Principles for Dealing with the Changing World Order by Ray Dalio

The Changing World Order

• Ray Dalio talks about the changing world order, which he believes will be radically different from what we’ve experienced in our lifetimes.
• He has learned through experience that important events that surprised him never happened in his lifetime before.
• He studied the last 500 years of history to understand similar situations that occurred when the Dutch, British, and US empires rose and fell.

Lessons learned from studying history

• Ray Dalio’s painful surprises led him to study the last 500 years of history for similar situations.
• He saw that the events he experienced had indeed happened many times before.
• Ray Dalio learned that every time these situations did occur, it was a sign of the changing world order.

“The point is that understanding the mechanics of this cycle provides insight into what is happening now and what is likely to happen in the future.”

Applying historic lessons to the present

• Ray Dalio explains that understanding the mechanics of the cycle provides insight into what is happening now.
• He shares lessons he learned from studying the last 500 years of history and applies them to the present.
• These lessons include that empires go through cycles of birth, expansion, and decline.

“Nothing lasts forever and improvement is always possible.”

US defaulting on its debt

• In 1971, the United States ran out of money and defaulted on its debts.
• Gold was the money used in transactions between countries, and paper money had no value other than it could be exchanged for gold.
• The US was spending more money than it earned by writing a lot more of these paper money checks than it had gold in the bank to exchange for them.

“We were actually printing money, and we were running out of money to support that…”

US breaking its promise

• People started turning these paper money checks into the bank for gold because the US was spending more paper money checks than it had gold to exchange for them.
• President Nixon announced on television that the US was breaking its promise to let people exchange their dollars for gold.
• This announcement broke the link between paper dollars and gold, allowing the US to continue spending more than it earned simply by printing more paper dollars.

The Principle of Printing Money

• When governments spend more than they take in taxes, they need more money and print more
• Printing more causes the value of paper money to fall, making stocks, gold, and commodity prices rise
• When central banks print a lot of money to relieve a crisis, buy stocks, gold, and commodities because their value will rise
• Print money was done in 2008 to relieve mortgage-driven debt crisis, and in 2020 to relieve the pandemic-driven economic crisis
• Keep the printing money principle in mind to anticipate future financial events

“To understand what is coming at you, you need to understand what happened before you.”

Changing Orders

• Three big things that hadn’t happened in the author’s lifetime prompted him to do a study – central banks printing money to pay debts, big internal conflicts, and increasing external conflict between rising and leading great powers
• These things have happened together many times before and almost always lead to changing domestic and world orders
• Internal orders for governing within countries are laid out in constitutions. World order for governing between countries is laid out in treaties
• Internal and world orders change at different times but typically after wars when new revolutionary forces defeat weak old orders
• The US internal order was established in the constitution in 1789 and is still operating today. Russia established a new order with the Russian revolution in 1917 that ended in 1991 with a relatively bloodless revolution. China began its current internal order in 1949 when the Communist Party won the civil war
• The current world order, commonly called the American world order, was established after the allied victory in World War II and the US emerged as the dominant world power
• The Bretton Woods Agreement in 1944 established the dollar as the world’s leading reserve currency and set out agreements and treaties for global governance and monetary systems
• With a new dominant power and monetary system established, a new world order begins in a timeless and universal cycle called the big cycle

The Rise and Decline of Empires

• The US dollar is one of the last three reserve currencies that Dalio has studied, along with the Dutch and British empires.
• He identified a pattern in the rise and decline of empires, by examining eight metrics that determine a country’s measure of total power.
• The Dutch and British empires, the US empire and the Chinese empire are the four most important empires that he focuses on.
• The cycles in which empires rise and decline typically last around 250 years, with 10 to 20-year transition periods in between.
• Empire transitions have historically been marked by periods of great conflict.
• Dalio measured the eight dimensions of each empire’s power by examining their education, inventiveness and technology development, competitiveness in global markets, economic output, share of world trade, military strength, the power of their financial center for capital markets and the strength of their currency as a reserve currency.
• Dalio simplifies the factors contributing to an empire’s rise and decline to a cyclical pattern of cause-effect relationships that are driven by stages from inherent strength, to prosperity, to decadence.
• To understand these patterns better, Dalio studied the rise and fall of Chinese dynasties and their currency, as well as the empires of Spain, Germany, France, India, Japan, Russia, and the Ottoman Empire.

“Typically, these two transitions have been periods of great conflict because leading powers don’t decline without a fight.” (796)

“Because these powers are measurable, we can see how strong each country is now, was in the past, and whether they’re rising or declining.” (842)

The Four Most Important Empires

• The four most important empires are the Dutch, British, US, and Chinese empires.
• These empires have historically had cycles that lasted around 250 years, with 10 to 20-year transition periods in between.
• These cycles are marked by a period of peace and prosperity that leads to increased borrowing, and the formation of a financial bubble, which eventually bursts, leading to conflict between the rich and the poor, and some form of revolution to redistribute wealth.
• As empires struggle with these internal conflicts and decline, their power diminishes relative to external rival powers on the rise.
• When a new power gets strong enough to compete with the dominant power that is struggling with internal breakdowns, external conflicts most typically lead to wars.
• The winners of these wars create new world orders that begin these cycles again.

“The big cycle typically begins after a major conflict, often a war, establishes the new leading power and the new world order.”

The Eight Metrics

• To determine each country’s measure of total power, Dalio measured eight key metrics that included: — Education — Inventiveness and technology development — Competitiveness in global markets — Economic output — Share of world trade — Military strength — The power of their financial center for capital markets — The strength of their currency as a reserve currency
• These dimensions allowed him to see how strong each country is, whether it’s rising or declining, and how that strength affects the global order.

“Because these powers are measurable, we can see how strong each country is now, was in the past, and whether they’re rising or declining.” (842)

A Typical Cycle

• A typical cycle begins with a major conflict that often establishes a new leading power and a new world order.
• This period is typically followed by one of peace and prosperity that leads people to bet on the continuation of peace.
• People then borrow money to invest in that prosperity, leading to financial bubbles.
• The empire’s share of trade grows, and the currency becomes a reserve currency.
• Increased prosperity leads to uneven wealth distribution between the rich and the poor.
• Eventually, the financial bubble bursts, leading to printing money and conflict between the rich and poor.
• The empire’s power diminishes relative to external rival powers rising.
• When a new rising power gets strong enough to compete with the dominant one, that is in the throes of internal breakdowns, external conflicts most typically lead to wars.
• These wars lead to new winners who create new world orders, and the cycle repeats.

“The big cycle typically begins after a major conflict, often a war, establishes the new leading power and the new world order.”

The big cycle

• Ray Dalio discusses the big cycle of empires and countries.
• He claims that by watching the indicators of power change, he was able to anticipate what was likely to come next.
• He will take the viewers through the big cycle in more detail during the next 20 minutes.

“Give me 20 minutes and I’ll give you the last 500 years of history and show you the similar patterns across the Dutch, British, US, and Chinese empires.”

The typical cycle

• Ray Dalio describes the typical cycle by dividing it into three phases: the rise, the top, and the decline.
• He claims that this cycle has been observed in all the leading empires throughout history.

The rise

• The rise is characterized by successful new orders that rise, both internal and external.
• This phase is typically started by powerful revolutionary leaders doing four things: winning power, consolidating power, establishing systems and institutions, and picking their successors well.
• During this phase, there is typically a period of peace and growing prosperity because the leadership is clearly dominant and has broad support so no one wants to fight it.
• Leaders within the country have to design an excellent system to raise the country’s wealth and power.
• To be great, they must have strong education, which is not just teaching knowledge and skills, but also strong character, civility, and work ethic.
• As they do this, they increasingly shift from producing basic products to innovating and inventing new technologies.
• For example, the Dutch rose to defeat the Habsburg empire and become superbly educated.
• They became so inventive that they came up with a quarter of all major inventions in the world.
• The most important of which was the invention of ships that could travel around the world to collect great riches and the invention of capitalism as we know it today to finance those voyages.
• As countries trade more globally, they must protect their trade routes and their foreign interests from attack, so they develop great military strength.
• If done well, this virtuous cycle leads to strong income growth, which can be used to finance investments in education, infrastructure, and research and development.
• The most successful empires used a capitalist approach to develop productive entrepreneurs.
• Even China, which is run by the Chinese Communist Party, used a form of this capitalist approach.

“That provides a healthy respect for rules and laws, order within society, low corruption, and enables them to unite behind a common purpose and work well together.”

“As a result, the people in the country become more productive and more competitive in world markets, which shows up in their growing economic output and rising share of world trade.”

“The Dutch created the first publicly listed company, the Dutch East India Company, and the first stock market to fund it, which were integral parts of the system that produced massive wealth and power.” The history of world trade

• Different cities have been the center of world finance throughout history, including Amsterdam, London, New York, and now China.
• For a country to become the leader in world trade, capitalists, governments, and military must work together.
• The Dutch East India Company was the first to achieve this, with a monopoly granted by the government and its own military.
• The British followed with the British East India Company, and the US Military Industrial Complex and China have similar systems today.
• The country with the leading reserve currency can borrow more than others, which is a huge advantage. The guilder was the main reserve currency when the Dutch led world trade, the pound was when the British led, and the dollar is now, though China’s currency is increasingly being used as a reserve currency.
• Having a reserve currency leads borrowing to increase and the beginning of a financial bubble.

“Having a reserve currency is an exorbitant privilege afforded by the empire’s reserve currency.”

The rise and decline of empires

• All empires that became the most powerful in the world followed the path to the top of mutually supportive financial, political, and military powers.
• While in the top phase, most of these strengths are sustained, but embedded within the fruits of their success are the seeds of their decline.
• As people in rich and powerful countries earn more, that makes them more expensive and less competitive relative to people in other countries who are willing to work for less.
• As people become richer, they tend not to work as hard and become more decadent, which makes them more vulnerable to challenges.
• 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 golden era of the Dutch empire and the Victorian era of the British empire were such high prosperity periods like this.
• As people get used to doing well, they increasingly bet on the good times continuing and borrow money to do that, which grows into financial bubbles.

“The golden era of the Dutch empire and the Victorian era of the British empire were such high prosperity periods like this.” The Changing World Order

• The world is divided into the “haves” and “have-nots”
• The less well-off feel that the system is unfair, which leads to resentments
• As long as the living standards of most people are rising, these gaps in resentments don’t boil over into conflict

“The big picture is that we are in the midst of a very typical cycle in which there’s a rise of a new power, a challenging of the existing power, and then there is a conflict,” – Ray Dalio

Borrowing and Spending

• Having the world’s reserve currency leads to borrowing excessively and 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 long-term
• In other words, when borrowing and spending are strong, the empire appears very strong, but its finances are in fact being weakened
• The borrowing sustains the country’s power beyond its fundamentals by financing both domestic overconsumption and international military conflicts required to maintain the empire
• The cost of maintaining and defending the empire becomes greater than the revenue it brings in, making having an empire unprofitable

Wealth and Power Shifts

• The richer countries eventually get deeper into debt by borrowing from poor countries that save more, which is an early sign 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 Chinese who wanted to save in dollars because the dollar was the world’s reserve currency
• Similarly, the British borrowed a lot of money from its much poorer colonies, and the Dutch did the same at their top

“We’re at the stage where there’s a wealth and power shift, going from the United States and the West to China and the East. And so, we have to be mindful of that shift,” – Ray Dalio

The Decline

• The decline comes from internal economic weakness together with internal fighting or costly external fighting or both
• Typically, the decline comes gradually and then very suddenly
• 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, the financial bubble bursts
• This creates great domestic hardships and forces the country to choose between defaulting on its debts or printing a lot of new money, which always chooses to print a lot of new money
• At first gradually, and eventually massively, that devalues the currency and raises inflation

Political Extremism

• When the government has problems funding itself, when there are bad economic conditions, and living standards for most people are declining, and there are large wealth, values, and political gaps, internal conflict between the rich and the poor, as well as different ethnic, religious, and racial groups greatly increases
• This leads to political extremism that shows up as populism of the left or the right
• Those on the left seek to redistribute the wealth while those on the right seek to maintain the wealth in the hands of the rich
• Typically during such times, taxes on the rich rise and when the rich fear their wealth and wellbeing will be taken away, they move to places, assets, and currencies they feel safer in
• These outflows reduce the empire’s tax revenue The Classic Hollowing Out Process
• In times of economic decline, the flight of wealth leads to a self-reinforcing, hollowing out process.
• As governments outlaw the flight of wealth, those seeking to get out begin to panic, and these turbulent conditions undermine productivity, which shrinks the economic pie and causes more conflict about how to divide the shrinking resources.
• Populist leaders emerge from both sides and pledge to take control and bring about order.
• That’s when democracy is most challenged because it fails to control the anarchy, and it is when the move to a strong populist leader who will bring order to the chaos is most likely.

“These turbulent conditions undermine productivity, which shrinks the economic pie and causes more conflict about how to divide the shrinking resources.” Empires and their vital signs

• Most empires have their time in the sun and inevitably decline.
• Reversing a decline is difficult because that requires undoing a lot that’s already been done, but it’s possible.
• By looking at these indicators, it’s pretty easy to see which stage of the big cycle an empire is in, how fit it is, and whether its condition is improving or worsening, which can help one estimate how many years it has left.
• Still, these estimates aren’t precise and the cycle can be extended if those in charge pay attention to their vital signs and improve them.

“One can do that with empires and their vital signs too. It won’t be precise, but it will be broadly indicative and give clear direction on steps to take to increase longevity.”

Two things

• It’s most often the case that a nation’s greatest war is with itself over whether or not it can make the hard decisions needed to sustain success.
• As for what we need to do, it comes down to just two things – earn more than we spend, and treat each other well.
• All other things I mentioned – strong education, inventiveness, being competitive, and all the rest – are just ways of getting at these two things.
• It’s easy to measure if we’re doing them.

“As for what we need to do, it comes down to just two things – earn more than we spend, and treat each other well.”