of internal order and disorder (due to degrees of cooperation and fighting over wealth and power largely caused by wealth and values gaps), and 3) the cycle of external order and disorder (due to the degrees of the competitiveness of existing powers in fighting for wealth and power).

History and logic show that when a country simultaneously has all three in their good phases it is strong and rising, and when all three are in their bad phases it is weak and declining.

If I were to add two more determinants to keep in mind, they would be 4) the pace of innovation and technological development to solve problems and make improvements and 5) acts of nature, most importantly droughts, floods, and diseases.

you can’t understand the success of the United States without recognizing that it is separated from European and Asian powers by two oceans and blessed with most of the minerals, metals, and other natural resources it needs to be prosperous and self-sufficient, including the topsoil, water, and temperate climate that allows it to produce most of its own food. These factors enabled it to be largely isolationist until a little more than a century ago while investing in education, infrastructure, and innovation in ways that made it strong.

While the inherited assets and liabilities of a country are very important, history has shown that the way people are with themselves and others is the most important determinant. By that I mean whether they hold themselves to high standards of behavior, whether they are self-disciplined, and whether they are civil with others in order to be productive members of their societies is most important.

Character, common sense, creativity, and consideration in most people make for a productive society.

The Ability to Learn from History. Most people don’t have this, which is an impediment, though it varies by society. For example, the Chinese are excellent at this. Learning from one’s own experiences is not adequate because, as explained earlier, many of the most important lessons don’t come in one’s lifetime. In fact, many encounters in the future will be more opposite than similar to what one encountered before in life. Since the peace/boom period at the beginning of the cycle is opposite to the war/bust period at its end, the periods people face later in their lives are more likely to be more opposite than similar to the ones they encountered earlier in their lives.

if you don’t understand what happened since at least 1900 and how that rhymes with what is happening now, there is a high likelihood that you will find yourself in trouble.

Different generations think differently because of their different experiences, which leads them to make their decisions differently, which affects what hap...

Those who favor long-term well-being over short-term well-being tend to do better. The human propensity to choose short-term enjoyment over long-term well-being naturally exaggerates the highs and lows of the cycle because it pulls the good times forward at the expense of the future. That happens in many harmful ways, most classically by creating the debt boom and bust cycle. Governments are especially vulnerable to this because of how the political dynamic works. More specifically, a) politicians are motivated to prioritize the near term over the long term, b) they don’t like to face limitations and difficult financial trade-offs (e.g., choosing whether to spend on the military for defense or to spend on social programs), and c) it is politically threatening to take money away from people by taxing them. This leads to a host of political and other problems.

Openness to Global Thinking. This is a good leading indicator of strength because isolated entities tend to miss out on the world’s best practices, which weakens them, while learning about the best the world has to offer helps people be their best.

In each generation, roughly a few hundred people made all the difference. Studying what these key people in these key roles were like, what they did in different situations, and the consequences of what they did helps us understand how this perpetual-motion machine works.

History shows us that widening values gaps, especially during periods of economic stress, have tended to lead to periods of greater conflict, while shrinking values gaps tend to lead to periods of greater harmony. This dynamic is driven by the fact that people tend to coalesce into tribes that are bound together (often informally) by the magnetism of their members’ commonalities. Naturally, such tribes operate with each other in ways that are consistent with their shared values. When under stress, people with greater values gaps also prove to have greater conflict. They frequently demonize members of other tribes rather than recognizing that those other tribes, like themselves, are simply doing what is in their self-interest in the best ways they know how.

Early in the Big Cycle, when times are good, there is generally more harmony among the classes, and when things are bad toward the end, there is more fighting. Class warfare has profound effects on the internal order, which I will explore in Chapter 5. For more on this determinant, see the addendum to this chapter.

all countries now have their existing way of choosing new leaders. In the US, the president is chosen both by the voters in accordance with the democratic system laid out in the Constitution and by how people choose to operate within the system. How well this works depends on how effective both are, which is a result of prior determinants, such as how effectively those in previous generations dealt with and modified the system. The people now interacting with the system are different from those of previous generations, who were shaped by different circumstances, so we should expect different outcomes based on how people today are different.

A determinant is a factor (e.g., the supply of money) while a cycle is a series of self-reinforcing determinants that lead to events transpiring in a certain way—e.g., central banks making lots of money and credit available eventually leads to strong economic growth, inflation, and bubbles, which then prompt central banks to reduce the money supply, which produces market and economic downturns, which then lead the central banks to increase the supply of money to… etc. So, cycles themselves are determinants that are a collection of complementary forces that interact in a process to produce the same results again and again through time.

The “self” that people are most attached to is the one they will do the most to protect and this will drive their behaviors.

I call countries in this stage “late-stage emerging countries.” While countries of all sizes can go through this stage, when big countries go through it, they are typically emerging into great world powers.

Humanity’s capacity to invent solutions to its problems and to identify how to make things better has proven to be far more powerful than all of its problems combined.

computerization is changing the character of decision making, making it faster and less emotional. As helpful as that is, it also poses certain dangers.