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

by Ray Dalio

I believe that the reason people typically miss the big moments of evolution coming at them in life is because they experience only tiny pieces of what’s happening. We are like ants preoccupied with our jobs of carrying crumbs in our very brief lifetimes instead of having a broader perspective of the big-picture patterns and cycles, the important interrelated things driving them, where we are within the cycles, and what’s likely to transpire.

I believe that the reason people typically miss the big moments of evolution coming at them in life is because they experience only tiny pieces of what’s happening. We are like ants preoccupied with our jobs of carrying crumbs in our very brief lifetimes instead of having a broader perspective of the big-picture patterns and cycles, the important interrelated things driving them, where we are within the cycles, and what’s likely to transpire.

I had studied that happening in the 1930s, which helped me see how and why central bank actions of creating a lot of money and credit/debt 90 years ago pushed financial asset prices up, which widened the wealth gap and led to an era of populism and conflict.

This study is called “Productivity and Structural Reform: Why Countries Succeed and Fail, and What Should Be Done So Failing Countries Succeed.” (This study, and every other study mentioned here, is available for free at economicprinciples.org.)

It is also the case that 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.

when wealth and values gaps are large and there is an economic downturn, it is likely that there will be a lot of conflict about how to divide the

In addition to these traditional tools being ineffective, printing money and buying financial assets (now called “quantitative easing”) also widens the wealth gap because buying financial assets pushes up their prices, which benefits the wealthy who hold more financial assets than the poor do.

I looked at the rises and declines of all the major empires and their currencies over the last 500 years, focusing most closely on the three biggest ones: the US Empire and the US dollar, which are most important now; the British Empire and the British pound, which were most important before that; and the Dutch Empire and the Dutch guilder before that.

You can miss seeing these cycles if you watch events too close up or if you are looking at the averages rather than the individual cases. Almost everyone talks about what is happening now and nobody talks about these big cycles,

For example, looking at a stock market average (e.g., the S&P 500) and not looking at individual companies will lead you to miss the important fact that almost all the individual cases that make up the average have periods of birth, growth, and death.

or were able to discern the rising periods from the declining periods ahead of the crowd so as to be able to move well.

However, countries as we know them didn’t come into existence until the 17th century, after the Thirty Years’ War in Europe.

I have followed this approach for debt cycles because I’ve had to navigate many of them over the last 50 years and they are the most important force driving big shifts in economies and markets.

I do my research, write it up, show it to the world’s best scholars and practitioners to stress test it, explore potential improvements, write it up again, stress test it again, and so on, until I get to the point of diminishing returns.

Embedded in the swings in one direction are the ingredients that lead to the swings in the opposite direction.

For example, fear, greed, jealousy, and other basic emotions have remained constants and are big influences that drive cycles.

Similarly the big money/credit/capital markets cycle, which builds up too much debt and debt assets (e.g., bonds) until the debts can’t be serviced with hard money, remains essentially the same.

As always, this leads to people trying to sell their debt assets to make purchases and finding out they can’t because there are far too many debt assets relative to the amount of money and the value of stuff there is to buy.

To see this change, we have to devise ways to measure things and watch the measurements change. Then, once we can see the change, we can study why it happens. This is what we must do if we are going to successfully think about the changes ahead and how to deal with them.

Human productivity is the most important force in causing the world’s total wealth, power, and living standards to rise over time.

Productivity—i.e., the output per person, driven by learning, building, and inventiveness—has steadily improved over time.

However, it has risen at different rates for different people, though always for the same reasons—because of the quality of people’s education, inventiveness, work ethic, ...

These reasons are important for policy makers to understand in order to achieve the best possible outcomes for their countries, and for investors and companies to understand in order to ...

This constantly increasing trend is the product of humanity’s capacity to evolve, which is greater than any other species’ because our brain gives us a uni...

This shift from slower productivity gains to faster productivity gains was primarily due to the improvements in broad learning and the conversion of that learning into productivity.

That was brought about by a number of factors going as far back as Gutenberg’s printing press in Europe in the mid-15th century (printing had already been in use in China for centuries), which increased the knowledge and education available to many more people, contributing to the Renaissance, the Scientific Revolution, the Enlightenment, the invention of capitalism, and the First Industrial Revolution in Britain.

In other words, since the Industrial Revolution, which brought about that change, we have been operating in a system in which wealth and power have primarily come more from the combination of education, inventiveness, and capitalism, with those who run governments working

with those who control most of the wealth and education.

For example, while ages ago agricultural land and agricultural production were worth the most and that evolved into machines and what they produced being worth the most, digital things that have no apparent physical existence (data and information processing) are now evolving to become worth the most.5 This is creating a fight over who obtains the data and how they use it to gain wealth and power.

While significant, 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.

However, over the long run capitalism has created wealth and opportunity gaps and overindebtedness that have led to economic downturns and revolutions and wars that have caused changes in the domestic and world orders.

Countries with large savings, low debts, and a strong reserve currency can withstand economic and credit collapses better than countries that don’t have much savings, have a lot of debt, and don’t have a strong reserve currency.

Because these turbulent times are small in relation to the evolutionary uptrend of humanity’s capacity to adapt and invent, they barely show up in the previous charts of GDP and life expectancy, appearing only as relatively minor wiggles. Yet these wiggles seem very big to us because we are so small and short-lived.

There are always arguments or fights between those who want to make big redistributions of wealth and those who don’t. In the 1930s, Mother Nature also gave the US a painful drought.

Looking over the whole of the cases I examined, past economic and market declines lasted about three years, give or take a few years, depending on how long it took to do the debt restructuring and/or debt monetization process. The quicker the printing of money to fill the debt holes, the quicker the closing of the deflationary depression and the sooner the worrying about the value of money began.

What are the different causes of inflation and deflation of monetary value?

The stress test that these years represented wiped out a lot, made clear who the winners and losers were, and led to a new beginning and a new world order in 1945. Classically that was followed by a lengthy period of peace and prosperity that became overextended so that all countries are now, 75 years later, being stress tested again.

The wealth redistributions, like those in the 1930–45 period, came about through large increases in taxes and government spending, big deficits, and big changes in monetary policies that monetized the deficits. Then the Spanish flu intensified the stress test and the resulting restructuring process. This stress test and global economic and geopolitical restructuring led to a new world order in 1919, which was expressed in the Treaty of Versailles. That ushered in the 1920s debt-financed boom, which led to the 1930–45 period and the same things happening again.

These periods of destruction/reconstruction devastated the weak, made clear who the powerful were, and established revolutionary new approaches to doing things (i.e., new orders)

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

while these revolution/war periods typically lead to a lot of human suffering, we should never, especially in the worst of times, lose sight of the fact that one can navigate them well—and that humanity’s power to adapt and quickly get to new and higher levels of well-being is much greater than all the bad stuff that can be thrown at us

PAST BIG CYCLE SHIFTS IN WEALTH AND POWER

When they gathered more wealth and power than any other group, they became the world’s leading power, which allowed them to determine the world order. When they lost that wealth and power, which they all did, the world order—and all aspects of life—changed in profound ways.

This is probably the reason fiat currencies have always failed, country-wide mismanagement by those in power. Is bitcoin safe from such mismanagement? For one it is independent from any one nation. But still requires human management. Gold doesn't require human management but is difficult to exchange value with. And gold has lasted as long as it has as a store of value.

(By the way, I think there is a lot to be said for putting peace and savoring life ahead of gaining wealth and power—interestingly, there was little correlation between the wealth and power of a nation and the happiness of its people,

As people in the country, which is now rich and powerful, earn more, that makes them more expensive and less competitive relative to people in other countries who are willing to work for less. At the same time people from other countries naturally copy the methods and technologies of the leading power, which further reduces the leading country’s competitiveness. For example, British shipbuilders hired Dutch designers to design better ships that were built by less expensive British workers, making them more competitive, which led the British to rise and the Dutch to decline.

Values change from generation to generation during the rise to the top—from those who had to fight to achieve wealth and power to those who inherited it. The new generation is less battle-hardened, steeped in luxuries, and accustomed to the easy life, which makes them more vulnerable to challenges.

Additionally, as people get used to doing well, they increasingly bet on the good times continuing—and borrow money to do that—which leads to financial bubbles.

Inevitably, the country begins borrowing excessively, which contributes to the country building up large debts with foreign lenders. While this boosts spending power over the short term, it weakens the country’s financial health—and weakens the currency—over the longer term. In other words, when borrowing and spending are strong, the empire appears very strong, but its finances are in fact being weakened because the borrowing sustains the country’s power beyond its fundamentals by financing both domestic overconsumption and international military conflicts required to maintain the empire.

If the empire begins to run out of new lenders, those holding their currency begin to look to sell and get out rather than buy, save, lend, and get in—and the strength of the empire begins to fall.

When debts become very large, and there is an economic downturn and the empire can no longer borrow the money necessary to repay its debts, this creates great domestic hardships and forces the country to choose between defaulting on its debts and printing a lot of new money. The country nearly always chooses to print a lot of new money, at first gradually and eventually massively. This devalues the currency and raises inflation.

This is the “anti-capitalist phase,” when capitalism, capitalists, and the elites in general are blamed for the problems.