Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail
“Dalio’s philosophical foundation for choosing investments is a sprawling, holistic study of how the world has worked over hundreds of years of history.”
Ray Dalio is among the world’s most successful investors, and in his new book, Principles for Dealing with the Changing World Order, he reveals how he and his colleagues at Bridgewater Associates choose investments for the future. His approach, however, is not what you would get from the standard-issue Wall Street stock picker. Dalio’s philosophical foundation for choosing investments is a sprawling, holistic study of how the world has worked over hundreds of years of history. What he found is that dominant countries—or what he calls “empires”— inevitably rise and fall over long segments of time. Nothing is forever, including, as Dalio documents, America’s position as the leading world power today.
The early part of the book is all about convincing the reader that these cycles happen, and that they make all the difference in which countries are rising and which are falling at any point in time. Dalio focuses on three major historical transitions: the rise of the Netherlands and its replacement by the United Kingdom; the replacement of the United Kingdom by the United States; and the pending (at least possible) replacement of the United States by China.
In his “Archetypical Big Cycle,” Dalio lists the forces that drive an empire’s rise: “a) relatively low levels of indebtedness; b) relatively small wealth, values, and political gaps between people; 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.”
He also succinctly states that three forces might drive the American empire’s decline. The first is a steadily increasing debt burden that financially weakens the empire. The second is a widening gap in household income and wealth that incites internal conflicts. The third is a rising external rival who is on course to topple the declining but-still-ruling empire.
Dalio fills many pages of his book with explanations and insights on the full impact of money and credit on the rise and fall of empires. He explains three monetary policies the US has used to boost the economy that have now become problematic. The first policy is for the Federal Reserve to lower short-term interest rates; the problem here is that short-term interest rates are already at zero. The second is to lower long-term interest rates by buying long-term bonds so the yield will fall; this “quantitative easing” is already substantially in place with the Federal Reserve buying billons of dollar of bonds each month.
The third policy is for the Federal Reserve essentially to print money and buy Treasury bills and bonds directly; this “debt monetization” has become the policy of choice in the US today. Monetization of debt has its risks in the context of the fall of empires. As noted, short-term interest rates are at zero, so investors are driven to purchase assets such as gold, property, and stocks, which drive up asset prices; this exacerbates the politically sensitive income and wealth gaps because only those who can afford the assets see an increase in wealth.
Moreover, the US dollar is the world’s primary reserve currency—the favorite currency for safely storing cash. If the US government drives the value of the dollar down by printing more dollars, there is the risk that the US could lose its role as the primary reserve currency and, thus, further undercut the ability of the US to borrow. Dalio argues that the US has too much debt and writes “what does that mean for the dollar (most importantly) and the other more minor reserve currencies? Will they decline and others replace them? Most probably they will decline analogously to past reserve currency declines: slowly for a long time and then very quickly.”
Dalio also highlights the essential link between monetized debt and productivity gains won through technological innovation. He argues that all this debt must be spent on investments that boost productivity: “an essential ingredient for success is that the debt and money that are created are used to produce productivity gains and favorable returns on investment, rather than just being given away.” If an empire fails to do that “the money will be devalued to the point that it won’t leave the government or anyone else with much buying power.”
Principles for Dealing with the Changing World Order is not an easy read; it is a thicket of historical discussion permeated with graph-after-graph of evidence on each cycle. Despite this obstacle, Dalio’s balanced, often unique, and worrisome analysis of the possible outcome of the now intense rivalry between the US and China is timely. This rivalry resonates in the headlines every day, and Dalio writes that “emotions have been running so high between the US and China that many people have urged [Dalio] not to publish this chapter [on China].”
Dalio sees the two countries in a tie. He writes that “China is now roughly tied with the US in being the leading power in trade, economic output, and innovation and technology and it is a strong and quickly rising military and educational power. It is an emerging power in the financial sector but is lagging as a reserve currency and financial center.”
He is unique in his explanations of the differences in philosophy for the two countries; but those differences are not what you expect. For example, Dalio opines that “America is run from the bottom up (e.g., democracy) and optimized for the individual; China is run from the top down and optimized for the collective.” Dalio explains further that democracy has no roots in China, but capitalism (at least meritocracy) does.
Finally, Dalio argues that the United States and China are already engaged in “wars” on seven fronts. Dalio writes that history has “taught us that there are five major types of wars: 1) trade/economic wars, 2) technology wars, 3) geopolitical wars, 4) capital wars, and 5) military wars. To these [Dalio] would add 6) culture wars and 7) the wars with ourselves.” These war fronts, Dalio argues, should be “recognized as interrelated conflicts that are extensions of one bigger evolving conflict.”
Dalio wants to define these different forms of conflict so that the world can avoid escalation to a hot war. For example, with trade/economic wars, Dalio concludes that “we haven’t seen the US-China trade war taken very far.” However, he identifies high-risk actions when he writes that “the most dangerous part of the trade/economic war comes when countries cut others off from essential imports.” He writes that the US could cut off “China’s imports of oil, other needed commodities, technologies.” And for its part “China could escalate by cutting off companies like General Motors (which sells more cars in China than in the US) and Apple.”
In conclusion, Dalio identifies a positive force, new technology, that can offset the negative forces in all the wars. He writes that “humanity’s inventiveness will probably lead to great advances while the debt/economic cycle, the internal order cycle, the external order cycle, and worsening acts of nature will almost certainly pose problems. In other words, there will be a battle between humanity’s inventiveness and these other challenges.” The pandemic proves his point. Biotech saved our lives with vaccines. InfoTech saved our jobs with platforms that enabled e-commerce and remote work.