(dramatic music)
- [Ray Dalio] The changing world order.
The times ahead will be radically different
from those that we've experienced in our lifetimes,
though 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've 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 for similar situations
where I saw that they had indeed happened many times before
with the ups and the downs of the Dutch,
British,
and US empires.
And every time they did,
it was a sign of the changing world order.
This study taught me valuable lessons
that I'm going to pass along to you here
in a distilled form.
You can find the comprehensive version in my book,
Principles for Dealing with the Changing World Order.
Let me begin 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
on the floor of the New York Stock Exchange,
the United States ran out of money
and defaulted on its debts.
That's right. The US ran out of money.
How?
Well, back then gold was the money
used in transactions between countries.
Paper money, like the dollar, was like checks in a checkbook
in that it had no value
other than it could be exchanged for gold,
which was the real money.
At the time, the United States was spending
a lot more money than it was earning
by writing a lot more of these paper money checks
than it had gold in the bank to exchange for them.
As people turned these checks into the bank for gold money,
the amount of gold in the US started to dwindle.
It soon became obvious
that the US couldn't keep its promises
for all the existing paper money,
so people holding dollars rushed to exchange them
before the gold ran out.
Recognizing that the US
was going to run out of real money,
on Sunday evening, August 15th,
President Nixon went on television to tell the world
that the US was breaking its promise
to let people exchange their dollars for gold.
Of course, he didn't say it that way.
He said it more diplomatically,
without making it clear
that the United States was defaulting.
- [President Nixon] 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 action necessary
to defend the dollar against the speculators.
I have directed Secretary Connally to suspend temporarily
the convertibility of the dollar into gold
or other reserve assets,
except in amounts and conditions
determined to be in the interest of monetary stability
and in the best interest of the United States.
- [Ray] I watched in awe
realizing that money as we understood it was ending.
What a crisis!
I expected the stock market to plunge the next day,
so I got on the exchange floor early to prepare.
When the opening bell rang, pandemonium broke out,
but not the kind I expected.
The market was up - way up -
and went on to rise nearly 25%.
That surprised me
because I never experienced a currency devaluation before.
When I dug into history,
I discovered that the exact same thing happened in 1933
and had the exact same effect.
Then, paper dollars were also linked to gold,
which the US was running out of
because it was spending more paper money checks
than it had gold to exchange for them.
And President Roosevelt announced on the radio
that he would break the country's promise
to exchange dollars for gold.
- [President Roosevelt] It was then that I issued the
proclamation providing for the national bank holiday.
And this was the first step
in the government's reconstruction
of our financial and economic fabrics.
The second step, last Thursday, was the legislation
promptly and patriotically passed by the Congress
confirming my proclamation and broadening my powers
so that it became possible
in view of the requirement of time
to extend the holiday and lift the ban of that holiday
gradually in the days to come.
This law also gave authority
to develop a program...
- [Ray] In both cases, breaking the link to gold
allowed the US to continue spending more than it earned
simply by printing more paper dollars.
Since there was an increase in the number of dollars
without an increase in the country's wealth,
the value of each dollar fell.
As these new dollars entered the market
without a corresponding increase in productivity,
they went to buy lots of stocks, gold and commodities,
and hence caused their prices to rise.
As I studied more history,
I saw that the exact same thing happened
many, many times before.
I saw that since the beginning of time,
when governments spent much more than they took in taxes
and conditions got bad,
they ran out of money and they needed more.
So, they printed more, a lot more,
which made its value fall
and made the prices of most everything,
including stocks, gold and commodities rise.
That's when I first learned the principle that
when central banks print a lot of money to relieve a crisis,
buy stocks, gold and commodities
because their value will rise
and the value of paper money will fall.
This printing of money is also what happened in 2008
to relieve the mortgage-driven debt crisis,
and in 2020 to relieve the pandemic-driven economic crisis.
And it almost certainly will happen in the future.
So, I suggest that you keep this principle in mind.
These experiences gave me another principle, which is,
to understand what is coming at you,
you need to understand what happened before you.
That principle led me to study
how the roaring twenties bubble
turned into the 1930s depression,
which gave me the lessons
that allowed me to anticipate
and profit from the 2007 bubble
turning into the 2008 bust.
All these experiences led me to develop
an almost instinctual urge
to look to the past for similar situations
to learn how to handle the future well.
Changing orders.
(man whistles)
(machine beeping)
Over the last few years,
three big things that hadn't happened in my lifetime
prompted me to do this study.
First, countries didn't have enough money
to pay their debts,
even after lowering interest rates to zero.
So their central banks began printing lots of money
to do so.
Second, big internal conflicts emerged
due to growing gaps in wealth and values.
This showed up in political populism
and polarization between the left,
who want to redistribute wealth,
and the right, who want to defend those holding the wealth.
And third, increasing external conflict
between a rising great power and the leading great power,
as is now happening with China and the United States.
So, I looked back.
I saw that all these had happened together before many times
and nearly always led to changing domestic and world orders.
The last time this sequence happened was from 1930 to 1945.
What exactly is an order? You might ask.
It's a governing system for people dealing with each other.
There are internal orders for governing within countries,
typically laid out in constitutions.
And there is a world order for governing between countries,
typically laid out in treaties.
Internal orders change at different times than world orders,
though whether within or between countries,
these orders typically change after wars.
Civil wars within countries,
international wars between countries.
They happen when revolutionary new forces
defeat weak old orders.
For example, the US internal order
was laid out in the constitution in 1789
after the American Revolution,
and it is still operating today,
even after the American Civil War.
Russia got rid of its old order and established a new one
with the Russian revolution in 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,
formed after the allied victory in World War II
when the US emerged as the dominant world power.
It was set out in agreements and treaties
for how global governance and monetary systems work.
In 1944, the new world monetary system
was laid out in the Bretton Woods Agreement
and established the dollar
as the world's leading reserve currency.
A reserve currency is a currency
that is commonly accepted around the world,
and having one is a key factor
in a country becoming the richest and most powerful empire.
With a new dominant power and monetary system established,
a new world order begins.
These changes take place in a timeless and universal cycle
that I call the big 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
over the last 500 years
and the last three reserve currencies,
it took me through the rise and decline
of the Dutch empire and the guilder,
the British empire and the pound,
the rise and early decline
in the United States 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 significant conflicts
as measured in this chart.
To understand China's patterns better,
I also studied the rise and fall
of Chinese dynasties and their monies back to the year 600.
Because looking at all these measures at once
can be confusing,
I'll focus on the four most important ones,
the Dutch, British, US and Chinese.
You'll quickly notice the pattern.
Now let's simplify the form a bit.
As you can see, they transpired in overlapping cycles
that lasted about 250 years
with 10 to 20 year transition periods between them.
Typically, these two transitions
have been periods of great conflict
because leading powers don't decline without a fight.
So, how am I measuring an empire's power?
In this study, I used eight metrics.
Each country's measure of total power
is derived by averaging them together.
They are 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.
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.
By examining the sequences from many countries,
we can see how a typical cycle transpires.
And because the wiggles can be confusing,
we can simplify it a bit
to focus on the pattern of cause-effect relationships
that drive the rise and decline of a typical empire.
As you can see, better education typically leads
to increased innovation and technology development,
and with a lag, the establishment of the currency
as a reserve currency.
You can also see that these forces
then declined in a similar order,
reinforcing each other's decline.
Let's now look at the typical sequence of events
going on inside a country
that produces these rises and declines.
In a nutshell, the big cycle typically begins
after a major conflict, often a war,
establishes the new leading power and the new world order.
Because no one wants to challenge this power,
a period of peace and prosperity typically follows.
As people get used to this peace and prosperity,
they increasingly bet on it continuing.
They borrow money to do that,
which eventually leads to a financial bubble.
The empire's share of trade grows.
And when most transactions are conducted in its currency,
it becomes a reserve currency,
which leads to even more borrowing.
At the same time, this increased prosperity
distributes wealth unevenly.
So the wealth gap typically grows
between the rich "haves" and the poor "have-nots".
Eventually, the financial bubble bursts,
which leads to the printing of money,
an increased internal conflict
between the rich and the poor,
which leads to some form of revolution
to redistribute wealth.
This can happen peacefully or as a civil war.
While the empire struggles with this internal conflict,
its power diminishes relative to
external rival powers on the rise.
When a new rising power
gets strong enough to compete with the dominant power
that is having domestic breakdowns,
external conflicts, most typically wars, take place.
Out of these internal and external wars
come new winners and losers.
Then the winners get together to create the new world order.
And the cycle begins again.
As I looked back,
I saw that these cause and effect relationships
drove the cycles of rises and declines
all the way back to the Roman empire.
I saw how the stories of each one of these cycles
blended together with others before, during, and after
in the same way as each individual story blends with others
to make the epic 500 year story
that is our collective history.
And like human life cycles,
no two are exactly the same, but most are similar.
They're driven by logical cause and effect relationships
that progress through stages from birth
to strength and maturity
to weakness and inevitably decline.
However, that's like saying a person's life cycle
takes 80 years on average
without recognizing that many are much shorter
and many are longer.
While age can be a good indicator of future longevity,
a better way is to look at health indicators.
One can do that with empires and their vital signs too.
I found that by watching the indicators of power change,
I was able to see what stage a country was in,
which helped me to anticipate what was likely to come next.
Now, I'll take you through the big cycle in more detail.
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.
500 years of big cycles.
(wind whooshing)
I'm going to describe the typical cycle
by dividing it into three phases.
The rise, the top, and the decline.
The rise.
Successful new orders that rise, both internal and external,
are typically started by powerful revolutionary leaders
doing four things.
First, they win power
by gaining more support than the opposition.
Second, they consolidate power
by converting, weakening, or eliminating the opposition
so they don't stand in their way.
Third, they establish systems and institutions
that make the country work well.
And fourth, they pick their successors well,
or create systems that do that,
because a great empire requires many great leaders
over several generations.
At this stage soon after winning the fight,
there was 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.
During this phase, leaders within the country
have to design an excellent system
to raise the country's wealth and power.
First and foremost, to be great
they must have strong education,
which is not just teaching knowledge and skills,
but also strong character, civility and work ethic.
These are typically taught in the family,
schools and religious institutions.
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 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.
They, like all leading empires, enhanced their thinking
by being open to the best thinking in the world.
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.
You can see this happening now
as the US and China are roughly comparable
in both their economic outputs
and their shares of world trade.
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.
They must also develop systems to incentivize and empower
those that have the ability to make or take wealth.
In all of these cases, 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.
(cash registers ringing)
Deng Xiaoping, when asked about this, 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 this well, they must develop their capital markets.
Most importantly, their lending, bond and stock markets.
That allows people
to convert their savings into investments,
to fund invention and development
and share in the successes
of those who make great things happen.
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.
As a natural consequence, the greatest empires developed
the world's leading financial centers
for attracting and distributing the world's capital.
Amsterdam was the world's financial center
when the Dutch were preeminent,
London when the British were on top,
New York is now,
and China is quickly developing its financial centers.
Most importantly, the capitalists, the governments
and the military must work together.
Not only did the Dutch work well together,
they were one in the same.
The Dutch East India Company
was granted a trade monopoly from the government
and had its own officially sanctioned military
to go out into the global markets to make and take wealth.
The British followed with the British East India Company
and had a similar coordination
of their government, business and military operations.
The US Military Industrial Complex followed suit,
as does the Chinese system today.
As the country becomes
the largest international trading empire,
its transactions can be paid with its currency,
making it the preferred global medium of exchange,
and because their currency
is so widely accepted and frequently used,
people around the world want to save in it,
making it the preferred store hold of wealth.
And thus the world's leading reserve currency.
The guilder was the world's main reserve currency
when the Dutch led world trade.
The pound was when the British led.
And the dollar has been since the US led.
Naturally, China's currency is increasingly being used
as a reserve currency.
Having a reserve currency enables the empire
to borrow more than other countries.
That advantage is huge.
Think about it.
People all over the world are eager to save
and hence lend back their currency to the empire.
Countries without a reserve currency don't have that.
And when the empire runs out of its own money,
remember the United States in 1971,
they can always print more.
The exorbitant privilege
afforded by the empire's reserve currency
leads borrowing to increase
and the beginning of a financial bubble.
This series of cause and effect relationships,
leading to mutually supportive
financial, political and military powers,
bolstered 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.
While in the top phase,
most of these strengths are sustained,
embedded within the fruits of their success
are the seeds of their decline.
As a rule,
as people in these 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.
At the same time, people in other countries naturally copy
the methods and technologies of the leading power,
which further reduces the leading power's competitiveness.
For example, British ship builders
had less expensive workers than Dutch ship builders.
So, they hired Dutch designers to design better ships
that were built by less expensive British workers,
making them more competitive,
which led the British to rise and the Dutch to decline.
Also, as people become richer,
they tend not to work as hard.
They enjoy more leisure,
pursue the finer and less productive things in life,
and at the extreme, 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 it.
(boy groans) (boy blows raspberry)
They're less battle heartened, steeped in luxuries
and 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 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 the financial bubbles.
Naturally, the financial gains come unevenly.
So, the wealth gap grows.
Wealth gaps are self-reinforcing
because rich people use their greater resources
to reinforce their powers.
For example, they give greater privileges to their children,
like better education,
and they influence the political system to their advantage.
This causes the gaps in values, politics,
and opportunities to grow between
the rich "haves" and the poor "have-nots".
Those who are less well-off feel the system is unfair,
so resentments grow.
But as long as the living standards
of most people are still rising,
these gaps in resentments don't boil over into conflict.
Having the world's reserve currency
inevitably 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 over consumption
and international military conflicts
required to maintain the empire.
Inevitably, the cost of maintaining and defending the empire
becomes greater than the revenue it brings in.
So having an empire becomes unprofitable.
For example, the Dutch empire overextended around the world
and fought war after increasingly expensive war
with the British and other European powers
to protect its territory and trade routes.
The British empire similarly became massive, bureaucratic,
and lost its competitive advantages as rival powers,
particularly Germany, soared,
leading to an increasingly expensive arms race
and world war.
The US has spent about eight trillion dollars
on foreign wars and their consequences since September 11th,
and trillions more for other military operations
and for supporting military bases in 70 countries,
and it still isn't spending enough
to support its military competition with China
in the area around China.
In this cycle, the richer countries
eventually get deeper into debt
by borrowing from poor countries that save more.
It's one of the early signs 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.
If the empire begins to run out of new lenders,
those holding their currency
begin to look to sell and get out
rather than to buy, save, lend, and get in,
and the strength of the empire begins to decline.
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.
It always chooses to print a lot of new money.
At first gradually, and eventually massively.
That devalues the currency and raises inflation.
For the Dutch, this was the financial crisis
brought about by financial excesses
and paying for the Fourth Anglo-Dutch War.
Similarly, for the British,
it was paying for its financial excesses
and its debts from the two world wars.
And for the US, it's been three cycles
of debt, finance, booms, and busts since the nineties
with the central bank stepping in each time
with stronger measures.
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 of the left seek to redistribute the wealth
while those of 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,
which leads to a classic, self-reinforcing,
hollowing out process.
When the flight of wealth gets bad enough,
governments outlaw it.
Those seeking to get out begin to panic.
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.
As conflict within the country escalates,
it leads to some form of revolution or civil war
to redistribute wealth and force the necessary big changes.
This can be peaceful and maintain the existing order,
but it's more often violent and changes the order.
For example, the Roosevelt 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 domestic weakness,
are more inclined to mount a challenge.
This raises the risk of great international conflict,
especially if the rival has built up a comparable military.
Defending one's self and one's empire against rivals
requires great military spending, which has to occur
as domestic economic conditions are deteriorating
and the empire can least afford it.
Since there is no viable system
for peacefully adjudicating international disputes,
these conflicts are typically resolved
through tests of power.
As bolder challenges are made,
the leading empire is faced with the difficult choice
of fighting or retreating.
Fighting and losing is the worst outcome,
but retreating is bad too as it cedes progress to the rival
and signals that the empire is weak
to those countries that are considering which side to be on.
Poor economic conditions
cause more fighting for wealth and power,
which inevitably leads to some kind of war.
Wars are terribly costly.
At the same time, they produce the tectonic shifts
that realign the new orders
to the new realities of wealth and power in the world.
When those holding the reserve currency and debt
of the declining empire lose faith and sell them,
that marks the end of its big cycle.
Of the roughly 750 currencies 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 weren't able to repay
the massive debts they built up during it.
This led to a run on the bank of Amsterdam
and a desperate sell off,
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 could not repay the massive debts they borrowed
to fund their war effort.
This led to a series of money printing, devaluations,
and selloffs in the British pound
as the US and the dollar emerged dominant
and created a new world order.
At the time of this recording,
the United States hasn't yet reached this point.
While it has massive debt, spends more than it earns
and funds this deficit with more borrowing
and printing huge amounts of new money,
the big sell off in dollars and dollar debt
hasn't yet begun.
And while there are great internal and external conflicts
occurring for all the classic reasons,
they've not yet crossed the line to become wars.
Eventually out of these conflicts,
whether they're violent or not,
come new winners who get together
and restructure the losers' debts and political systems
and establish the new world order.
Then the old cycle and empire ends
and the new one begins
and they do it all over again.
That's a lot of detail I just threw at you
to paint a picture of how the typical big cycle transpires.
Of course, not all of them transpire exactly this way,
but most largely do, so much so
that it seems like the stories of rises and declines
stay essentially the same
and the only things that change
are the clothes the characters wear
and the technologies they use.
So, where are we heading?
The future.
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.
For example, knowing that a person is 60 years old,
how fit they are, whether they smoke or not
and a few other basic vital signs,
one can estimate the person's longevity.
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.
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.
So like people who want to get fit,
let's get on the program and improve our vitals.
Let's do that individually and collectively.
My goal for sharing this picture of how the world works
and a few principles for dealing with it well
is to help you recognize where we are
and the challenges we face,
and to make the wise decisions needed
to navigate these times well.
Since there is a lot more to discuss and we are out of time,
you can learn more in my book
Principles for Dealing with the Changing World Order.
And I look forward to continuing this conversation
at economicprinciples.org
and on social media.
Thank you,
and may the force of evolution be with you.
(dramatic music)