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

by Ray Dalio

From gaining this perspective, I’ve come to believe that throughout history there are only a limited number of personality types4 going down a limited number of paths, which lead them to encounter a limited number of situations to produce a limited number of stories that repeat over time. The only things that change are the clothes the characters are wearing, the languages they are speaking, and the technologies they’re using.

From examining all these cases across empires and across time, I saw that the great empires typically lasted roughly 250 years, give or take 150 years, with big economic, debt, and political cycles within them lasting about 50 to 100 years.

Throughout time, the formula for success has been a system in which well-educated people, operating civilly with each other, come up with innovations, receive funding through capital markets, and own the means by which their innovations are turned into the production and allocation of resources, allowing them to be rewarded by profit making.

One timeless and universal truth that I saw go back as far as I studied history, since before Confucius, who lived around 500 BCE, is that 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.

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.

When one can manufacture money and credit and pass them out to everyone to make them happy, it is very hard to resist the temptation to do so.5 It is a classic financial move. Throughout history, rulers have run up debts that won’t come due until long after their own reigns are over, leaving it to their successors to pay the bill.

The Fed announced that plan on April 9, 2020. That approach of printing money to buy debt (called “debt monetization”) is vastly more politically palatable as a way of shifting wealth from those who have it to those who need it than imposing taxes because those who are taxed get angry. That is why central banks always end up printing money and devaluing. When governments print a lot of money and buy a lot of debt, they cheapen both, which essentially taxes those who own it, making it easier for debtors and borrowers. When this happens to the point that the holders of money and debt assets realize what is going on, they seek to sell their debt assets and/or borrow money to get into debt they can pay back with cheap money. They also often move their wealth into better storeholds, such as gold and certain types of stocks, or to another country not having these problems. At such times central banks have typically continued to print money and buy debt directly or indirectly (e.g., by having banks do the buying for them) while outlawing the flow of money into inflation-hedge assets, alternative currencies, and alternative places.

When the devaluations and defaults become so extreme that the money and credit system breaks down, necessity generally compels governments to go back to some form of hard currency to rebuild people’s faith in the value of money as a storehold of wealth. Quite often, though not always, the government links its money to gold or a hard reserve currency with a promise to allow holders of that new money to convert it to the hard money. Sometimes that hard money is another country’s. For example, over the past decades many weak-currency countries have linked their money to the US dollar or simply dollarized their economy (i.e., used the dollar as their own medium of exchange and storehold of wealth).

These cycles of building debts and writing off debts have existed for thousands of years and in some cases have been institutionalized. For example, the Old Testament describes a year of Jubilee every 50 years, in which debts were forgiven. Knowing that the debt cycle would happen on that schedule allowed everyone to act in a rational way to prepare for it.

For thousands of years, there have always been three types of monetary systems: Type 1: Hard money (e.g., metal coins) Type 2: Paper money (claims on hard money) Type 3: Fiat money

The Classic Toxic Mix The classic toxic mix of forces that brings about big internal conflicts consists of 1) the country and the people in the country (or state or city) being in bad financial shape (e.g., having big debt and non-debt obligations), 2) large income, wealth, and values gaps within that entity, and 3) a severe negative economic shock.

Out of disorder and discontent come leaders who have strong personalities, are anti-elitist, and claim to fight for the common man. They are called populists. Populism is a political and social phenomenon that appeals to ordinary people who feel that their concerns are not being addressed by the elites. It typically develops when there are wealth and opportunity gaps, perceived cultural threats from those with different values both inside and outside the country, and “establishment elites” in positions of power who are not working effectively for most people. Populists

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. However, the “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.

discipline, and productivity. Examples of revolutions from the left to the right include Germany, Spain, Japan, and Italy in the 1930s; the fall of the Soviet Union in the 1980s to the early 1990s; the 1976 coup in Argentina replacing Isabel Perón with a military junta; and the coup leading to the Second French Empire in 1851.

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.

From my study of Chinese dynasties and European empires, I’ve learned that the financial strength to outspend one’s rivals is one of the most important strengths a country can have. That is how the United States beat the Soviet Union in the Cold War. Spend enough money in the right ways, and you don’t have to have a shooting war. Long-term success depends on sustaining both the “guns” and the “butter” without producing the excesses that lead to their declines. In other words, a country must be strong enough financially to give its people both a good living standard and protection from outside enemies. The really successful countries have been able to do that for 200 to 300 years. None has been able to do it forever.

What is fascism? Consider the following three big choices that a country has to make when selecting its approach to governance: 1) bottom-up (democratic) or top-down (autocratic) decision making, 2) capitalist or communist (with socialist in the middle) ownership of production, and 3) individualistic (which treats the well-being of the individual with paramount importance) or collectivist (which treats the well-being of the whole with paramount importance).

At the time, Confucian scholars were then seen to be near the top of the social hierarchy, which helped them get ahead in politics. To get ahead one needed to study Confucianism in depth and pass highly competitive exams. Political decisions were frequently based on ruler’s interpretations of Confucian ideals. “Neo-Confucianism,” which was dominant at the time, shifted the focus of the belief system toward a more rational, philosophical, academic, and humanistic form. This way of thinking, which was practical, evidence-based, and scientific, was a key reason China pulled so far ahead of Europe in the Middle Ages. At the time, scholars and scientists had significant power, which led to remarkable technological advances (gun powder, the printing press, architecture, and more). Literacy rates were extremely high relative to other places at the time, and China was also advanced in medicine. For example, it had a widespread program of fighting smallpox infection via an early form of vaccination, centuries before Europe. Its financial system was

In his wonderful book, The Rise and Fall of the Great Powers, historian Paul Kennedy described it well: “Of all the civilizations of premodern times, none appeared more advanced, none felt more superior than that of China. Its considerable population, 100–130 million compared with Europe’s 50–55 million in the fifteenth century; its remarkable culture; its exceedingly fertile and irrigated plains, linked by a splendid canal system since the eleventh century; and its unified, hierarchic administration run by a well-educated Confucian bureaucracy had given a coherence and sophistication to Chinese society which was the envy of foreign visitors.”

Ironically and typically, the enormity of the Ming Dynasty’s wealth and power is one possible explanation of what eventually led to its fall. Believing that they did not need anything else, the emperors put an end to China’s exploration of the world, closed its doors, and retired to lives of pleasure, and turned over the running of government to their ministers and eunuchs, which led to dysfunctional infighting, corruption, weakness, and vulnerability to attack. There was a shift away from pragmatic scientific study and innovation toward pedantic scholarship. As we’ll see in Chapter 12, this helped drive the decline of China relative to Europe.

The Commercial Revolution was the move away from a solely agriculture-based economy to one that included trade in a variety of goods. This evolution began in the 12th century, and by 1500, it was centered in the Italian city-states due to a confluence of two factors that enabled them to become terrifically wealthy. First, the wars between Christian Europe and the Ottoman Empire significantly slowed land trade (especially for spices and luxuries) between Europe and the rest of the world, which created a significant opening for maritime trade. Second, a number of Italian city-states developed republican governments modeled after the Roman Republic. Their governments were more inventive and responsive than those in the rest of Europe, which allowed a strong merchant class to develop. Venice was a prime example of this, as its governance system was designed with multiple checks and balances to ensure that there was a more meritocratic approach to government than existed in the rest of Europe. Venice’s leader—called the doge—did not have the right to name a successor and was restricted from bringing family members into government. New doges were chosen by vote by a series of committees whose members, in some cases, were chosen by lot from among several hundred aristocratic families. The Italians produced well-functioning capital markets, supported by new advances in bookkeeping and impartial institutions to enforce contracts. While private and government borrowing weren’t new, ...

Invention of Capitalism (1600s) Beginning with the Dutch, the development of publicly available and popularly used equity markets allowed savers to effectively transfer their buying power to entrepreneurs who could put that buying power to productive and profitable use. This significantly improved the allocation of resources and was stimulative to economies because it produced new buying power. It also produced the capital markets cycles. While there were many elements involved in the creation of capitalism, a series of related economic and financial developments—most notably the developments of publicly traded stock and bond markets such as the opening of the Amsterdam Stock Exchange in 1602 and the Bank of England’s first government bond issuance (to fund the war with France) in 1694—are associated with it. Along with the advances of the Scientific Revolution, the invention of capitalism was a key reason behind the shift from slow real GDP growth to the faster growth, as seen in the chart I showed in Chapter 1.

The Scientific Revolution (1500s–1600s) 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. The scientific method was pioneered by Francis Bacon in the early 1600s, though many important advances in astronomy—particularly the work of Copernicus and Galileo—took place earlier, in the 1500s.

The Enlightenment and the Age of Revolutions (1600s–1700s) 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. New fields like economics expanded thanks to thinkers like Adam Smith, while figures like John Locke and Montesquieu pushed political philosophy in new directions. In particular, the Enlightenment ideas of these and other figures promoted rationality and individual liberties and undermined monarchic and religious powers, creating a movement toward overthrowing monarchies known as the Age of Revolutions. This wave of revolutions included the American, French, Spanish, German, Portuguese, and Italian.

The Dutch invented capitalism as we know it. This was great for the Dutch and great for the world, but like most great inventions, it brought with it some potentially deadly consequences. While production, trade, and private ownership had existed before, the ability of large numbers of people to collectively buy ownership in money-making endeavors through public equity markets did not exist. The Dutch created that when they invented the world’s first publicly listed company (the Dutch East India Company) and the first stock exchange in 1602. Like most inventions, these capital market developments arose out of necessity and self-interest. The voyages across the world in search of new trade routes were risky ventures, so it made sense for merchants to sell some of the risk associated with the voyage to others in exchange for a share of the future profits. At the time the Dutch introduced equity shares in their voyages in the mid-1500s, it was revolutionary. Until 1600, these shares were held by only a small number of merchants, largely lacked transparency, and were illiquid, so their attractiveness to outside investors was limited. The formation of the Amsterdam Stock Exchange in August 1602 and the listing of the Dutch East India Company spread share ownership much wider (more than one in 50 Dutch adults owned shares), and the exchange’s clear rules about ownership and transfer of shares made the market much more transparent. The Dutch East India Company was an equally revo...

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. Prior to the Dutch banking innovations, the international currency situation was a mess. In the late 1500s, around 800 different foreign and domestic coins circulated in the Netherlands, many of which were debased (i.e., had a lowered content of precious metal in the coins) and difficult to distinguish from counterfeits. This created uncertainty over the value of money, which made international trade slower and more expensive.

The English Civil War specifically led to the king (Charles I) being tried and executed and the monarchy being replaced by the Commonwealth of England under the rule of the general who led the revolt, Oliver Cromwell. These conflicts established rule of law rather than rule of the monarchy and they created a new balance of power between the king and Parliament that set the foundation for Great Britain’s later rise. That is because a strong Parliament allowed for a moderately meritocratic selection of national leaders, as the prime minister had to command the confidence of Parliament rather than just be a favorite of the royal court. Statesmen who led Britain during its later rise and peak—such as William Pitt the Elder and his son, Will Pitt the Younger, Robert Peel, William Gladstone, and Benjamin Disraeli—were strong forces for shaping Britain. They all came from families of merchants, not the landed gentry.

The productivity revolution started with agriculture. Agricultural inventions increased productivity, which reduced the labor intensity of farming. It also made food more plentiful and cheaper, which led to a population boom. Together these forces led to people flocking to cities, which benefited industry from the steadily increasing supply of labor. The Industrial Revolution was driven not only by the creation of brand-new inventions like the steam engine but also by adapting and improving on existing concepts to make production more efficient, such as standardizing inputs and moving production from individual artisans to factories. Ample labor, energy, and connected global markets together helped support the burst of innovation. This

list gives a sense of the timing and pace of innovation in the UK: 1712: Steam engine invented. 1719: Silk factory established. 1733: Flying shuttle (basic weaving machine) invented. 1764: Spinning jenny (multi-spindle weaving machine) invented. 1765: Separate condenser (for steam engines) invented. 1769: Water frame (hydraulic power for weaving machines) invented; steam engine upgraded. 1785: Power loom invented; iron refining developed. 1801: Steam-powered locomotive on wheels invented. 1816: Steam-powered locomotive on rail patented. 1825: Railway construction initiated on a line connecting Manchester and Liverpool.

At the time, France’s most famous economist was John Law (a Scotsman by birth) who thought the creation of new money would stimulate the economy. In 1716 he created a national bank with the ability to issue paper money backed by land, gold, silver, and state bills. That began the upswing in the cycle. The original capital for this bank, Banque Générale, was provided by shareholders, who also sat on the bank’s board. France had had a stock market since 1673, when Finance Minister Jean-Baptiste Colbert’s Ordinance of Trade was codified into commercial law,1 so it had all the ingredients for a classic capital markets upswing.

As mentioned, at their peak in the late 19th century around 1870, the British produced 20 percent of the world’s income and controlled 40 percent of global exports, 20 percent of the world’s land mass, and 25 percent of the world’s population. And the pound, of course, became the world’s undisputed reserve currency. The charts on the following pages help paint the picture of Britain’s dominant strength.

Schuman and Adenauer’s project, along with the rest of the EU’s founders, was to make war “not merely unthinkable, but materially impossible.”

As with all new countries and dynasties, the US went through the usual revolution and post-revolution process in which it created a new domestic order as 1) a coordinated group of strong leaders fought to gain control, 2) that group won and consolidated control, 3) the new leadership had a vision supported by the population, but 4) it split into factions that had conflicts over how the government should work to implement that vision. Eventually, these factions 5) figured out the system for control and laid it out in agreements (in the US case, at first in the Articles of Confederation and then in the Constitution), 6) set up the parts of government (e.g., the money and credit system, the legal system, the legislative systems, the military, etc.), and 7) put people in jobs and made it work well. The US did these things in a uniquely peaceful way through negotiations, near-total respect for agreements, and good designs for governance that gave it a great start.

remember the inflation psychology of that time very well; it led Americans to borrow money and immediately take their paychecks to buy things to “get ahead of inflation.” They also bought things that you couldn’t make more of, like gold and waterfront properties. The panic out of dollar debt also led interest rates to rise and drove the gold price from the $35 that it was fixed at in 1944 and officially stayed at until 1971 to $850 in 1980.

Economics and politics have swings between the left and the right in varying extremes as the excesses of each become intolerable and the memories of the problems of the other fade. It’s like fashion—the widths of ties and the lengths of skirts change through time. When there is great popularity of one extreme, one should expect that it won’t be too long before there will be a comparable move in the opposite direction. The move to monetary tightness broke the backs of debtors and curtailed borrowing, which drove the world economy into its worst downturn since the Great Depression. The Federal Reserve slowly started to cut interest rates, but the markets continued to decline. Then Mexico defaulted on its debt in August 1982. Interestingly, the US stock market rallied in response.

I learned that the value of assets is the reciprocal of the value of money and credit (i.e., the cheaper money and credit are, the more expensive asset prices are) and the value of money is the reciprocal of the quantity of it in existence, so when central banks are producing a lot of money and credit and making it cheaper, it is wise to be more aggressive in owning assets.

In 2016, Donald Trump, a blunt-speaking businessman and capitalist/populist of the right, led a revolt against establishment politicians and “elites” to get elected president by promising to support people with conservative values who had lost jobs and were struggling. He went on to cut corporate taxes and run big budget deficits that the Fed accommodated. While this debt growth financed relatively strong market-economy growth and created some improvements for lower-income earners, it was accompanied by a further widening of the wealth and values gap, leading the “have-nots” to become increasingly resentful of the “haves.” At the same time, the political gap grew with increasingly extreme Republicans on the one side and increasingly extreme Democrats on the other. This is reflected in the next two charts. The first one shows how conservative Republicans in the Senate and House and how liberal Democrats in the Senate and House have become relative to the past. Based on this measure they have become more extreme, and their divergence has become larger than ever before. While I’m not sure that’s exactly right, I think it’s by and large right.

The next chart shows the percentage of votes along party lines for the average representative, which is the highest ever. This continues to be reflected in the reduced willingness to cross party lines to compromise and reach agreements. In other words, the political splits in the country have become deep and intransigent.

History has shown us that greater polarization equals either a) greater risk of political gridlock, which reduces the chances of revolutionary changes that rectify the problems or b) some form of civil war/revolution. In Chapter 5, I described the classic markers signaling the probabilities of escalation from Stage 5 to Stage 6. The three most important markers I am watching now are: 1) the rules being disregarded, 2) both sides emotionally attacking each other, and 3) blood being spilled.

Stage 1, when the new order begins and the new leadership consolidates power, which leads to… … Stage 2, when the resource-allocation systems and government bureaucracies are built and refined, which if done well leads to… … Stage 3, when there is peace and prosperity, which leads to… … Stage 4, when there are great excesses in spending and debt and the widening of wealth and political gaps, which leads to… … Stage 5, when there are very bad financial conditions and intense conflict, which leads to… … Stage 6, when there are civil wars/revolutions, which leads to… … Stage 1, which leads to Stage 2, etc., with the whole cycle happening over again.

Let’s review this cycle quickly. The typical cycle begins with strong leaders who win control and implement improvements needed to build a great empire. As with most other empires, the initial winning of

the war for control is typically followed by struggling to get most of the population in line and united (often through conflict to establish the leadership’s power). That is typically followed by a peace that is due to no entities wanting to challenge the dominant power (Stage 1). Then the new ruler turns to building up the empire. To be successful an empire needs a smart and determined population that works well with each other. It also needs to be strong financially. These things are obtained by systems that train and produce people who have strong education and self-discipline. Getting the most capable people into the most important roles requires the meritocratic selection of people. In Chinese dynasties, the imperial exams often played that role, and it was common for new dynasties to implement educational reforms. It also requires an effective resource-allocation system (Stage 2). During that period of peace and ...

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. 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.

Chinese leaders don’t just try to implement their plans; they set out clear metrics by which to judge their performance, and they achieve most of their goals. I’m not saying that this process is perfect because it isn’t, and I’m not saying that they don’t have political and other challenges that lead to disagreements, including some brutal fights over what should be done, because they do (in private). What I am saying is that the Chinese have much longer-term and historically based perspectives and planning horizons, which they break down into shorter-term plans and ways of operating, and they have done an excellent job of achieving what they have set out to do by following this approach. 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.

Confucianism seeks to bring about harmony by ensuring that people know their roles in the hierarchy and how to play them well, starting from within the family (between the husband and the wife, the father and the son, the older sibling and the younger sibling, etc.) and extending up to the ruler and their subjects. Each person respects and obeys those above them, who are benevolent and at the same time impose strict standards of behavior. All people are expected to be kind, honest, and fair. Confucianism values harmony, broad-based education, and meritocracy. Legalism favors the rapid conquest and unification of “everything under heaven” by an autocratic leader. It argues that the world is a kill-or-be-killed jungle in which strict obedience to the emperor’s central government is required, without much benevolence given in return. The Western equivalent of legalism is fascism. Taoism teaches that it is of paramount importance to live in harmony with the laws of nature. Taoists believe that nature is composed of opposites—yin

and yang—and that harmony is achieved when they are balanced well.

All of these Chinese systems are hierarchical and nonegalitarian. Wang Qishan, the vice president of China and a remarkable historian and explorer of different cultures, told me that 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. The Chinese word “country” consists of the two characters for “state” and “family,” he explained, so Chinese leaders seek to run their state the way they think parents should run their families, with each person knowing their place and having filial respect for those above them. As a result, the Chinese are more humble, respectful, and rules-bound, while Americans are more arrogant, egalitarian, and rules-averse. I’ve observed that while the Chinese are more interested in asking questions and learning, Americans are more interested in telling you what they think.

Traditional Chinese military philosophy teaches that the ideal way to win a war is not by fighting but by quietly developing one’s power to the point that simply displaying it will cause an opponent to capitulate. It also calls for the extensive use of psychology to influence opponents’ behaviors.11 Still, there have been numerous violent dynastic wars inside China. The few wars that were fought outside China were for the purpose of establishing China’s relative power and opening trade.

As previously explained, currencies are used for 1) domestic transactions, which the government has a monopoly in controlling (and hence can be carried out with fiat or even flimflam currencies) and 2) international transactions, in which case the currencies must be of real value or they won’t be accepted. 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. So, as a principle: when you see capital controls being put on a currency, especially when there is a big domestic debt problem, run from that currency.

Though I’m no expert on Marxism, 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.” In other words, I believe, and it sounds like Marx believed, that learning and evolving from conflicts and mistakes is the best approach.