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

by Ray Dalio

all reserve currencies in the past have ceased to be reserve currencies, often coming to traumatic ends for the countries that enjoyed this special power. So I also began to wonder whether, when, and why the dollar will decline as the world’s leading reserve currency, what might replace it, and how that would change the world as we know it.

because these learnings and productivity improvements are evolutionary, they don’t cause big abrupt shifts in who has what wealth and power. The big abrupt shifts come from booms, busts, revolutions, and wars, which are primarily driven by cycles, and these cycles are driven by logical cause/effect relationships.

Keep in mind that economic destruction periods and war periods typically don’t last very long—roughly two or three years.

Unless you understand how money and credit work, you can’t understand why the world changed as it did in 1933 or what happened next (World War II), how the war was won and lost, and why the new world order was created as it was in 1945. But when you can recognize the underlying mechanics that drove all of those things in the past, you can also understand what is happening now and have a much better sense about what is likely to happen in the future.

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. However, having a reserve currency typically sows the seeds of a country ceasing to be a reserve currency country. That is because it allows the country to borrow more than it could otherwise afford to borrow, and the creation of lots of money and credit to service the debt debases the value of the currency and causes the loss of its status as a reserve currency. The loss of its reserve currency status is a terrible thing because having a reserve currency is one of the greatest powers a country can have because it gives the country enormous buying power and geopolitical power.

the intrinsic value of a thing doesn’t increase just because its price goes up.

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.

When credit cycles reach their limit, it is the logical and classic response for central governments and their central banks to create a lot of debt and print money that will be spent on goods, services, and investment assets in order to keep the economy moving.

It also happened in a big way in 2020 in response to the plunge triggered by the COVID pandemic. That was also done in response to the 1929–32 debt crisis, when interest rates had similarly been driven to 0 percent. At the time I am writing this, the creation of debt and money has been happening in amounts greater than at any time since World War II.

History has shown that we shouldn’t rely on governments to protect us financially. On the contrary, we should expect most governments to abuse their privileged positions as the creators and users of money and credit for the same reasons that you might commit those abuses if you were in their shoes. That is because no one policy maker owns the whole cycle.

This is what has been happening during the coronavirus crisis as central governments and banks send out large amounts of money and credit. Note that you don’t hear anyone complaining about the money and credit creation; in fact, people say that governments would be cheap and cruel if they didn’t provide a lot more of it. Hardly anyone acknowledges that governments don’t actually have this money to give out. Governments aren’t rich entities with piles of money lying around. They are just their people collectively, who will ultimately have to pay for the creation and giving out of money.

imagine what those same citizens would say if government officials cut expenses to balance their budgets and asked them to do the same, making lots of them go broke, and/or if they sought to redistribute wealth from those who have more to those who have less by raising taxes. The money and credit producing path is much more acceptable politically than either of those options. It’s as if you changed the rules of Monopoly to allow the banker to make more money and redistribute it whenever too many players are going broke and getting angry.

It is become clearer to me the role of central banks in preventing civil wars.

There are systemically beneficial devaluations (though they are always costly to holders of money and debt), and there are systemically destructive ones that damage the credit/capital allocation system but are needed to wipe out debt in order to create a new monetary order. It’s important to be able to tell the difference.

Interestingly, those states and cities in the US that have the highest per capita income and wealth levels tend to be the states and cities that are the most indebted and have the largest wealth gaps—e.g., cities like San Francisco, Chicago, and New York City and states like Connecticut, Illinois, Massachusetts, New York, and New Jersey.

Expenditure cuts are most intolerable for those who are poorest, so there needs to be more taxation of people who can afford to pay more and there is a heightened risk of some form of civil war or revolution. But when the haves realize that they will be taxed to pay for debt service and to reduce the deficits, they typically leave, causing the hollowing-out process. This is currently motivating movements from some states to others in the US. If bad economic conditions occur, that hastens the process. These circumstances largely drive the tax cycle.

History shows that raising taxes and cutting spending when there are large wealth gaps and bad economic conditions, more than anything else, has been a leading indicator of civil wars or revolutions of some type. To be clear they don’t have to be violent, though they can be.

Those who favor policies that are good for the whole—e.g., free trade, globalization, advances in technology that replace people—without thinking about what happens if the whole is not divided in a way that benefits most people are missing the fact that the whole is at risk. To have peace and prosperity, a society must have productivity that benefits most people. Do you think we have this today?

Yes! I couldn’t agree more!

Populists can be of the right or of the left, are much more extreme than moderates, and tend to appeal to the emotions of ordinary people. They are typically confrontational rather than collaborative and exclusive rather than inclusive. This leads to a lot of fighting between populists of the left and populists of the right over irreconcilable differences.

A classic marker in Stage 5 that increases in Stage 6 is the demonization of those in other classes, which typically produces one or more scapegoat classes who are commonly believed to be the source of the problems. This leads to a drive to exclude, imprison, or destroy them, which happens in Stage 6.

Demonizing and scapegoating are a classic symptom and problem that we must keep an eye on.

During times of great wealth gaps and populist thinking, stories that bring down elites are popular and lucrative, especially those that bring down left-leaning elites in right-leaning media outlets and those that bring down right-leaning elites in left-leaning media outlets. History shows that significant increases in these activities are a problem that is typical of Stage 5, and that when combined with the ability to inflict other punishments, the media becomes a powerful weapon.

When the causes that people are passionately behind are more important to them than the system for making decisions, the system is in jeopardy. Rules and laws work only when they are crystal clear and most people value working within them enough that they are willing to compromise in order to make them work well.

That brings me to my next principle: when in doubt, get out—if you don’t want to be in a civil war or a war, you should get out while the getting is good.

When one is in Stage 5 (like the US is now), the biggest question is how much the system will bend before it breaks. The democratic system, which allows the population to do pretty much whatever it decides to do, produces more bending because the people can make leadership changes and only have themselves to blame. In this system regime changes can more easily happen in a peaceful way.

Almost all civil wars have had some foreign powers participating in attempt to influence the outcome to their benefit.

Wow!

The truth is that almost no one at the time knows that a civil war has begun or that it has ended, but they know when they are in them.

As conditions change the best approaches change—i.e., what is best depends on the circumstances and the circumstances are always changing in the ways we just looked at. For that reason it is a mistake to rigidly believe that any economic or political system is always best because there will certainly be times when that system is not best for the circumstances at hand, and if a society doesn’t adapt it will die. That is why constantly reforming systems to adapt well is best. The test of any system is simply how well it works in delivering what most of the people want, and this can be objectively measured, which we can do and will continue to do. Having said that, the lesson from history that comes through most loudly and most clearly is that skilled collaborations to produce productive win-win relationships to both grow and divide the pie well, so that most people are happy, are much more rewarding and much less painful than fighting civil wars over wealth and power that lead to one side subjugating the other side.

For example, if the US, China, or other countries have more power than the United Nations, then the US, China, or other countries will determine how things go rather than the United Nations. That is because power prevails, and wealth and power among equals is rarely given up without a fight.

For example, the decline of China from around 1840 to 1949, known as the “Century of Humiliation,” came about because the Western powers and Japan exploited China. As you read on, keep in mind that the two things about war that one can be most confident in are 1) that it won’t go as planned and 2) that it will be far worse than imagined. It is for those reasons that so many of the principles that follow are about ways to avoid shooting wars. Still, whether they are fought for good reasons or bad, shooting wars happen. To be clear, while I believe most are tragic and fought for nonsensical reasons, some are worth fighting because the consequences of not fighting them (e.g., the loss of freedom) would be intolerable.

It is far too easy to slip into stupid wars because of a) the prisoner’s dilemma, b) a tit-for-tat escalation process, c) the perceived costs of backing down for the declining power, and d) misunderstandings existing when decision making has to be fast. Rival great powers typically find themselves in the prisoner’s dilemma; they need to have ways of assuring the other that they won’t try to kill them lest the other tries to kill them first. Tit-for-tat escalations are dangerous in that they require each side to escalate or lose what the enemy captured in the last move; it is like a game of chicken—push it too far and there is a head-on crash.

When the existing great power is declining in relation to a rising power, it has a natural tendency to want to maintain the status quo or the existing rules, while the rising power wants to change them to be in line with the changing facts on the ground.

After his 1935 tax bill, then popularly called the “Soak the Rich Tax,” the top marginal income tax rate for individuals rose to 75 percent (versus as low as 25 percent in 1930). By 1941, the top personal tax rate was 81 percent, and the top corporate tax rate was 31 percent, having started at 12 percent in 1930. Roosevelt also imposed a number of other taxes. Despite all of these taxes and the pickup in the economy that helped raise tax revenue, budget deficits increased from around 1 percent of GDP to about 4 percent of GDP because the spending increases were so large.5 From 1933 until the end of 1936 the stock market returned over 200 percent, and the economy grew at a blistering average real rate of about 9 percent. In 1936, the Federal Reserve tightened money and credit to fight inflation and slow an overheating economy, which caused the fragile US economy to fall back into recession and the other major economies to weaken with it, further raising tensions within and between countries.

Before there is a shooting war there is usually an economic war.

When countries are weak, opposing countries take advantage of their weaknesses to obtain gains.

This is such a saddening statement.

In the 35 years before 1945, virtually all wealth was destroyed or confiscated in most countries, and in some countries many capitalists were killed or imprisoned because of anger at them when the capital markets and capitalism failed along with other aspects of the old order.

This is mind blowing!

Up until around 1350, lending with an interest rate was prohibited by both Christianity and Islam—and in Judaism it was banned within the Jewish community—because of the terrible problems it caused, with human nature leading people to borrow more than they could pay back, which created tensions and often violence between borrowers and lenders. As a result of this lack of lending, currency was “hard” (gold and silver). A century or so later, in the Age of Exploration, explorers went around the world collecting gold and silver and other hard assets to make more money. That’s how the greatest fortunes were built at the time. The explorers and those who backed them split the profits. It was an effective incentive-based system for getting rich.

And as mentioned in previous chapters was taken by force, i.e. colonialism.

Relevant to what is happening today in the world.

While I think that the odds of the US devolving into a Stage 6 (civil-war-type) dynamic within the next 10 years are only around 30 percent, that is a dangerously high risk that must be protected against and watched closely via my coincident and leading indicators.