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

by Ray Dalio

Similarly, when the three big cycles that I described in the last chapter come together in a bad way (heavy indebtedness with the central bank printing a lot of money; internal conflict stemming from gaps in wealth, values, and politics; and the rise of one or more competing powers), that typically leads to the decline of an incumbent empire.

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.

Making Wealth = Being Productive. Over the long run the wealth and buying power you have will be a function of how much you produce. That is because real wealth doesn’t last long and neither do inheritances. That is why being continuously productive is so important. If you look at societies that expropriated the wealth of the rich and tried to live off it and weren’t productive (e.g., Russia after the revolutions of 1917), you will see that it didn’t take them long to become poor. The less productive a society, the less wealthy and hence the less powerful. By the way, spending money on investment and infrastructure rather than on consumption tends to lead to greater productivity, so investment is a good leading indicator of prosperity.

Allied powers owed each other (particularly

The stats in my model suggest that the US is roughly 70 percent through its Big Cycle, plus or minus 10 percent. The United States has not yet crossed the line into the sixth phase of a civil war/revolution, when the active fighting begins, but internal conflict is high and rising.

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.

Americans are impulsive and tactical; they fight for what they want in the present. Most Chinese are strategic; they plan for how they can get what they want in the future. I have also found Chinese leaders to be much more philosophical (literally, readers of philosophy) than American leaders.

China toward where it has set out to be on the 100th anniversary of the People’s Republic of China in 2049—which is to be a “modern socialist country that is prosperous, strong, democratic, culturally advanced, and harmonious”—is occurring under Xi and his successors. Its ultimate goal is to make the Chinese economy about twice the size of the US’s and to have the benefits of its growth broadly shared.8 Nearer-term goals and ways to achieve them were set out in the Made in China 2025 plan,9 Xi’s new China Standards Plan 2035, and the usual five-year plans.

In the Western world, the dominant philosophies are Judeo-Christian, democratic, and capitalist/socialist, and each individual pretty much chooses from them to come up with a mix that suits them. In China, the main philosophies were Confucian, Taoist, and legalist until the early 20th century, when Marxism and capitalism entered the mix.

Confucianism seeks to bring about harmony by ensuring that people know their roles in the hierarchy and how to play them well,

Legalism favors the rapid conquest and unification of “everything under heaven” by an autocratic leader.

Taoism teaches that it is of paramount importance to live in harmony with the laws of nature.

the core difference between Americans and the Chinese is that Americans hold the individual above all else while the Chinese put the family and the collective above everything. America is run from the bottom up (e.g., democracy) and optimized for the individual; China is run from the top down and optimized for the collective.

Marx’s most important theory/system is called “dialectical materialism.”

In a nutshell, dialectical materialism is a system for producing change by observing and influencing the “contradictions” of “opposites” that produce “struggles” that, when resolved, produce progress. Marx meant it to apply to everything. The conflict and struggle between the classes that is manifest in the conflict between capitalism and communism is just one of many such examples.

Put yourself in Mao’s position during the 1900–49 period. Imagine him reading what Marx wrote, and think about his actions during that period and in the post-1949 period. It makes sense that Mao was a Marxist and held the established Confucian approach to harmony in disdain. Democracy as we know it doesn’t have any roots in China. Legalism, with its autocratic approach, does. Capitalism, on the other hand, is growing and becoming much more deeply rooted today.

Early on, Deng set out a 70-year plan to a) double incomes and ensure that the population would have enough food and clothing by the end of the 1980s, b) quadruple GDP per capita by the end of the 20th century (which was achieved in 1995, five years ahead of schedule), and c) increase per capita GDP to the levels of medium-level developed countries by 2050 (on the 100th anniversary of the PRC). He made it clear that China would achieve those goals by having a “socialist market economy,” which he also referred to as “socialism with Chinese characteristics.”

During this period of globalization, a symbiotic relationship developed between China and the US in which the Chinese manufactured consumer goods in an extremely cost-effective way and loaned the US money to buy them. It was a hell of a “buy now, pay later” deal for the Americans, and the Chinese liked it because they built their savings in the world’s reserve currency. It struck me as odd that the Chinese, who were earning about a 40th of Americans on average, would be lending money to Americans, since rich people are in a better position to lend than poor ones. To

me, it was a shocking reflection of how deeply Americans were willing to get into debt to finance their overconsumption and how much more the Chinese valued saving. It was also a reflection of how emerging countries that want to save in the bonds/debt of the leading reserve currency countries can lead those countries to become overindebted.

Deng died on February 19, 1997, having transformed China almost beyond recognition. When he came to power, 90 percent of the population lived in extreme poverty; at the time of his death that number had fallen by more than half, and as of the most recent data is below 1 percent. From the start of his reforms in 1978 until his

death in 1997, the Chinese economy grew at an average rate of 10 percent a year, sextupling in size while experiencing an average inflation rate of just 8 percent.

Over the years, the Xi administration has aggressively pursued policies to reform and open up its markets and its economy; manage its debt growth; more flexibly manage its currency; support entrepreneurship and market-oriented decision making, especially in industries that China wants to be world leaders in; establish sensible regulations run by well-developed regulatory organizations; build its capabilities in the technologies and industries of the future; broaden the economic benefits extended to the people and regions that were lagging the most; and control pollution and environmental degradation. Yet many people don’t see it that way, which I suspect is because a) the reforms are coming at the same time as other controls are tightening up, b) some of the supports (like credit availability) for small- and medium-size organizations are not as good as they are for larger state-owned enterprises (which has more to do with technical challenges than any reduced desire to foster the development of small- and medium-size organizations), c) the government directs the economy from the top down, sometimes expecting banks and companies to make uneconomic loans (because it wants to do what is best for the

country as a whole), d) China coordinates with its businesses in pursuit of national goals, e) it doesn’t let some foreign companies operate on the same terms as Chinese companies, and f) it coordinates fiscal and monetary policy to regulate the economy much more than is done in the major reserve currency countries—all of which are typically unpopular with capitalist outsiders.

To understand their circumstances and perspectives, I suggest that you not view what they are doing through stereotypes (e.g., of “what communists do”) and accept that they are trying, and will continue to try, to juggle these two seemingly inconsistent things. In their view capitalism is a way of raising the living standards of most people and is not meant to serve capitalists. Whether one thinks this approach is good or bad, their results have been extremely impressive so we should not expect the Chinese to abandon it for an American or Western approach. Rather, we should study it to see what we can learn from it, the same way that the Chinese have studied and learned from the West. After all, what we have is a

competition of approaches that we need to understand in order to play this competitive game well. As far as foreign policy is concerned, China has become stronger and more forceful while the United States has become more confrontational. More specifically, from 2012 until the time of my writing China’s strengths have grown, which has become increasingly apparent and more openly shown (e.g., the Made in China 2025 plan trumpets its plans to dominate certain industries that the United States currently controls). This has sparked a strong reaction in the US, which became most evident after the election of Donald Trump in 2016.

The results of China’s reform and opening up are reflected in the following table, which shows just a few representative statistics. Output per person has increased 25 times, the percentage of people living below the poverty line has fallen from 96 percent to less than 1 percent, life expectancy has increased by an average of about 10 years, and the average number of years of education has increased by 80 percent. I could go on and on, rattling off equally impressive statistics in virtually every area.

CHINA'S DEVELOPMENT SINCE 1949 AND 1978 1949 1978 2018 Δ Since 1949 Δ Since 1978 RGDP Per Capita* 348 609 15,243 44x 25x Share of World GDP 2% 2% 22% 12x 11x Population Below the Poverty Line ($1.90/Day)** — 96% 1% at least -96% -96% Life Expectancy 41 66 77 +36 Yrs +11 Yrs Infant Mortality Rate (per 1,000 Births) 200 53 7 -96% -86% Urbanization 18% 18% 59% +41% +41% Literacy 47% 66% 97% +50% +31% Avg Yrs of Education 1.7 4.4 7.9 +6.2 Yrs +3.5 Yrs *USD 2017, PPP-adjusted **The World Bank only has poverty data back to 1981

UNITED STATES CHINA 1980 Today Change Change (%) 1980 Today Change Change (%) Average Years of Schooling 11.9 13.6 +1.7 +14% 4.6 7.9 +3.3 +72% Govt Spending on Education (% of GDP) 5.30% 5.50% 0.20% +4% 1.90% 5.20% 3.30% +174% Est Population w/ Tertiary Education (Mln) 25 60 +35 +140% 3 120 +117 +3,900% Population w/ Tertiary Education (% Working-Age Pop) 17% 28% 11% +68% 1% 12% 11% +2,272%

For example, it is because of the United States’ great global successes that the US dollar became the world’s dominant reserve currency, which allowed Americans to borrow excessively from the rest of the world (including from China), which put the US in the tenuous position of owing other countries (including China) a lot of money which has put those other countries in the tenuous position of holding the debt of an overly indebted country that is rapidly increasing and monetizing its debt and that pays significantly negative real interest rates to those holding its debt.

China will probably advance its technologies, and the quality of decision making that is enabled by them, faster than the US will because big data + big AI + big computing = superior decision making.

The amount of resources that are being poured into these and other technology areas is far greater than those in the US. As for providing money, both venture capitalists and the government are providing virtually unlimited amounts to Chinese developers. As for providing people, the number of science, technology, engineering, and math (STEM) graduates that are coming out of college and pursuing tech careers in China is about eight times that in the US. The United States has an overall technology lead (though it is behind in some areas) and of course has some big hubs for new innovations, especially in its top universities and its big tech companies.

In discussions with leaders from different parts of the world I have repeatedly heard it said that there are two overriding considerations—economic and military. They almost all say that if they were to choose on the basis of economics, they would choose China because China is more important to them economically (in trade and capital flows), while if they were to choose on the basis of military support, the United States has the edge but the big question is whether the United States will be there to protect them militarily when they need it. Most doubt that the US will fight for them, and some in the Asia-Pacific region question whether the US has the power to win.

Over the last few years Chinese influence over other countries has been expanding while US influence has been receding. That is also true in multilateral organizations—e.g., the United Nations, the IMF, the World Bank, the World Trade Organization, the World Health Organization, and the International Court of Justice—most of which were set up by the United States at the beginning of the American world order. As the United States has been pulling back from them, these organizations are weakening and China is playing a greater role in them.

As described earlier, Chinese culture compels its leaders and society to make most decisions from the top down, demanding high standards of civility, putting the collective interest ahead of individual interests, requiring each person to know their role and how to play it well, and having filial respect for those superior in the hierarchy. They also seek “rule by the proletariat,” which in common parlance means that opportunities and rewards are broadly distributed. In contrast, 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.

For example, one should accept the fact that when choosing leaders most Chinese believe that having capable, wise leaders make the choices is preferable to having the general population make the choice on a “one person, one vote” basis because they believe that the general population is less informed and less capable. Most believe that the general population will choose the leaders on whims and based on what those seeking to be elected will give them in order to buy their support rather than what’s best for them. Also, they believe—like Plato believed and as has happened in a number of countries—that democracies are prone to slip into dysfunctional anarchies during very bad times when people fight over what should be done rather than support a strong, capable leader. They also believe that their system of choosing leaders lends itself to better multigenerational strategic decision making because any one leader’s term is only a small percentage of the time that is required to progress along its long-term developmental arc.7 They believe that what is best for the collective is most important and best for the country and is best determined by those at the top.

Another study reported that 80 percent of Democrats think that the Republican Party has been taken over by racists and 82 percent of Republicans think that the Democratic Party has been taken over by socialists.

History shows us that reversing a decline is very difficult because it requires undoing so many things that have already been done. For example, if one’s spending is greater than one’s earnings and one’s liabilities are greater than one’s assets, those circumstances can only be reversed by working harder or consuming less. The question is whether we Americans can face our challenges honestly and adapt and change to meet them.

Put deferred gratification ahead of immediate gratification so you will be better off in the future. Triangulate among the smartest people possible. I tag along with the smartest people I can find, so I can stress test my thinking and learn from them.