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

by Ray Dalio

Lenin built on what Marx said to create a two-step process for building the state, in which there is at first a vanguard of workers though “democratic centralism” (in which only members of the party vote), which eventually leads to a higher communist state in which there is common ownership of the means of production, social and economic equality, and general prosperity. Mao liked the Marxist-Leninist approach, in which the achievement of the communist ideal came at the end of a very long evolutionary process. Deng Xiaoping reiterated this view in an interview with “60 Minutes” in 1986, in which he said that the capitalism he was adopting and communism were not incompatible. “According to Marxism,” he said, “communist society is based on material abundance… Only when there is material abundance can the principle of a communist society—‘from each according to his ability, to each according to his needs’—be applied. Socialism is the first stage of communism…” Maybe that’s true and maybe it’s not. Time will tell.

History has shown that all countries’ success depends on sustaining the strengthening forces without producing the excesses that lead to countries’ declines. The really successful countries have been able to do that in a big way for 200–300 years. No country has been able to do it forever.

I would worry a lot if we were to see an emerging fight over sovereignty, especially if we were to see a “Fourth Taiwan Strait Crisis.” Would the US fight to defend Taiwan? Uncertain. The US not fighting would be a great geopolitical win for China and a great humiliation for the US. It would signal the decline of the US Empire in the Pacific and beyond in much the same way as the British loss of the Suez Canal signaled the end of the British Empire in the Middle East and beyond. The implications of that would extend well beyond that loss. For example, in the British case it signaled the end of the pound as a reserve currency. The more of a show the US makes of defending Taiwan the greater the humiliation of a lost war or a retreat would be. That is concerning because the United States has been making quite a show of defending Taiwan while destiny appears to be bringing a direct conflict to a head before long. If the US does fight, I believe that a war with China over Taiwan that costs American lives would be very unpopular in the US and the US would probably lose that fight, so the big question is whether that would lead to a broader war. That scares everyone. Hopefully the fear of that great war and the destruction it would produce, like the fear of mutually assured destruction, will prevent it.

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 has taught us that when there are leadership transitions and/or weak leadership at the same time that there is big internal conflict, the risk of the enemy making an offensive move should be considered elevated. Because time is on China’s side, if there is to be a war, it is in the interest of the Chinese to have it later (e.g., five to 10 years from now when it will likely be stronger and more self-sufficient) and in the interest of the US to have it sooner.

To have peaceful coexistence Americans must understand that the Chinese believe that their values and their approaches to living out these values are best, as much as Americans believe their American values and their ways of living them out are best. 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. Their system of governance is more like what is typical in big companies, especially multigenerational companies, so they wonder why it is hard for Americans and other Westerners to understand the rationale for the Chinese system following this approach and to see the challenges of the democratic decision-making process as the Chinese see them.

But we can see that a picture drawn from pure extrapolation is not good enough. For example, standing in 1750, it would have been reasonable to believe that it was a timeless and universal truth that monarchies and landowning nobles overseeing peasants with the help of soldiers would be the governance system in the future, that agricultural land would continue to be the most important money-earning asset, that per capita incomes would grow at only around half a percent per year, and that life expectancy would remain steady at about 30 years. That was how it had always been. You would not have imagined capitalism and democracy as we now know it, let alone that there would be a United States and that it would be the leading world power. The big curveballs come when a few really big things cause a paradigm shift that alters the evolutionary rates of change. 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 these things couldn’t be anticipated, they could have been perceived, understood, and adapted to. That’s why while extrapolating the past is generally a reasonable thing to do, also be prepared to be surprised because t...

One of the overarching principles I derived from my research and my 50-plus years of investing experience is 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. In other words, betting on things being better—e.g., real earnings being greater—is pretty much a sure bet. But betting too much on that so that a bump along the way can ruin you is bad. That’s why having quality indicators helps a lot.

the end of the day, power rules and tests of power are the ways one learns who rules. Sometimes that happens within a framework of rules that are respected. In those cases, fights for power occur in a mutually agreed-upon and productive way that supports the internal order. But they can also happen in unproductive, no-holds-barred ways that can lead to the violent disruption of both the leadership and the internal order. 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.

There is also an exceptional amount of polarization in the US right now, as reflected in the stats. Survey data about the sentiments of the voters paints a picture of polarization and intransigence. For example, in a 2019 Pew survey 55 percent of Republicans and 47 percent of Democrats viewed the other as more immoral than other Americans, and 61 percent of Republicans and 54 percent of Democrats said that those of the other party don’t share their values. When asked whether they had warm or cold feelings to those of the other party, 79 percent of Democrats and 83 percent of Republicans said they had “cold” or “very cold” feelings for members of the other party (of that, 57 percent of Democrats and 60 percent of Republicans selected “very cold”). 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. A 2010 study showed that nearly half of Republican parents and a third of Democratic parents would be displeased if their child married someone from the other political party. That compares with about 5 percent for both parties in 1960. One recent survey showed that 15 percent of Republicans and 20 percent of Democrats thought the country would be better off if large numbers of the other side “just died.”

In the end, which country wins the game of obtaining the most wealth and power depends most on their internal capacities, which is why I monitor those factors in my indices as I do for military strength. As the Chinese know very well (and it would be good for others to keep in mind), the best way to fight a war is to get strong and show one’s opponent one’s strength so they don’t want to fight violently. This will most likely be the dynamic that we see in the years ahead.

For example, as shown before, when 1) a country’s finances are deteriorating at the same time as 2) the level of internal conflict is high (e.g., over wealth and/or values differences), while 3) the country is being challenged by one or more strong foreign rivals, that typically produces 4) a mutually and self-reinforcing decline. That’s because the country’s deteriorating finances make it impossible for it to satisfy domestic spending needs and finance the war, which causes worse outcomes. Now that these things