Ray Dalio is widely considered one of the greatest living investors. He is the founder of Bridgewater Associates, as well as a master educator through How the Economic Machine Works and his latest book Principles For Navigating Big Debt Crises. What follows are my notes of Dalio’s Chapter 1: The Big Picture in a Tiny Nutshell, the first installment in his series “The Changing World Order” (originally published 4/2/2020).
productivity uptrend & surrounding cycles
- Human productivity is the driving force behind the rise in wealth, power, & living standards over longer timeframes.
- However, the biggest shifts in wealth & power come from a series of forces, chiefly money & credit cycles.
- These forces act on longer time scales with big ups/downs that track with the ascent & decline of empires.
- Key forces to understand right now:
- Debt cycle
- Money & credit cycle
- Wealth gap cycle
- Global geopolitical cycle
- We are undergoing a global realignment of wealth & power that everyone in the world will feel.
- Over long periods of time, there is a clear upward trend in human productivity.
- Over shorter periods of time, people feel big swings around this upward trend.
- The upward trend began around 1800, driven by huge improvements in learning (e.g. printing press).
- Widespread learning shifted power away from an agriculture-based economy and toward an industrial-based economy.
- Agricultural economy: Power with landowners, mainly monarchies, nobles, and churches.
- Industrial economy: Power with owners of the means of production, mainly capitalists and governments
- Governments & capitalists ultimately work together to maintain their wealth & power
- Successful formula: educated citizen with innovations + access to capital markets + ownership of means of production = profits.
- This formula works best under capitalism. However, capitalism fell short in producing equal opportunity and maximum productivity.
- Productivity’s upward trend has turbulent periods, mostly due to:
- Money/credit bubbles
- Wealth gaps
- Wars/revolutions over wealth & power
- Acts of nature (droughts, floods, epidemics)
- Formula to survive collapse = large savings + low debt + strong reserve currency + (strong, competent leadership & citizens)
- We are in the middle of a debt bust.
- Past economic & market declines lasted about 3 years. They reversed a big restructuring, including:
- Debt
- Monetary system
- Fiscal policies (taxation & spending)
- Political power
- Periods of destruction/restructuring = 10-20 years
- Periods of peace and prosperity = 40-80 years.
- Debt/Business cycle = 7-10 years
- Money printing ensues to cover debts ➡ ends deflationary depression ➡ opens questions about the value of money.
- Most cycles happen for more/less the same reasons. Example 1907-1919:
- 1907: Money & credit crisis
- Gilded Age: Debt-financed bubbles➡ economic & market decline
- Large wealth gaps ➡ wealth redistributions + world war
- Wealth distributions: Big taxes, big spending, big deficits, debt monetization by central bank
- 1918: Act of nature = Spanish Flu ➡ new world order w/ 1919 Treaty of Versailles
- Then the cycle began again with a debit bubble in the 1920s
- Destruction/reconstruction cycles in endless loops:
- Eliminates the weak players
- Establishes who’s powerful
- Creates new ideas, approaches, institutions
- Sets the stage for prosperity
- Sows the seeds for the next bust
- Destruction/reconstruction periods causes tremendous human suffering, even though most people stay employed, are unharmed by war, or survive acts of nature.
- Destruction/reconstruction periods also pull people together and makes them stronger.
- Rarely do you get all three types of big crises at the same time: economic, revolution/war, natural disaster
shifts in wealth & power between countries
- Empires come and go. As one declines, another ascends.
- 600 – 1250: China
- 1250 – 1375: Mongol Empire
- 1375 – 1600: China
- 1600 – 1750: Netherlands
- 1750 – 1918: United Kingdom
- 1918 – Now: United States
- Measures of wealth & power (mutually reinforcing)
- Education
- Competitiveness
- Technology
- Economic output
- Share of world trade
- Military strength
- Financial center strength
- Reserve currency
- There is a “Big Cycle” that occurs as these measures go up and down for countries/empires.
- Long-leading strength = education. Marks the beginning of a country ascending.
- Long-lagging strength = reserve currency. When this goes, so begins the decline of an empire.
the “big cycle”
Rises and declines have 3 phases: Ascent, Top, Decline
the ascent
- Strong, capable leadership
- Strong education
- Strong character, civility, work ethic
- Low corruption, high respect for rule of law
- Unity, common view, common purpose
- Good system for allocating resources
- Open minded to best ideas from around the world
- More & more competitive in the global market
- Strong income growth
- Increased investments to improve infrastructure, education, research & development
- Increased productivity
- New technologies & innovation ➡ more competitive
- Increase share of global trade
- Strong military (to protect trade and project influence)
- Financial centers (e.g. Amsterdam, London, NYC, Shanghai)
- Strong equity, currency, & credit markets ➡ world reserve currency
- Empires are able to harness a profitable economic/political/military system. (Dutch/British East India companies, US military-industrial complex, China state capitalism)
the top
- Competitive Decline: Prosperity ➡ higher wages ➡ more expensive goods/services ➡ less competitive globally
- Copycats: Emerging competitors copy from leaders because it takes less time and money than inventing.
- Laziness: Prosperity ➡ wealthy people ➡ more leisure, less work (maybe even decadent)
- Borrowed Dimes: Reserve currency ➡ encourages borrowing more money (increasing debt) ➡ appearance of strength, but financially weakened ➡ financing domestic over-consumption + military & wars
- Wealth shift begins when rich countries borrow from poorer countries (Chinese buying US T bonds)
- US has done a lot of borrowing and debt monetization, but still firmly holds reserve currency for now.
- Over-Extension: Empire becomes uneconomical to support and defend. This is the case for the US.
- Wealth Gap: The wealthy and powerful conspire to maintain the existing system that benefits them to the exclusion of others. This is an issue in the US.
the decline
- Devaluation: Big debts + central banks unable to stimulate + economic downturn ➡ debt/economic instability ➡ money printing ➡ currency devalues
- Populism: Big wealth & value (W&V) gaps + economic stress ➡ increased likelihood of rich/poor conflict ➡ increased political extremism ➡ autocratic responses
- Left = Socialism/Communism = redistribute wealth
- Right = Capitalists = keep the rich wealthy
- Populists = autocratic, confrontational (fight), respect power over law
- Wealth Flight to Safety: Rich worry about losing their wealth ➡ move $$$ and families to safe havens ➡ reduce country’s tax/spending revenue ➡ hollowing-out loop (more families want to leave and loop continues) ➡ governments prevent capital flight (outlawing outflows from certain accounts/assets and/or to certain countries/assets ➡ rich people panic more
- Democracy Challenged: Productivity declines ➡ economic pie shrinks ➡ people fight over scarce resources ➡ populist leaders emerge ➡ people begin to prefer centralized leadership over chaos
- Challenger for the Title: Leading country has unsustainable costs exceeding revenues ➡ economically weakens the country ➡ competitors emerge ➡ leading country feel compelled to flex ➡ increased military spending + worsening economic conditions ➡ more difficult to tax + more need to spend domestically ➡ leading power must choose between fighting or retreating
- Exogenous Shocks: Acts of nature (plagues, droughts, COVID-19) combined with the above vulnerabilities ➡ increased risk of self-reinforcing downward spiral
- Leadership Fails: At this point we discover that “destiny, more than the leader, is in control.”
factors in the ascent or decline of an empire
| Positive (Building Prosperity) | Factor | Negative (Destruction/ Restructuring) |
| Strong | Leadership Capabilities | Weak |
| High | Education Levels | Low |
| Strong | Character/Determination | Weak |
| Strong | Rule of Law | Weak |
| Low | Corruption | High |
| High | Resource Allocation Efficiency | Low |
| A Lot | Openness to Global Thinking | Little |
| High | Productivity/Output Growth | Low |
| Inexpensive | Cost Competitiveness | Expensive |
| Favorable | Trade & Capital Flows | Unfavorable |
| High | Infrastructure & Investment | Low |
| Low | Indebtedness | High |
| High | Military Strength | Low |
| Small | Gaps in Wealth, Opportunity, & Values | Large |
| Low | Internal Conflict (Social & Political) | High |
| Advantageous | Geography | Disadvantageous |
| Stabilizing | Acts of Nature | Disruptive |
where we are now
- Last period of destruction/restructuring = 1930-1945 ➡ new world order, 1945 with the creation of a new global monetary system (Bretton Woods).
- The US emerged as the dominant power because
- Richest country coming out of WWII – 80% of the world’s gold stock when gold was money.
- Dominant economy – half of world production
- Strongest military – monopoly on nuclear weapons + strong conventional forces
- 75 years later, we are near the end of a long-term debt cycle:
- Large debts
- Federal Reserve stimulation is “pushing on a string”
- Deep economic and debt contraction happening right now (people, companies, governments)
- Government is giving out money (borrowed, not from tax receipts)
- Central banks are monetizing that debt
- Big wealth & value gaps that opened in 2008 are now blowing wide open
- China is a rising power that is competing with the US on multiple fronts: trade, technology, capital markets, geopolitics.
- COVID-19 pandemic (natural disaster)
Time to burn this down and start rebuilding…