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

by Ray Dalio

There was enough money for the US to improve education, invent fabulous technologies (e.g., those that allowed it to go to the moon), and a lot more. The stock market hit its high in 1966, which marked the end of the good times for 16 years, though nobody knew it then.

The US did all the classic things that helped the world become more dollarized. Its banks increased their operations and lending in foreign markets. In 1965, only 13 US banks had foreign branches. By 1970, 79 banks had them, and by 1980 nearly every major US bank had at least one foreign branch, and the total number of branches had grown to 787. Global lending boomed. However, as is also typical, a) those who prospered overdid things by operating financially imprudently while b) global competition, especially from Germany and Japan, increased. As a result, American lending and America’s finances began to deteriorate as its trade surpluses disappeared.

Paul Volcker was Nixon’s undersecretary of international monetary affairs when Nixon severed the link with gold, and he was head of the Federal Reserve from 1979 until 1987. He did more to shape and guide the dollar-based monetary system before, during, and after these years than anyone. I was lucky enough to know him well so I can personally attest that he was a person of great character, capabilities, influence, and humility—a classic hero/role model in a world that lacks hero/role models, especially in economic public service. I believe that he and his thinking deserve to be studied more.

As explained more comprehensively in my book Principles for Navigating Big Debt Crises there are three types of monetary policy: 1) interest-rate-driven monetary policy (which I call Monetary Policy 1 because it is the first to be used and is the preferable way to run monetary policy), 2) printing money and buying financial assets, most importantly bonds (which I call Monetary Policy 2 and is now popularly called “quantitative easing”), and 3) coordination between fiscal policy and monetary policy in which the central government does a lot of debt-financed spending and the central bank buys that debt (which I call Monetary Policy 3 because it is the third and last approach to be used when the first two cease to be effective). The next charts show how the debt crises of 1933 and 2008 both led to interest rates hitting 0 percent and were followed by big money printing by the Federal Reserve.

Probably the most important thing I gained from studying the history of so many countries is the ability to see the big patterns of causes and effects. Shifting my perspective to the very long term felt like zooming out in Google Maps because it allowed me to see contours that I couldn’t see before and how the same stories play out over and over again for basically the same reasons. I also came to understand how having so much history to study has affected the Chinese way of thinking, which is very different from the American way of thinking, which is much more focused on what is happening now. Most Americans believe their own history is just 300 or 400 years old (since they believe the country began with European settlement), and they aren’t terribly interested in learning from it. Whether they are interested or not, 300 years seems like a very long time ago to Americans, but for the Chinese, it isn’t long at all. While the prospect of a revolution or a war that will overturn the US system is unimaginable to most Americans, both seem inevitable to the Chinese because they have seen those things happen again and again and have studied the patterns that inevitably precede them. While most Americans focus on particular events, especially those that are happening now, most Chinese leaders view current events in the context of larger, more evolutionary patterns.

Coincidentally, my own search for patterns in history and my way of dealing with tactical decisions has had a similar effect on how I see and do things—e.g., I now view the last 500 years as recent history, the most relevant historical arcs seem about 100-plus years long, and the patterns I’ve gleaned from this perspective help me anticipate how events are likely to transpire, and how I should be positioned for them over the coming weeks, months, and years.

the first fiat currency, known as huizi notes, was issued in modest quantities starting in 1160 and traded at near face value for more than 30 years.

The test of the real value of a currency is whether it is actively used and traded at the same exchange rate internationally as domestically. When there are capital controls that prevent the free exchange of a domestic currency internationally, that currency is more susceptible to being devalued. By definition reserve currencies have no such controls.

The America I came of age in was the land of opportunity, in which one could learn, contribute, and be rewarded fairly and without boundaries. This experience of seeing through another’s eyes was another reminder for me of how important radical open-mindedness and thoughtful disagreement are to finding out what is true.

the process of dialectical materialism is similar to the process that I discovered for myself and explained in my book Principles: Life and Work, in which I struggle with conflicts, reflect on them, write down the principles I derive from them, and then improve them—and do that over and over again, in a never-ending, evolutionary way that I describe as “looping.”

learning and evolving from conflicts and mistakes is the best approach.

It is also my opinion that capitalism—an incentive system that rewards the people who are most inventive and productive, and that has capital markets that reward good capital allocation decisions and penalizes bad ones—will lead to a) more productivity over the long run (and hence a bigger total pie), b) big wealth differences, and c) capital markets (especially debt markets) that become overextended and then break down. When there is a capital market/economic breakdown at the same time that there are big wealth and values disparities, that is likely to l...

To me, thus far capitalism—in China or anywhere else—is winning the competition.

As is typical of post-war periods of peace and prosperity, when the leading power isn’t threatened and emerging countries aren’t yet threatening, emerging countries can learn a lot from the leading powers as they work together in a symbiotic way, until the emerging power becomes powerful enough to threaten the leading power. In addition to benefiting from the learning, they benefit from trading with each other (until that becomes disadvantageous), and they benefit from using the capital markets to their mutual benefit (until that becomes disadvantageous).

As is classic, periods of prosperity financed by debt growth lead to debt bubbles and large wealth gaps. In the US, the bubble burst in 2008 (as it did in 1929), and the world economy contracted and middle-class Americans and those in other countries were hurt (as in 1929–32). Interest rates were pushed down to 0 percent (as in 1931), which still wasn’t enough easing, so central banks printed a lot of money and bought a lot of financial assets after 2008 (like in 1934), which drove up their prices in most countries starting in 2009 (as happened in 1933–36). This benefited the “haves” (people who had financial assets) more than the “have-nots” (those without them) so the wealth gaps grew wider still (as they did in the 1933–38 period). The “have-nots,” especially those whose jobs were being taken by the Chinese and immigrants, began to rise up against the elites who were benefiting from globalization. As is typically the case when economic bad times coincide with large wealth gaps, populism and nationalism grew around the world (as they also did in the 1930s). That is when the threat the rising powers pose becomes more apparent to the leading powers. The era of peace, prosperity, and globalization began to wane, giving way to an era of conflicts between the rich and the poor within countries and between the rising country (China) and the dominant world power (the US).

As you probably know by now, I believe that everything works like a machine, with timeless and universal cause/effect relationships. Chinese leaders do too, so we almost always came to similar conclusions.

Basically China does not want to be contained and the United States (and some other countries) want to contain it. What does that mean geopolitically? As you know by now, countries’ boundaries have constantly changed over time, they are often in dispute, and international law isn’t worth a hill of beans relative to power in resolving these disputes. In 2009 China declared to the United Nations that it has “indisputable sovereignty over” an area in the East and South China Seas. The area is marked by a “nine-dash line” on a World War II era map presented by China; it covers offshore waters east of Vietnam, north of Malaysia, and west of the Philippines, which include a bunch of islands, are important for shipping that China needs, and are believed to have undiscovered oil reserves, which I imagine China would love to have given its huge imported oil needs and the risk of oil imports from the Middle East being cut off. If you read the World War II case study in Chapter 6 and saw how the US cut off resources to Japan, you know the issue: China has a great need for oil and other imports that currently come through a choke point at the Strait of Malacca. As a result of all of this and other assertions, the perception of China as a threat/enemy has emerged, globalization has reversed, and “wars” have intensified, starting with the trade and economic wars, expanding to the technology and the geopolitical wars and, most recently, to the capital war. All remain relatively mild in r...

The amounts invested and earmarked for investment are enormous—the largest such program since the Marshall Plan. It is a good demonstration that wealth = power. While these moves have been appreciated by the countries that received the benefits from roads and other infrastructure, resources, and trade, they have also sparked resentments from recipient countries who are having problems paying back their loans and find that China is too controlling, and from the United States because China’s assertions of soft power have lessened American influence in those countries.

during periods of great crisis, more autocratic and less democratic leadership tends to be preferred.

The devaluations in 1985–86 and 1993 came after a period of opening up trade and an expansion in Special Economic Zones. These openings created immense demand for foreign currency and imports to build production capacity—but it would still be a couple more years before those zones yielded much higher exports. That mismatch contributed to China’s growing current account deficit.

From playing the game I play—global macro investing—I know how complicated it is to simultaneously consider all that is relevant in order to make winning decisions. I also know that what I do is not as complicated as what those in the seats of power do and I know that I don’t have access to information that is as good as what they have, so it would be arrogant for me to think I know better than they do about what’s going on and how to best handle it. For those reasons I am offering my views with humility. With that equivocation I will tell you how I see the US-China relationship and the world setting in light of these wars, and I will be brutally honest.

We should use past cases in history and our understandings of actual developments as they are taking place to think about what is most likely to happen next and how to deal with it well.

That is because in wars leaders want to convince their constituents that “we are good and they are evil” because that is the most effective way to rally people’s support, in some cases to the point that they are willing to kill or die for the cause. Though true, it is not easy to inspire people if a practical leader explains that “there are no laws in war” other than the ethical laws people impose on themselves and “we have to play by the same rules they play by or we will stupidly fight by self-imposing that we do it with one hand behind our backs.”

The technology war is much more serious than the trade/economic war because whoever wins the technology war will probably also win the military wars and all the other wars.

Consider that 40 percent of the world’s largest civilian supercomputers are now in China, and it is leading in some dimensions of the AI/big data race and some dimensions of the quantum computing/encryption/communications race. Similar leads in other technologies exist, such as in fintech where the volume of e-commerce transactions and mobile-based payments in China is the highest in the world and well ahead of that in the US. There are likely technologies that even the US’s most informed intelligence services don’t know about that are being developed in secret.

big data + big AI + big computing = superior decision making.

Remember that China is a country whose leaders 37 years ago marveled at the handheld calculators I gave them. Imagine where they might be 37 years from now.

because throughout history, as we’ve seen, the most powerful country is typically taken down by alliances of countries that are less powerful but collectively stronger.

“Sanctions” as they are now called and employed come in many forms, with the broad categories being financial, economic, diplomatic, and military. Within each of these categories there are many versions and applications. I’m not going to delve into the various versions and targets because that would be too much of a digression. The main things to know are: The United States’ greatest power comes from having the world’s leading reserve currency, which gives the US enormous buying power because it gives it the ability a) to print the world’s money and have it widely accepted abroad and b) to control who gets it. The United States is at risk of losing its reserve currency status.

History and logic show that the leading reserve currency is slow to be replaced for the same reasons that the leading world language is slow to be replaced—because so many people have adopted it and because it is entwined within the system.

Because the dollar is the dominant currency in world trade, capital flows, and reserves, it is the world’s leading reserve currency, which puts the US in the enviable position of being able to print the world’s money and to inflict sanctions on its enemies. The US now has an arsenal of sanctions, which is its most used arsenal of weapons.

Countries being hurt by US sanctions are developing ways to get around them or undermining the United States’ power to impose them. For example, Russia and China, which both are encountering these sanctions and are at great risk of encountering more of them in the future, are each now developing and cooperating with the other to develop an alternative payment system. China’s central bank has created a digital currency, which will make China less exposed to US sanctions.

Gold (12 percent) is a hard currency that is held because it has worked the best over the ages and because it is an effective diversifier to other assets held, particularly fiat currencies. While before 1971 gold was at the foundation of the world’s currency system, at this time it is a relatively dead asset since there are no significant international trade and capital transactions in it and it isn’t used to balance external accounts. It is also a market that is too small to become a high share of wealth at current prices. A move to gold from fiat-currency-based assets (i.e., credit assets), which would only come in the event of an abandonment of that system (which history shows could come), would lead to an explosion in gold’s price.

It is up to American policy makers to decide whether or not they will try to disrupt this evolutionary path by becoming more aggressive or accept that evolution, which will likely lead to China becoming relatively stronger, more self-sufficient, and less vulnerable to being squeezed by the US.

American culture compels its leaders to run the country from the bottom up, demanding high levels of personal freedom, favoring individualism over collectivism, admiring revolutionary thinking and behavior, and not respecting people for their positions as much as for the quality of their thinking. These core cultural values drove the types of economic and political systems each country chose.

The main challenge the Chinese and Americans have with each other arises from some of them failing to understand and empathize with the other’s values and ways of doing things, and not allowing each other to do what they think is best.

As for which approach will work best and win out in the end, I will leave that for others to debate, hopefully without bias, though I will note that most knowledgeable observers of history have concluded that neither of these systems is always good or bad.

most Americans and most Westerners would fight to the death for the ability to have and express their opinions, including their political opinions.

… People being able to work well together, united behind a common view of how they should be together, is also important. When people have knowledge, skills, good character, and the civility to behave and work well together, and there is… … a good system for allocating resources, which is significantly improved by… … being open to the best global thinking, the country has the most important ingredients in order to succeed. That leads to it gaining… … greater competitiveness in global markets, which brings in revenues that are greater than expenses, which leads the country to have… … strong income growth, which allows it to make… … increased investments to improve infrastructure, education, and research and development, which lead it to have… … rapidly increasing productivity (more valuable output per hour worked). Increasing productivity is what increases wealth and productive capabilities. When the country achieves higher productivity levels, it can become productive inventors in… … new technologies. These new technologies are valuable for both commerce and the military. As the country becomes more competitive in these ways, naturally it gains… … a rising and significant share of world trade, which requires it to have… … a strong military to protect its trade routes and to influence those who are important to them outside their borders. In becoming economically preeminent the country develops… … strong and widely used currency, equity, and credit markets. Naturally those ...

Whatever makes these measures go up is good and whatever makes them go down is bad. For this reason it is wise for citizens of all countries to ask themselves how well they collectively and their leaders are doing at making the lines in these measures go up. I also hope that they will remember the cause/effect relationships, avoiding the excesses and divisions that lead to declines.

It is widely recognized that “regime change” has been commonly employed by the United States for managing its world order.

I have learned to look at the past 1) to determine what’s likely to happen and 2) to protect myself and others I am responsible for against the possibility I am wrong or missing something important.

While what I don’t know about the future is probably much more than what I do know, what I do know is also a lot. Dealing with the future is all about 1) perceiving and adapting to what is happening, even if it can’t be anticipated; 2) coming up with probabilities for what might happen; and 3) knowing enough about what might happen to protect oneself against the unacceptable, even if one can’t do that perfectly.

In playing the game of life it pays to do one’s best to understand how the world works, imagine the full range of possibilities (including their risks and rewards), and know how to spread one’s bets around well.

The most important things evolve in ways that are easy to see and extrapolate forward, so it’s not difficult to get a pretty good sense of roughly where they are likely to be in the future, so long as a once-in-500-years-type game changer doesn’t come along.

the real value of what was produced per person grew slowly until the 19th century and then accelerated, with that broad evolutionary trend dominant relative to the wobbles within it.

The paradigm shifts that came in the early 19th century arose from the confluence of the invention of modern tools of finance, machines that could do the work of people, the development of more inclusive societies that broadened opportunities to be inventive and productive, the increased use of books and libraries so knowledge could be more broadly shared, and the application of the scientific method.

while extrapolating the past is generally a reasonable thing to do, also be prepared to be surprised because the future will be much different than you expect it to be.

identifying, understanding, and adapting to paradigm shifts is essential, even if one can’t anticipate them—though trying to anticipate them with good indicators that help is important too. Having good indicators can also help you tell when what looks like a paradigm shift is only a passing fad, which is just as important.

in the markets and in life, to be successful one should bet on the upside that comes from a) evolution that leads to productivity improvements, but not so aggressively that b) cycles and bumps along the way knock you out of the game.