Principles for Dealing with the Changing World Order by Ray Dalio

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

Leave a Comment