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

by Ray Dalio

This Big Cycle produces swings between 1) peaceful and prosperous periods of great creativity and productivity that raise living standards a lot and 2) depression, revolution, and war periods when there is a lot of fighting over wealth and power and a lot of destruction of wealth, life, and other things we cherish.

no system of government, no economic system, no currency, and no empire lasts forever, yet almost everyone is surprised and ruined when they fail. Naturally I asked myself how would I and the people I care about

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. 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.

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

The British Empire generally occupied the countries in its empire while the American Empire has controlled more via rewards and threats—though that is not entirely true, as at the time of this writing the US has military bases in at least 70 countries.

I also saw how, throughout time and in all countries, the people who have the wealth are the people who own the means of wealth production. In order to maintain or increase their wealth, they work with the people who have the political power, who are in a symbiotic relationship with them, to set and enforce the rules. I saw how this happened similarly across countries and across time. While the exact form of it has evolved and will continue to

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. 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.

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

The common reserve currency, just like the world’s common language, tends to stick around after an empire has begun its decline because the habit of usage lasts longer than the strengths that made it so commonly used.

innovating and inventing new technologies. For example, the Dutch were superbly inventive—at their peak they came up with a quarter of all major inventions in the world. One of these was ships that could travel around the globe to collect great riches. They also invented capitalism as we know it. Innovation is generally enhanced by being… … open to the best thinking in the world to be able to learn the best ways of doing things and by…

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.

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.

Also, as people in the leading country become richer, they tend to not work as hard. They enjoy more leisure, pursue the finer and less productive things in life, and at the extreme become decadent. 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...

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

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

Having a reserve currency gives it the “exorbitant privilege”9 of being able to borrow more money, which gets it deeper into debt. This boosts the leading empire’s spending power over the short term and weakens it over the longer run.

The richer countries get into debt by borrowing from poorer countries that save more—that is one of the earliest signs of a wealth and power shift. This started in the United States in the 1980s when it had a per capita income 40 times that of China’s and started borrowing from the Chinese who wanted to save in dollars because the dollar was the world’s reserve currency.

Good

To be successful over the long run, a country must earn an amount that is at least equal to what it spends. Those that earn and spend modestly and have a surplus are more sustainably successful than those that earn and spend a lot more and have deficits. History shows that when an individual, organization, country, or empire spends more than what it earns, misery and turbulence are ahead.

13. Openness to Global Thinking. This is a good leading indicator of strength because isolated entities tend to miss out on the world’s best practices, which weakens them, while learning about the best the world has to offer helps people be their best. Isolation also prevents them from benefiting from the challenge of facing off against the world’s best competitors.

History shows us that widening values gaps, especially during periods of economic stress, have tended to lead to periods of greater conflict, while shrinking values gaps tend to lead to periods of greater harmony. This dynamic is driven by the fact that people tend to coalesce into tribes that are bound together (often informally) by the magnetism of their members’ commonalities. Naturally, such tribes operate with each other in ways that are consistent with their shared values. When under stress, people with greater values gaps also prove to have greater conflict.

At the same time, the United States appears to be losing its cohesion as people’s views about how they should be with each other are becoming more divergent. These divergences are leading people to migrate to the states that align with their preferences, causing those states to be more relevant individually than as parts of a unified whole. History and logic show us that these changes in domestic and international orders are typically accompanied by conflicts because there is a lot of disagreement about how they should work—e.g.,

People and Their Countries Are Poorer and Still Think of Themselves as Rich. In this stage, debts rise relative to income. The psychological shift behind this leveraging up occurs because the people who lived through the first two stages have died off or become irrelevant and those whose behavior matters most are used to living well and not worrying about the pain of not having enough money. Because the workers in these countries earn and spend a lot, they become expensive, and because they are expensive, they experience slower real income growth rates. Since they are reluctant to constrain their spending in line with their reduced income growth rates, they lower their savings rates, increase their debts, and cut corners. Because their spending continues to be strong, they continue to appear rich, even though their balance sheets are deteriorating. The reduced level of efficient investments in infrastructure, capital goods, and research and development slows their productivity gains. Their cities and infrastructure become older and less efficient than in the two previous stages. They increasingly rely on their reputation rather than on their competitiveness to fund their deficits. Countries typically spend a lot of money on the military at this stage to protect their global interests, sometimes in very large amounts because of wars. Often, though not always, countries run “twin deficits”—i.e., both balance of payments and government deficits. In the last few years of this ...

Socialists and communists tend to focus on dividing the pie well and typically aren’t very good at increasing its size.

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.

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. That was done during the 2008 debt crisis, when interest rates could no longer be lowered because they had already hit 0 percent. 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

There is nothing wrong with having an increase in money growth instead of an increase in credit/debt growth, if the money is put to productive use. The risk is that it will not be. If money is printed too aggressively and it is not used productively, people will stop using it as a storehold of wealth and shift their wealth into other things.

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.

As I explained comprehensively in my book Principles for Navigating Big Debt Crises, there are four levers that policy makers can pull to bring debt and debt-service levels down relative to the income and cash flow levels required to service debts: 1. Austerity (spending less) 2. Debt defaults and restructurings 3. Transfers of money and credit from those who have more than they need to those who have less than they need (e.g., raising taxes) 4. Printing money and devaluing it

For example, the Old Testament describes a year of Jubilee every 50 years, in which debts were forgiven.

During World War I, warring countries ran enormous deficits that were funded by central banks’ printing and lending of money. Gold served as money in foreign transactions, as international trust (and hence credit) was lacking. When the war ended, a new monetary order was created with gold and the winning countries’ currencies, which were tied to gold.

countries lose wars; that typically leads to the total collapse and restructuring of their currencies and their economies. However, winners of wars that end up with debts much larger than their assets and reduced competitiveness (e.g., the UK after the World Wars) also lose their reserve currency status, though more gradually.

When lots of these conditions are in place (greater than 80 percent) there is around a 1-in-3 chance of a civil war or revolution—so not very probable but still too probable for comfort. The US is in the 60–80 percent bucket today.

to be successful the system has to produce prosperity for most people, especially the large middle class. As Aristotle conveyed in Politics: “Those states are likely to be well-administered in which the middle class is large, and stronger if possible than both the other classes… where the middle class is large, there are least likely to be factions and dissensions… For when there is no middle class, and the poor are excessive in number, troubles arise, and the state soon comes to an end.”

In almost all cases, after becoming rich, the country (and its leaders) become decadent, overspend, borrow to finance excess consumption, and lose competitiveness.

From studying 50-plus civil wars and revolutions, it became clear that the single most reliable leading indicator of civil war or revolution is bankrupt government finances combined with big wealth gaps. That is because when the government lacks financial power, it can’t financially save those entities in the private sector that the government needs to save to keep the system running (as most governments, led by the United States, did at the end of 2008), it can’t buy what it needs, and it can’t pay people to do what it needs them to do. It is out of power.

That leading indicator is turned on when governments that can’t print money have to raise taxes and cut spending, or when those that can print money print a lot of it and buy a lot of government debt.

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.

Naturally the revolutionaries want to radically change the system, so naturally they are willing to break the laws that those in power demand they adhere to. These revolutionary changes typically happen violently through civil wars, though as previously described, they can come about peacefully without toppling the system.

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

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. When powerful countries have disputes, they don’t get their lawyers to plead their cases to judges. Instead, they threaten each other and either reach agreements or fight. The international order follows the law of the jungle much more than it follows international law.

Hitler refused to pay any further reparation debts, left the League of Nations, and took autocratic control of Germany in 1934. Holding the dual roles of chancellor and president, he became the country’s supreme leader. In democracies there are always some laws that allow leaders to grab special powers; Hitler seized them all. He invoked Article 48 of the Weimar Constitution to put an end to many civil rights and suppress political opposition from the communists, and forced the passage of the Enabling Act, which allowed him to pass laws without the approval of the Reichstag and the president. He was ruthless against any opposition—he censored or took

He privatized state-owned businesses and encouraged corporate investment, acting aggressively to raise Aryan Germans’ living standards. For example, he set up Volkswagen to make cars affordable and accessible, and he directed the building of the Autobahn. He financed this substantially increased government spending by forcing banks to buy government bonds.

Japan set out to get the natural resources (e.g., oil, iron, coal, and rubber) and human resources (i.e., slave labor) it needed by seizing them from other countries, invading Manchuria in 1931 and spreading out through China and Asia.

Fascism is autocratic, capitalist, and collectivist. Fascists believe that top-down autocratic leadership, in which the government directs the production of privately held companies such that individual gratification is subordinated to national success, is the best way to make the country and its people wealthier and more powerful.

Raising tariffs to protect domestic businesses and jobs during bad economic times is common, but it leads to reduced efficiency because production does not occur where it can be done most efficiently. Ultimately, tariffs contribute to greater global economic weakness, as tariff wars cause the countries that impose them to lose exports. Tariffs do, however, benefit the entities that are protected by them, and they can create political support for the leaders who impose them.

In March 1941, Congress passed the Lend-Lease Act, which allowed the US to lend or lease war supplies to the nations it deemed to be acting in ways that were “vital to the defense of the United States,” which included Great Britain, the Soviet Union, and China. Helping the Allies was good for the US both geopolitically and economically because it made a lot of money selling weapons, food, and other items to these soon-to-be-allied countries who were struggling to maintain production while waging war. But its motivations weren’t entirely mercenary. Great Britain was running out of money (i.e., gold), so the US allowed them to postpone payment until after the war (in some cases waiving payment entirely). Although not an outright declaration of war, Lend-Lease effectively ended the United States’ neutrality.

All markets are primarily driven by just four determinants: growth, inflation, risk premiums, and discount rates. That is because all investments are exchanges of lump-sum payments today for future payments. What these future cash payments will be is determined by growth and inflation, what risk investors are willing to take in investing in them as compared to having cash in hand is the risk premium, and what they are worth today, which is called their “present value,” is determined by the discount rate.1

Governments influence these factors through their fiscal and monetary policies. As a result, interactions between what governments want to happen and what is actually happening are what drive the cycles.