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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

(Building Prosperity)
(Destruction/ Restructuring)
StrongLeadership CapabilitiesWeak
HighEducation LevelsLow
StrongRule of LawWeak
HighResource Allocation EfficiencyLow
A LotOpenness to Global ThinkingLittle
HighProductivity/Output GrowthLow
InexpensiveCost CompetitivenessExpensive
FavorableTrade & Capital FlowsUnfavorable
HighInfrastructure & InvestmentLow
HighMilitary StrengthLow
SmallGaps in Wealth, Opportunity, & ValuesLarge
LowInternal Conflict (Social & Political)High
StabilizingActs of NatureDisruptive

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…