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.
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.
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.
Author is also on Twitter
