Excerpts from 

Ray Dalio's

"The Changing World Order, Chapter 1"

Alternate Title: Cycles of Rising and Declining Empires

I read Chapter 1 of Ray Dalio's The Changing World Order and copied below the parts that I'd like to remember. Think of this as a shorter version of the original piece which can be read that much more quickly. 

The Changing World Order may be found on LinkedIn (Intro, Ch.1, Ch. 2) or on its own website. Chapter 1 was first published on 3/29/20. 

By way of general stock market context, US equities peaked on Feb. 19, Covid-19 shelter-in-place started in San Francisco around March 11 and is still on-going although some relaxation started less than a week ago, US equities bottomed on March 23 and have rallied since then. The S&P 500 Index is up 32% from its 3/23 close (trough) to its 5/22 close (most recent date). From 2/19 peak to 3/23 trough, it had dropped 34% close to close. It is now sitting 13% below its 2/19 close.

Font color convention: Everything in black font represents a verbatim excerpt from the original script. My own comments as well as section titles appear in blue font such as this very sentence.

From the Introduction,

3 major forces at play, globally:

1) excessive DEBT levels

2) extreme wealth INEQUALITY

3) rising POWER of China

Three ways that wealth was gained throughout history

Throughout History Wealth Was Gained by Either Making It, Taking It from Others, or Finding It in the Ground.

Why most people miss the big shifts in history

I believe that we are now seeing an archetypical big shift in relative wealth and power and the world order that will affect everyone in all countries in profound ways.  This big wealth and power shift is not obvious because most  people don’t have the patterns of history in their minds to see this one as “another one of those.” 

General pattern of uptrend with cycles around it

Most Everything Evolves in an Uptrend with Cycles Around It. E.g. chart of productivity (real GDP per person) over the last 500 years. 

Driving forces: knowledge, education.

How does a debt bust come about?

Almost all debt busts, including the one we are now in, come about for basically the same reason of extrapolating the uptrend forward and over-borrowing to bet heavily on things going up and being hurt when they go down.

What reverses economic and market declines?

Looking over the whole of the cases I examined, I’d say that past economic and market declines each lasted about three years until they were reversed through a big restructuring process that included restructuring of the debt and the monetary and credit system, fiscal policies of taxation and spending, and changes in political power.  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 [i.e. inflation] begins. 

The US cycle from 1930 to today: default, war, new world order, peace & prosperity, stress test (currently), destruction/reconstruction (forthcoming)

In the 1930s US case, the stock market and the economy bottomed the day that newly elected President Roosevelt announced that he would default on the government’s promise to let people turn in their money for gold, and that the government would create enough money and credit so that people could get their money out of banks and others could get money and credit to buy things and invest (1932-1933).  As shown in the [next] chart, that created a big improvement but not a full recovery.  Then came the war (1939-1945), which resulted from fighting over wealth and power as the emerging powers of Germany and Japan challenged the existing leading world powers of Great Britain, France, and eventually the US (which was dragged into the war).  The war period raised economic output of things that were used in war, but it would be a misnomer to call the war years a “productive period”—even though when measured in output per person, it was—because there was so much destruction.  At the end of the war, global GDP per capita had fallen by about 12%, much of which was driven by declines in the economies of countries that lost the war. 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.

Relative Wealth

The chart below shows you the relative wealth and power of the 11 leading empires over the last 500 years. Note 12 major wars. More on the metric plotted on the y-axis later.

Netherlands: power of the 1600s

UK: power of the 1800s

USA: power of the 1900s, specifically starting in 1944 Bretton Woods /end of WWII

China: power of the 1500s (and 2000s?)

(Geek’s note: Additionally, the lines shown on the chart are 30-year moving averages of these indices, shifted so that there is no lag.  I chose to use the smoothed series because the volatility of the unsmoothed series was too great to allow one to see the big movements.)

The chart below goes back an additional 900 years.

Note China.

Measure of Wealth and Power

The single measure of wealth and power that I showed you for each country in the prior charts is made up as a roughly equal average of eight measures of strength.  They are: 1) education, 2) competitiveness, 3) technology, 4) economic output, 5) share of world trade, 6) military strength, 7) financial center strength, and 8) reserve currency. 

The chart below shows the average of each of these measures of strength, with most of the weight on the most recent three reserve countries(i.e., the US, the UK, and the Dutch).

(Note the lag for Reserve Status Peak (black line) relative to the Empire Peak (year 0 on the chart). Lets' calculate this for the US. To get the Reserve Status Peak, we add ~70 years from the chart below (Reserve Status peak year) to ~1960 from two charts above (US overall peak year). Result: ~2030. That’s when the US dollar as global reserve currency would peak. We seem to have at least ~10 more years to go, as of May 2020.)

(Note the leading variables: blue, green, red. They are Education, Competitiveness, Innovation & Technology. They all make good intuitive sense.)

Those who build empires allocate resources well by coordinating their economic, political, and military forces into a profitable economic/political/military system.

Signs of peak Power & Wealth

People: Those who become richer naturally tend to work less hard, engage in more leisurely and less productive activities, and at the extreme, become decadent and unproductive.

Debt: When the richest get into debt by borrowing from the poorest, it is a very early sign of a relative wealth shift. 

Copying: Those who are most successful typically have their ways of being more successful copied by emerging competitors, which also contributes to the leading power becoming less competitive. 

Over-extension: The leading country extends the empire to the point that the empire has become uneconomical to support and defend. True for the US today.

Intolerable unfair wealth gap: Economic success naturally leads to larger wealth gaps because those who produce a lot of wealth disproportionately benefit. True for the US today.

Causes of decline in Power & Wealth

The decline phase typically happens as (1) the excesses of the top phase are reversed in a mutually reinforcing set of declines, and (2) because a competitive power gains relative strength in the previously described areas. 

(More on “mutually reinforcing” below.)

Dynamics of rising and falling Power & Wealth

To summarize, around the upward trend of productivity gains that produce rising wealth and better living standards, there are cycles that produce 1) prosperous periods of building, in which the country is fundamentally strong because there are a) relatively low levels of indebtedness, b) relatively small wealth, values, and political gaps, c) people working effectively together to produce prosperity, d) good education and infrastructure, e) strong and capable leadership, and f) a peaceful world order that is guided by one or more dominant world powers. These are the prosperous and enjoyable periods.  

When they are taken to excess, which they always are, the excesses lead to 2) depressing periods of destruction and restructuring, in which the country’s fundamental weaknesses of a) high levels of indebtedness, b) large wealth, values, and political gaps, c) different factions of people unable to work well together, d) poor education and poor infrastructure, and e) the struggle to maintain an overextended empire under the challenge of emerging powerful rivals lead to a painful period of fighting, destruction, and then a restructuring that establishes a new order, setting the stage for a new period of building. 

Looked at even more simply, the items shown below are the main forces that drive the rises and declines of countries.  For any country, the more items it has on the left, the more it is likely to ascend; the more items it has on the right, the more it is likely to decline.  Those that make it to the top acquire the characteristics on the left (which causes them to ascend), but with time they move to the right, which makes them more prone to decline, while new competitive countries acquire the characteristics to the left until they are stronger, at which time the shift occurs. 

Because all of these factors, both ascending and descending, tend to be mutually reinforcing, it is not a coincidence that large wealth gaps, debt crises, revolutions, wars, and changes in the world order have tended to come as a perfect storm. 

Last two empire transitions

Next, I review Chapter 2.

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