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

by Ray Dalio

Naturally I think about how I would have approached these periods if I had been living through them. I’m certain that even if I had seen the signs of things coming that I’m passing along in this book I never would have confidently predicted such bad outcomes—as noted earlier, seven of 10 countries saw their wealth wiped out. In the early 1900s, even those looking back over the past few decades would never have seen it coming because there were plenty of reasons to be optimistic based on what had happened during the second half of the 19th century.

The bad parts of all the cycles that took place prior to 1900 were similarly bad. To make matters even worse, these periods of internal and external fighting over wealth and power led to many deaths.

In Part I, I described how I believe the perpetual-motion machine works. In Part II, I will show you what this perpetual-motion machine has produced over the last 500 years of history.

This chapter will set the stage for the remaining chapters of Part II, which will cover in detail how the Big Cycle played out in the Dutch, British, American, and Chinese cases.

A few of the most important ways that the world was different in 1500 were: The World Was Much “Bigger” Then. Five hundred years ago one could travel about 25 miles in a day on horseback. Today it is possible to travel to the other side of the world in the same amount of time.

The Apollo astronauts traveled to the moon and back much faster than it took a traveler to get from Paris to Rome in 1500.

Countries Didn’t Exist—Instead, Territories Were Run by Families.

Back in 1500, there were no sovereign states with borders and ruling orders. They hadn’t been invented yet. Instead there were big family estates called kingdoms and dynasties run by kings and emperors that almost constantly fought with their neighbors for wealth and power.

The most important changes were the changes in thinking that led to people changing behaviors, particularly about how wealth and power should be shared. They were what made the story transpire as it did.

Venice’s leader—called the doge—did

A new way of thinking in many respects modeled after the ancient Greeks and Romans started in Italian city-states around 1300 and passed through Europe until the 1600s, in a period known as the Renaissance. Renaissance thinkers made a big pivot toward using logical reasoning instead of divine intention as the way to explain how the world works. This shift contributed to dizzyingly fast discoveries that led to artistic and technological advances in Europe.

The Renaissance was one of history’s greatest cases of a self-reinforcing cycle I described in Chapter 5: peaceful periods in which creativity and commerce reinforce each other to produce an economic boom and great advancements.

Alongside the flourishing in art and architecture were huge advances in science, technology, and business. Knowledge and ideas spread rapidly because of the invention of the printing press in the mid-15th century.

Spain’s integration into the Habsburg Empire and its control over highly profitable silver mines made it stronger than Portugal in the 1500s, and for a roughly 60-year period starting in the late 1500s the Habsburg king ruled Portugal as well. Both translated their wealth into golden ages of art and technology. The Spanish Empire grew so large it became known as “the empire on which the sun never sets”—an expression that would later be used to describe the British Empire.

As European nations found ways to make their explorations more profitable, the rise of global trade transformed their economies. Most notably, the flow of new riches (particularly silver) to Europe fueled a rise in prices for basic goods and services. Referred to as the Spanish Price Revolution, Europe went from hundreds of years of steady prices to a doubling of prices every few decades, a reminder of how big shifts can have economic impacts that seem unimaginable based on one’s most recent experiences.

The Portuguese were the first of these explorers to approach China in 1513, though other European explorers like Marco Polo had been in contact before. Europeans were dazzled by the quality of Chinese porcelain, silk, and other goods, which became highly sought after, but the Chinese weren’t interested in buying European goods, which they considered inferior. However they eagerly accepted silver, which was money in China as well as in Europe, as payment. As we’ll cover later, China struggled for centuries with shortages of the precious metals it needed to have a sufficient supply of money. However the Europeans didn’t have enough silver to trade and the Chinese weren’t interested in other goods, which eventually led to the Opium Wars and other interesting stories that we will explore later.

The result of this pullback was an Age of Isolationism in China and in Japan as well, where it was called Sakoku. For the next several centuries, China and Japan broadly moved away, in fits and starts, from openness toward foreigners and toward distance and isolation.

Beginning in the 1500s in Europe, Protestant religious movements initiated a revolution against the Roman Catholic Church, which contributed to a series of wars and the bringing down of the then-existing European order. As previously explained, at the time, the existing order consisted of monarchs, nobles, and the church in symbiotic relationships.

The Reformation took aim at the power and corruption of the Roman Catholic Church and sought an independent religion in which people dealt with God directly rather than one mediated by the church’s rules. At the time, many Catholic bishops and other senior clergy lived like princes in palaces and the church sold “indulgences” (a supposed reduction in time people would have to spend in purgatory). The Roman Catholic Church was a nation as much as it was a religion, directly governing a sizable share of modern Italy (the Papal States).

The Scientific Revolution was an extension of the Renaissance-era shift from finding truth in religion to finding truth in logical reasoning and the Reformation’s drive to question authority and think for oneself. These factors led to the development of the scientific method, which improved humanity’s understanding of the world, establishing protocols by which scientific discoveries could be investigated and proven and ushering in many discoveries that raised living standards.

Beginning in the UK in the 1700s, freeing people to be inventive and productive and providing them with capital led many societies to shift to new machine-based manufacturing processes, creating the first sustained and widespread period of productivity improvement in thousands of years.

As people flocked to cities, industry benefited from the steadily increasing supply of labor, creating a virtuous cycle and leading to shifts in wealth and power both within and between nations.

Also known as the Age of Reason, the Enlightenment was essentially the scientific method applied to how humans should behave. This way of thinking became widespread in Europe in the 1700s and 1800s and was an extension of the diminishing of the rights of the monarchy and the church and the increasing of the rights of the individual that characterized earlier intellectual movements.

This wave of revolutions included the American, French, Spanish, German, Portuguese, and Italian. As is typical, this era of upheaval led some nations to seek out strong leaders who could bring order to the chaos. In the case of France, that leader was Napoleon, who changed the course not just of French history but of European history as he sought to conquer all of Europe.

The Napoleonic Wars lasted from 1803 to 1815, when Great Britain and its allies defeated Napoleon and his allies. As is usual, the victors got together to create a new world order, which was hashed out at the Congress of Vienna. It drew new boundaries to ensure that no European power would become too dominant, based on balance of power concepts that would avoid war. The British emerged as the world’s leading empire, and as is typical after the war and the establishment of a new order, there was an extended period of peace and prosperity—the Pax Britannica.

That brings us to the 20th century, which had two big cycles of boom, busts, wars, and new orders, the second of which we appear to be in the late stages of. Because I review these comprehensively in Chapters 10 through 13, and because they are much more familiar to most readers, I will end this overview here and dive now into the story of the Dutch and how they rose to become the first global reserve currency empire.

After a series of attempted revolts in the mid-1500s, the Dutch, who were under the control of Habsburg Spain, finally became powerful enough to gain de facto independence in 1581. From 1625 until their collapse in 1795, the Dutch gained enough wealth and power to eclipse both the Habsburgs and China as the world’s richest empire.

The Dutch Empire rose for all the classic reasons explained in earlier chapters, peaking around 1650 in what is now remembered as the Dutch Golden Age.

From 1519 until 1556, the Holy Roman emperor and head of the Habsburg Empire was Charles V. The union of territories he controlled—which included most of modern-day Netherlands, Belgium, Italy, Germany, Austria, and Spain—made the Habsburg Empire the most powerful family empire in Europe. Spain was especially strong1 because of the wealth and power it acquired in the Age of Exploration.

Things began to change around the mid-1500s as the seeds of decline that were planted in the top phase began to germinate and a revolutionary shift in power began to brew.

The break from Spain allowed the Dutch to create a more open and inventive society. The Dutch invented ships that could go around the world to collect riches, capitalism that could finance these and other productive endeavors, and many more breakthroughs that made them rich and powerful. The Dutch created the world’s first mega-corporation, the Dutch East India Company, which accounted for about one-third of world trade.3 Dutch openness to new ideas, people, and technology helped them rise quickly.

To support trade the Dutch government increased military investments, which allowed the country to control still more trade by holding off the British in a number of military conflicts.

The Dutch also created the world’s first reserve currency other than gold and silver, the Dutch guilder, supported by an innovative banking and currency system put into place...

In short, the Dutch were superbly educated people who were very hardworking and inventive—in fact, they came up with about a quarter of all major inventions in the world when they were at their peak, a spike that began shortly before Dutch independence from Spain.

In addition to creating an equity market, the Dutch developed an innovative banking system, which grew rapidly and began to finance international trade for Dutch and non-Dutch merchants.

All the classic balance of power dynamics came into play. In this case, the Thirty Years’ War was a classic fight over wealth and power, just a lot longer one. On one side was the Catholic emperor of Habsburg Austria, who was allied with the German Catholic territories (most prominently Bavaria), as well as with Spain and the Papal States. On the other side were the German Protestant nobles, allied at different points in time with Denmark, the Netherlands, Sweden, and France. The fighting was about money, religion (Protestants versus Catholics), and geopolitics.

the deal that was cut at Westphalia invented countries as we know them, which is to say it allowed sovereignty of the state with the ability to make choices within its geographic borders (e.g., their religions, their languages, and all their rules) and instituted respect for those boundaries so that no longer would borderless, free-flowing power grabs occur (without, of course, the understanding that you’d be starting a major war).

The Dutch first declared independence in 1581, but their full independence was not realized until the Peace of Westphalia (1648) ended both the Thirty Years’ War and the Eighty Years’ War.

The rise of the British Empire started long before it became preeminent, as it first had to build its educational, institutional, and technological strengths to become more competitive and then challenge and defeat the Dutch.

Britain won through effective economic as well as military warfare. Then, following the classic Big Cycle script of what happens after wars that establish the dominant power, there was a new world order set out by the winners followed by a long period—in this case 100 years—of relative peace and prosperity.

This revolutionary strengthening of Parliament was heavily influenced by the new Enlightenment thinking about who should have what powers and how governments should work that had spread throughout Europe starting in the late 1600s. That was shaped by the earlier scientific thought of Englishman Francis Bacon (1561–1626). At the core of this new, human-centric philosophy was the idea that society should be based on reason and science and that the government’s power comes from the people, not from God. Debate and skepticism were encouraged. Improvements in basic education (which caused literacy rates to rise), the dissemination of ideas via printed materials (the first encyclopedias and dictionaries were printed en masse at this time), and a growing number of transnational elites (who were well-read and cultivated cross-border contacts) created a new and wider “public sphere” of political and social thought. The key thinkers during this time produced ideas and concepts that are still important in the Western world.

The story of Britain’s rise is obvious in retrospect. It’s easy to look back and describe what happened. It’s another thing to position oneself well for it by anticipating it and seeing it happen at the time. I wonder what I would have thought at the time. I wonder whether in looking at the readings of my indicators and systems and thinking about the situations whether I would have bet well. That is why it is so important to me to have the data and the decision rules to see what I would have actually done and what the results would have been.

Ultimately, the inflationary spiral was halted by the introduction of the hard currency that was acquired through Napoleon’s successful military conquests in Italy and the decision to declare bankruptcy on two-thirds of the government’s debt. Additional measures such as increased taxes further strengthened the government’s fiscal condition. In 1796, the government held a ceremony in which it destroyed the presses it had been using to print money.

The bubble, the big wealth gaps, and the costly expense of war led to the bust and then to revolution, which threw out the old order and put in a new one. That new order consisted of revolutionary leaders who fought with each other, producing 10 years of painful chaos that required a strong leader to get control of the mess. It was all consistent with the classic, melodramatic script that has played innumerable times in the past. As if on cue, Napoleon entered the picture. Napoleon was the classic hero rising to the occasion. He had gained a sterling reputation as a military commander as France attempted to spread its republican system across Europe, and he was very popular.

Following his election as chancellor as a Christian Democrat in 1949, his policies focused on rebuilding the German economy, reconciling with other European powers, and opposing communism. Schuman and Adenauer’s project, along with the rest of the EU’s founders, was to make war “not merely unthinkable, but materially impossible.”

According to historian Eric Hobsbawm, “[Bismarck] remained undisputed world champion at the game of multilateral diplomatic chess for almost twenty years after 1871.”

Then World War I, the war few people expected to happen and nobody expected to last so long, began in 1914 and ended in 1918. The US was not in World War I for most of it and was the only major country to maintain convertibility to gold during the war. Not only were the economies and markets of Europe badly hurt from the wartime efforts, but the policies undertaken by European governments also further undermined the faith in their currencies. In contrast, the United States’ relative financial and economic position benefited from the war. That the Allies’ wartime debts were largely owed to the US boosted the use of the dollar for denominating global government debt.

What will the next high-stakes military conflict look like? Because of new technologies, it will be very different from previous ones. Classically the country that wins wars spends more, invests more, and outlasts the opposition. But it is a delicate balance. Because spending on the military takes government money away from spending on social programs, and because military technologies go hand in hand with private sector technologies, the biggest military risk for the leading powers is that they lose the economic and technology wars.

Sometimes there is too much debt around the world and it is in all governments’ interests to devalue their currencies. At such times gold (and recently digital currencies) can be preferable. Also at such times governments are more likely to outlaw these alternative currencies, though they can’t fully outlaw them. When the money and credit systems based on fiat currencies break down, it eventually leads to hard money monetary systems.

the US private sector went global and invested abroad from 1945 through the 1970s. Stocks were cheap and dividend yields were high; the result was a multidecade bull market that reinforced New York’s dominance as the world’s financial center, bringing in still more investment and further strengthening the dollar as a reserve currency. All of this was classic; it was a mutually self-reinforcing Big Cycle upswing.