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

by Ray Dalio

As long as the living standards of most people are still rising, these gaps and resentments don’t boil over into conflict.

The decline phase typically comes from internal economic weakness together with internal fighting, or from costly external fighting, or both. Typically, the country’s decline comes gradually and then suddenly.

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.

the important thing to note for now is that internal orders can change without leading to a change in the world order. It’s only when the forces that produce internal disorder and instability align with an external challenge that the entire world order can change.

The most vulnerable position to be in is having a high reliance on one or a few commodities because they are highly cyclical and sometimes lose value altogether.

Class warfare has profound effects on the internal order,

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 find this dynamic worth keeping an eye on, especially in conflicts.

Wealth = Buying Power. Without getting too nuanced, let’s call wealth buying power to distinguish it from money and credit.

Real wealth is what people buy because they want to have and use it, such as a house, car, streaming video service, etc. Real wealth has intrinsic value. Financial wealth consists of financial assets that are held to a) receive an ongoing income in the future and/or b) be sold in the future to get money to buy the real assets people will want. Financial wealth has no intrinsic value.

Wealth = Power. That is because if one has enough wealth one can buy most anything—physical property, the work and loyalty of others, education, healthcare, influential powers of all sorts (political, military, etc.), and so on.

To be successful one must earn an amount that is at least equal to the amount one spends.

Stage 1: People and Their Countries Are Poor and They Think of Themselves as Poor.

Stage 2: People and Their Countries Are Rich but Still Think of Themselves as Poor.

Stage 3: People and Their Countries Are Rich and Think of Themselves as Rich.

Stage 4: People and Their Countries Are Poorer and Still Think of Themselves as Rich.

Stage 5: People and Their Countries Are Poor and They Think of Themselves as Poor.

“The poor and the rich quarrel with one another, and whichever side gets the better, instead of establishing a just or popular government, regards political supremacy as the prize of victory.”

Rich or poor? 2. Right, left, or moderate? 3. Race? 4. Ethnicity? 5. Religion? 6. Gender? 7. Lifestyle (e.g., liberal or conservative)? 8. Location (e.g., urban, suburban, or rural)?

those societies that draw on the widest range of people and give them responsibilities based on their merits rather than privileges are the most sustainably successful because 1) they find the best talent to do their jobs well, 2) they have diversity of perspectives, and 3) they are perceived as the fairest, which fosters social stability.

All entities—people, companies, nonprofit organizations, and governments—deal with the same basic financial realities, and always have.

They have money that comes in (i.e., revenue) and money that goes out (i.e., expenses) that, when netted, make up their net income.

The way entities collectively handle their finances as reflected in their income statements and balance sheets is the biggest driver of changes in internal and world orders. If you can take your understanding of your own income, expenses, and savings, imagine how that applies to others, and put them together, you will see how the whole thing works.

For example, since one entity’s spending is another’s income, when one entity cuts its expenses, that will hurt not just that entity, but it will also hurt others who depend on that spending to earn income.

This dynamic produces a self-reinforcing downward debt and economic contraction that becomes a political issue as people argue over how to divide the shrunken pie.

Pencil out what your financial safety margin looks like (how long will you be financially OK if the worst-case scenario happens—e.g., you lose your job and your investment assets fall to be only half as much to account for possible price falls, taxes, and inflation). Then do that calculation for others, add them up, and you will have a good picture of the state of your world. I’ve done that with the help of my partners at Bridgewater and find it invaluable in imagining what is likely to happen.1

debt eats equity but central banks can feed debt by printing money instead.

Having a reserve currency is great while it lasts because it gives a country exceptional borrowing and spending power and significant power over who else in the world gets the money and credit needed to buy and sell internationally.

Money is a medium of exchange that can also be used as a storehold of wealth.

Basically, people produce things in order to exchange them with people who have other things they want.

currency), which is something portable that everyone agrees is of value so it can be exchanged for what they want.

Money is what settles claims—you pay your bills and are done. Debt is a promise to deliver money.

While the loan is outstanding, it is an asset for the lender (e.g., a bond) and a liability (i.e., debt) for the borrower.

In the real economy, supply and demand are driven by the amount of goods and services produced and the number of buyers who want them.

That’s where the financial economy comes in. Facing inflation, central banks normally tighten money and credit to slow demand in the real economy; when there is too little demand, they do the opposite by providing money and credit to stimulate demand.

When a lot of a currency is created relative to the demand for it, it declines in value.

we have to watch movements in the supplies and demands of both the real economy and the financial economy to understand what is likely to happen financially and economically.

if you own a house and the government creates a lot of money and credit, there might be many eager buyers who would push the price of your house up. But it’s still the same house; your actual wealth hasn’t increased, just your calculated wealth.

money and credit are stimulative when they’re given out and depressing when they have to be paid back. That’s what normally makes money, credit, and economic growth so cyclical. The central bankers who control money and credit (i.e., central banks) vary the costs and availability of money and credit to control markets and the economy.

When the economy is growing too quickly and they want to slow it down, central bankers make less money and credit available, causing both to become more expensive. This encourages people to lend rather than borrow and spend. When there is too little growth and central bankers want to stimulate the economy, they make money and credit cheap and plentiful, which encourages people to borrow and invest and/or spend.

All currencies devalue or die, and when they do, cash and bonds (which are promises to receive currency) are devalued or wiped out. That is because printing a lot of currency and devaluing debt is the most expedient way of reducing or wiping out debt burdens.

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.

That prosperous period is called the Second Industrial Revolution, when borrowers turned the money they borrowed into earnings that allowed their debts to be paid back at high interest rates.

this bubble process. That is because as their assets go up in value their net worth and spending-to-income level rise, which increases their borrowing capacity, which supports the leveraging-up process, and so the spiral goes until the bubbles burst.

A classic marker of being in Stage 5 and a leading indicator of the loss of borrowing and spending power, which is one of the triggers for going into Stage 6,

To have peace and prosperity, a society must have productivity that benefits most people. Do you think we have this today?

What a society spends money on matters. When it spends on investment items that yield productivity and income gains, it makes for a better future than when it spends on consumption items that don’t raise productivity and income.

Watch populism and polarization as markers. The more that populism and polarization exist, the further along a nation is in Stage 5, and the closer it is to civil war and revolution. In Stage 5, moderates become the minority. In Stage 6, they cease to exist.

Not knowing what is true because of distortions in the media and propaganda increases as people become more polarized, emotional, and politically motivated.

“one person, one vote” democratic process has the drawback of having leaders selected via popularity contests by people who are largely not doing the sort of thoughtful review of capabilities that most organizations would do when trying to find the right person for an important job. Democracy has also been shown to break down in times of great conflict.