Principles for Dealing with the Changing World Order by Ray Dalio

(dramatic music) - The

changing

world

order

. The times ahead will be radically different from those we have experienced in our lives, yet similar to many times before. How do I know that? Because they always have been. Over my roughly 50 years of global macroeconomic investing, I have learned the hard way that the most important events that surprised me did so because they never happened in my lifetime. These painful surprises led me to study the last 500 years of history in search of similar situations that I saw had actually happened many times before with the ups and downs of the Dutch, British, and American empires.

And each time they did, it was a sign of the

changing

world

order

. This study taught me valuable lessons that I will convey to you here in summary form. You can find the full version in my book Principles for Addressing the Changing World Order. Let me start with a story that brought me to this point, about how I learned to anticipate the future by studying the past. In 1971, when I was a young clerk at the New York Stock Exchange, the United States ran out of money and defaulted on its debts. That's how it is. The United States ran out of money.

As? Well, back then gold was the money used in transactions between countries. Paper money, like the dollar, was like checks in a checkbook in the sense that it had no value other than that it could be exchanged for gold, which was real money. At the time, the United States was spending far more money than it earned by writing far more checks in paper money than it had gold in the bank to cash them. As people gave these checks to the bank in exchange for gold money, the amount of gold in the United States began to decrease.

It soon became clear that the United States could not keep its promises on all existing paper money, so those who had dollars rushed to exchange them before the gold ran out. Recognizing that the United States was going to run out of real money, on Sunday afternoon, August 15, President Nixon appeared on television to tell the world that the United States was breaking its promise to allow people to exchange their dollars for gold. Of course, he didn't mean it that way. He put it more diplomatically, without making it clear that the United States was failing to comply. - The strength of a nation's currency is based on the strength of that nation's economy.

And the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the necessary steps to defend the dollar against speculators. I have directed Secretary Connally to temporarily suspend the convertibility of the dollar into gold or other reserve assets, except in amounts and under conditions determined to be in the interest of monetary stability and for the benefit of the United States. - I looked on in amazement as I realized that money as we understood it was running out. What a crisis! I expected the stock market to crash the next day, so I arrived at the trading floor early to prepare.

When the opening bell rang, chaos broke out, but not the kind I expected. The market was on the rise (very high) and rose almost 25%. That surprised me because I had never experienced a currency devaluation before. When I looked into history, I discovered that exactly the same thing happened in 1933 and it had exactly the same effect. So, paper dollars were also tied to gold, which the United States was running out of because it was spending more paper checks than gold it had to exchange them. And President Roosevelt announced on the radio that he would break the country's promise to exchange dollars for gold. - That was when I proclaimed the national holiday.

And this was the first step in the government's reconstruction of our financial and economic fabric. The second step, last Thursday, was legislation quickly and patriotically passed by Congress confirming my proclamation and expanding my powers so that it would be possible, in view of the need for time, to extend the holiday and gradually lift the ban on that holiday in the days to come. This law also gave authority to develop a program... - In both cases, breaking the link with gold allowed the United States to continue spending more than it earned simply by printing more dollars on paper.

Because there was an increase in the number of dollars without an increase in the country's wealth, the value of each dollar fell. When these new dollars entered the market without a corresponding increase in productivity, they went to buy many stocks, gold and commodities and therefore caused their prices to rise. As I studied more history, I saw that the exact same thing had happened many, many times before. I saw that from the beginning of time, when governments spent far more than they received in taxes and conditions worsened, they ran out of money and needed more. So they printed more, much more, which caused their value to fall and the prices of almost everything, including stocks, gold, and commodities, to rise.

That's when I first learned the principle that when central banks print a lot of money to alleviate a crisis, they buy stocks, gold, and commodities because their value will rise and the value of paper money will fall. This money printing is also what happened in 2008 to alleviate the mortgage-driven debt crisis, and in 2020 to alleviate the pandemic-driven economic crisis. And it will almost certainly happen in the future. Therefore, I suggest you keep this principle in mind. These experiences gave me another principle: to understand what is coming, you need to understand what happened before you. That principle led me to study how the bubble of the 1920s became the depression of the 1930s, which gave me the lessons that allowed me to anticipate and profit from the 2007 bubble that became the 2008 crisis.

All of these experiences led me to develop an almost instinctive impulse to look to the past in search of similar situations to learn how to handle the future well. Changing orders. (man whistles) (machine beeps) In recent years, three important things that had not happened in my life prompted me to conduct this study. First, countries did not have enough money to pay their debts, even after reducing interest rates to zero. So their central banks started printing a lot of money to do it. Second, major internal conflicts arose due to growing gaps in wealth and values. This manifested itself in political populism and polarization between the left, which wants to redistribute wealth, and the right, which wants to defend those who own the wealth.

And third, the increase in external conflict between a rising great power and the leading great power, as is happening now with China and the United States. Then I looked back. I saw that all of this had happened many times before and almost always led to changes in the national and world order. The last time this sequence occurred was from 1930 to 1945. What exactly is an order? You could ask. It is a system of government for people

dealing

with each other. There are internal orders to govern within countries, generally established in constitutions. And there is a world order for governing between countries, typically established in treaties.

Internal orders change at different times than world orders, although whether within or between countries, these orders often change after wars. Civil wars within countries, international wars between countries. They occur when new revolutionary forces defeat weak old orders. For example, the internal order of the United States was established in the Constitution of 1789, after the American Revolution, and remains in effect today, even after the American Civil War. Russia threw off its old order and established a new one with the Russian Revolution of 1917, which ended in 1991 with a relatively bloodless revolution. China began its current internal order in 1949, when the Chinese Communist Party won the civil war.

You get the idea. The current world order commonly called the American world order, was formed after the Allied victory in World War II, when the United States emerged as the dominant world power. How global governance and monetary systems work was established in agreements and treaties. In 1944, the new world monetary system was established in the Bretton Woods Agreement and established the dollar as the world's primary reserve currency. A reserve currency is a commonly accepted currency around the world, and having one is a key factor in a country becoming the richest and most powerful empire. With the establishment of a new dominant power and a new monetary system, a new world order begins.

These changes take place in a universal and timeless cycle that I call the great cycle. I'll start with a quick overview, then give you a more complete version, and then direct you to my book if you want more. As I studied the 10 most powerful empires of the last 500 years and the last three reserve currencies, he took me through the rise and decline of the Dutch Empire and the guilder, the British Empire and the pound, the rise and initial decline of the El American empire and the dollar, and the decline and rise of the Chinese empire and its currencies, as well as the rise and decline of the Spanish, German, French, Indian, Japanese, Russian, and Ottoman empires, along with their important conflicts. as measured in this table.

To better understand China's patterns, I also studied the rise and fall of Chinese dynasties and their monies since the year 600. Since looking at all of these measures at once can be confusing, I'll focus on the four most important: the Dutch. , British, Americans and Chinese. You will quickly notice the pattern. Now let's simplify the shape a little. As you can see, they occurred in overlapping cycles lasting about 250 years with transition periods of 10 to 20 years between them. Typically, these two transitions have been periods of great conflict because the leading powers do not decline without a fight. So how do I measure the power of an empire?

In this study, I used eight metrics. The measure of the total power of each country is obtained by averaging all of them together. They are education, inventiveness and technological development, competitiveness in global markets, economic production, participation in world trade, military strength, the power of its financial center for capital markets and the strength of its currency. as reserve currency. Because these powers are measurable, we can see how strong each country is now, how strong it was in the past, and whether they are increasing or decreasing. By examining sequences from many countries, we can see how a typical cycle plays out.

And since the swings can be confusing, we can simplify it a bit to focus on the pattern of cause-and-effect relationships that drive the rise and fall of a typical empire. As can be seen, better education generally leads to greater innovation and technological development and, with a delay, to the establishment of the currency as a reserve currency. It can also be seen that these forces then declined in a similar order, reinforcing the mutual decline. Let us now look at the typical sequence of events that occur within a country that produce these rises and falls. Simply put, the great cycle usually begins after a major conflict, often a war, establishes the new leading power and the new world order.

Since no one wants to challenge this power, a period of peace and prosperity usually follows. As people become accustomed to this peace and prosperity, they increasingly bet on it continuing. They borrow money to do it, which eventually leads to a financial bubble. The empire's participation in trade grows. And when most transactions are made in its currency, it becomes a reserve currency, leading to even more debt. At the same time, this greater prosperity distributes wealth unequally. Thus, the wealth gap often grows between the rich "haves" and the poor "have-nots." In the end, the financial bubble bursts, leading to money printing, further internal conflict between rich and poor, leading to some form of revolution to redistribute wealth.

This can happen peacefully or as a civil war. As the empire struggles with this internal conflict, its power declines relative to rising external rival powers. When a new rising power becomes strong enough to compete with the dominant power that is suffering from internal crises, external conflicts, usually wars, occur. From these internal and external wars new winners and losers emerge. The winners then come together to create the new world order. And the cycle begins again. Looking back, I saw that these cause-and-effect relationships drove the cycles of rise and fall since the Roman Empire. I saw how the stories from each of these cycles blended with others before, during, and after in the same way that each individual story blends with others to form the 500-year epic story that is our collective history.

And just like human life cycles, no two are exactly alike, but most are similar. They are driven bylogical cause-and-effect relationships that progress through stages from birth to strength and from maturity to weakness and inevitably decline. However, that is like saying that a person's life cycle lasts on average 80 years without recognizing that many are much shorter and others are much longer. While age can be a good indicator of future longevity, a better way is to look at health indicators. The same can also be done with empires and their vital signs. I found that by looking at power shift indicators, I could see what stage a country was in, which helped me anticipate what was likely to come next.

Now, I will explain the great cycle to you in more detail. Give me 20 minutes and I will tell you the last 500 years of history and show you similar patterns in the Dutch, British, American and Chinese empires. 500 years of great cycles. (wind whistle) I am going to describe the typical cycle by dividing it into three phases. The rise, the peak and the decline. Increasing. Successful new orders that emerge, both internal and external, are usually initiated by powerful revolutionary leaders who do four things. First, they gain power by gaining more support than the opposition. Secondly, they consolidate power by converting, weakening or eliminating the opposition so as not to take their place.their way.

Third, they establish systems and institutions that make the country function well. And fourth, they choose their successors well, or create systems that do so, because a great empire requires many great leaders over several generations. At this stage, shortly after winning the fight, there was usually a period of peace and increasing prosperity because the leadership is clearly dominant and has wide support, so no one wants to fight it. During this phase, the leaders of the country have to design an excellent system to increase the wealth and power of the country. First of all, to be great they must have a solid education, which is not only about teaching knowledge and skills, but also strong character, citizenship and work ethic.

They are usually taught in the family, schools, and religious institutions. That provides a healthy respect for rules and laws, order within society, low corruption and allows them to unite behind a common purpose and work well together. In doing so, they increasingly shift from producing basic products to innovating and inventing new technologies. For example, the Dutch rose up to defeat the Habsburg Empire and gained an excellent education. They became so inventive that they created a quarter of all the world's most important inventions. The most important of these was the invention of ships that could travel around the world to collect great wealth and the invention of capitalism as we know it today to finance those voyages.

They, like all leading empires, improved their thinking by being open to the best ideas in the world. As a result, the country's people become more productive and more competitive in world markets, which is reflected in their growing economic output and growing participation in global trade. This can be seen happening now, as the United States and China are roughly comparable in both their economic output and their share of global trade. As countries trade more globally, they must protect their trade routes and foreign interests from attack. So they develop a large military force. If done well, this virtuous cycle leads to strong revenue growth, which can be used to finance investments in education, infrastructure, and research and development.

They must also develop systems to incentivize and empower those who have the ability to generate or receive wealth. In all of these cases, the most successful empires used a capitalist approach to developing productive entrepreneurs. Even China, ruled by the Chinese Communist Party, used a form of this capitalist approach. (Cash registers ring) When Deng Xiaoping was asked about this, he said: "It doesn't matter if it's a white cat or a black cat, 'as long as it catches mice.' And 'it's glorious to be rich.' To do it well, They must develop their capital markets, and most importantly, their loan, bond and stock markets.

That allows people to turn their savings into investments, finance invention and development, and share in the successes of those who make great things happen. The Dutch created the first publicly traded company, the Dutch East India Company, and the first stock market to finance it, which were integral parts of the system that produced massive wealth and power. As a natural consequence, the largest empires developed. the world's major empires. Amsterdam was the financial center of the world when the Dutch were preeminent, London when the British were on top, New York is now, and China is rapidly developing its financial centers.

Governments and the military must work together. The Dutch not only worked well together, they were one in the same. The Dutch East India Company was given a trade monopoly by the government and had its own military officially authorized to go out into global markets to generate and receive wealth. The British followed with the British East India Company and had similar coordination of their government, commercial, and military operations. The US Military Industrial Complex did the same, as does the current Chinese system. As the country becomes the largest international trading empire, its transactions can be paid for with its currency, making it the preferred global medium of exchange, and because its currency is so widely accepted and used so People from all over the world often want to save on it. making it the preferred store of wealth.

And, therefore, the main reserve currency in the world. The guilder was the world's main reserve currency when the Dutch led world trade. The pound was when the British were leading. And the dollar has been since the United States led. Naturally, the Chinese currency is increasingly used as a reserve currency. Having a reserve currency allows the empire to borrow more than other countries. That advantage is enormous. Think about it. People around the world are eager to save and therefore lend their currency to the empire. Countries without a reserve currency do not have one. And when the empire runs out of its own money, remember the United States in 1971, they can always print more.

The exorbitant privilege granted by the empire's reserve currency leads to increased debt and the beginning of a financial bubble. This series of cause-and-effect relationships, leading to mutually supportive financial, political, and military powers reinforced by the borrowing power of a reserve currency, have gone together since history began to be recorded. All the empires that became the most powerful in the world followed this path to the top. Although in the upper phase most of these strengths are maintained, embedded in the fruits of their success are the seeds of their decline. As a general rule, as people in these rich and powerful countries earn more, it 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 competitiveness of the leading power. For example, British shipbuilders had less expensive workers than Dutch shipbuilders. So, they hired Dutch designers to design better ships that were built by less expensive British workers, making them more competitive, leading the British to rise and the Dutch to decline. Also, as people get richer, they tend not to work as hard. They enjoy more leisure, pursue the better and less productive things in life and, in the extreme case, 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 them. (child moans) (child blows raspberry) They have less spirit for battle, are immersed in luxuries and are accustomed to the easy life, which makes them more vulnerable to challenges. The golden era of the Dutch Empire (glasses clink) and the Victorian era of the British Empire (glasses clink) were periods of great prosperity like this. As people become accustomed to doing well, they increasingly bet on the good times continuing and borrow money to do so, which turns into financial bubbles.

Naturally, financial gains are made unevenly. So the wealth gap grows. Wealth gaps are self-reinforcing because the rich use their greater resources to reinforce their powers. For example, they give their children greater privileges, such as a better education, and influence the political system in their favor. This causes gaps in values, politics, and opportunities to grow between the rich "haves" and the poor "have-nots." The less fortunate feel that the system is unfair, so resentment increases. But as long as most people's living standards continue to rise, these gaps in resentment will not lead to conflict. Having the world's reserve currency inevitably leads to excessive debt and contributes to the country accumulating large debts with foreign lenders.

While this increases purchasing power in the short term, it weakens the country's financial health and weakens the currency in the long term. In other words, when borrowing and spending are strong, the empire appears very strong, but in reality its finances are weakening. Debt sustains the country's power beyond its foundations by financing both domestic overconsumption and the international military conflicts necessary to maintain the empire. Inevitably, the cost of maintaining and defending the empire becomes greater than the income it generates. Therefore, having an empire is no longer profitable. For example, the Dutch empire spread itself too far across the globe and fought increasingly costly war after war with the British and other European powers to protect its territory and trade routes.

Similarly, the British empire became massive, bureaucratic, and lost its competitive advantages as rival powers, particularly Germany, grew, leading to an increasingly costly arms race and a world war. The United States has spent some $8 trillion on foreign wars and their consequences since 9/11, and trillions more on other military operations and supporting military bases in 70 countries, and is still not spending enough to support its military competence. with China in the area around China. In this cycle, richer countries eventually go deeper into debt by borrowing from poorer countries that save more. It is one of the first signs of a change in wealth and power.

This began in the United States in the 1980s, when it had a per capita income 40 times that of China, and began 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 their much poorer colonies and the Dutch did the same at their tops. If the empire begins to run out of new lenders, those who hold its currency will begin to look to sell and exit rather than buy, save, lend, and enter, and the strength of the empire begins to decline. The reduction.

Decline comes from internal economic weakness coupled with internal fighting or costly external fighting, or both. Typically, the decline occurs gradually and then very suddenly. When debts become very large, there is an economic recession and the empire can no longer borrow the money needed to pay its debts, the financial bubble bursts. This creates great internal difficulties and forces the country to choose between defaulting on its debts or printing a large amount of new money. It always chooses to print a large amount of new money. At first gradually and, finally, massively. This devalues ​​the currency and increases inflation.

For the Dutch, this was the financial crisis caused by financial excesses and the payment of the Fourth Anglo-Dutch War. Similarly, for the British, it was paying off their financial excesses and their debts from the two world wars. And for the United States, there have been three cycles of debt, finance, booms and busts since the 1990s, in which the central bank intervened with increasingly stronger measures. When the government has trouble financing itself, when there are poor economic conditions and the living standards of most people are declining, and there are large gaps in wealth, values ​​and policies, internal conflicts arise between rich and poor, as well as different groups. ethnic, religious and racial groups increases considerably.

This leads to political extremism that manifests itself as left-wing or right-wing populism. Those on the left seek to redistribute wealth while those on the right seek to keep wealth in the hands of the rich. Normally, at such times, taxes on the rich increase and whenThe rich fear that their wealth and well-being will be taken away, they move to places, assets and currencies in which they feel more secure. These departures reduce the tax revenues of the empire, leading to a classic, self-reinforcing process of hollowing out. When wealth flight becomes serious enough, governments ban it. Those who try to leave begin to panic.

These turbulent conditions undermine productivity, shrinking the economic pie and causing further conflict over how to divide dwindling resources. Populist leaders emerge from both sides and vow to take control and bring order. This is when democracy is most challenged, because it fails to control anarchy, and it is when the transition to a strong populist leader who brings order to chaos is most likely. As conflict within the country increases, it leads to some form of revolution or civil war to redistribute wealth and force the big changes needed. This can be peaceful and maintain the existing order, but more often it is violent and changes the order.

For example, Roosevelt's revolution to redistribute wealth was relatively peaceful and maintained the existing internal order, while the French Revolution, the Russian Revolution, and the Chinese Revolution were much more violent and led to new internal orders. This internal conflict makes the empire weak and vulnerable to rising external rivals who, seeing this internal weakness, are more inclined to pose a challenge. This increases the risk of a major international conflict, especially if the rival has created a comparable army. Defending oneself and one's empire against rivals requires large military expenditure, which has to occur as internal economic conditions are deteriorating and the empire can least afford it.

Since there is no viable system for peacefully resolving international disputes, these conflicts are usually resolved through tests of power. As bolder challenges are posed, the leading empire faces the difficult choice of fighting or retreating. Fighting and losing is the worst outcome, but retreating is also bad, as it cedes progress to the rival and signals that the empire is weak to those countries considering which side to be on. Poor economic conditions cause more struggles for wealth and power, which inevitably leads to some form of war. Wars are terribly expensive. At the same time, they produce tectonic shifts that realign the new orders with the new realities of wealth and power in the world.

When those who hold the reserve currency and debt of the declining empire lose faith and sell them, it marks the end of their great cycle. Of the approximately 750 coins that existed since 1700, less than 20% now exist, and all of them have been devalued. For the Dutch, this happened after their defeat in the Fourth Anglo-Dutch War, when they were unable to pay off the huge debts they accumulated during it. This sparked a run on the Amsterdam bank and a desperate liquidation, forcing massive money printing, which devalued the currency and the empire into irrelevance. For the British, this happened after World War II, when despite their victory, they were unable to pay off the huge debts they incurred to finance their war effort.

This led to a series of money printing, devaluations, and sterling sell-offs as the United States and the dollar emerged as dominant and created a new world order. At the time of this recording, the United States has not yet reached this point. While it has enormous debt, spends more than it earns, and finances this deficit with more borrowing and printing huge amounts of new money, the great liquidation of dollars and dollar debt has not yet begun. And while major internal and external conflicts are occurring for all the classic reasons, they have not yet crossed the line into wars.

In the end, from these conflicts, whether violent or not, new winners emerge who unite and restructure the debts and political systems of the losers and establish the new world order. Then the old cycle and the empire end and a new one begins and they do it all over again. There are many details that I have just presented to you to paint a picture of how the typical great cycle occurs. Of course, not all of them play out exactly this way, but most do, to the point that it seems like the stories of promotions and descents remain essentially the same and the only thing that changes is the clothes the characters wear and the technologies they use. they use. wear.

So where are we headed? The future. Most empires spend their time in the sun and inevitably decline. Reversing a decline is difficult because it requires undoing much of what has already been done, but it is possible. By looking at these indicators, it is quite easy to see what stage of the grand cycle an empire is in, how fit it is, and whether its condition is improving or worsening, which can help estimate how many years it has left. Still, these estimates are not precise and the cycle can be extended if those responsible pay attention to their vital signs and improve them.

For example, knowing that a person is 60 years old, his physical condition, whether or not he smokes and some other basic vital signs, one can estimate the person's longevity. The same can also be done with empires and their vital signs. It will not be precise, but it will be broadly indicative and will give clear instructions on the steps to take to increase longevity. Most often, a nation's greatest war is with itself, over whether or not it can make the difficult decisions necessary to maintain 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 the other things I mentioned (solid education, resourcefulness, being competitive and everything else) are just ways to get to these two things. It is easy to measure if we are doing them. So as people who want to get fit, let's get into the program and improve our vital signs. Let's do it individually and collectively. My goal in sharing this picture of how the world works and some

principles

for coping well is to help you recognize where we are and the challenges we face, and make the wise decisions necessary to navigate these times well. Since there is much more to discuss and we are running out of time, you can learn more in my book Principles for Addressing the Changing World Order.

And I hope to continue this conversation on economic

principles

.org and on social media. Thank you and may the force of evolution be with you. (dramatic music)