Principles For Dealing With the Changing World Order Book Summary
Why Nations Succeed and Fail
Book by Ray Dalio
Summary
Ray Dalio draws on historical patterns to provide a thought-provoking framework for understanding the cycles of rise and decline of nations, currencies, and markets, offering invaluable insights for investors and leaders navigating the complex dynamics shaping our future.
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1. How The World Works
The Times Ahead Will Be Radically Different
Dalio believes the times ahead will be very different from what we've experienced in our lifetimes, though similar to many times in history. To handle his responsibilities well over the past 50 years, he needed to understand the factors that make countries succeed and fail. This led him to study historical cases to discern principles for dealing with situations he had never faced before.
A few years ago, he observed the emergence of developments that hadn't happened in his lifetime but had occurred in history - the confluence of huge debts, near-zero interest rates, large wealth and political gaps, and the rising of a new world power to challenge the existing world order. This concerning situation led him to study the rises and declines of empires, reserve currencies and markets.
Section: 1, Chapter: 1
No Empire Lasts Forever
“No system of government, no economic system, no currency, and no empire lasts forever, yet almost everyone is surprised and ruined when they fail.”
Section: 1, Chapter: 1
Eight Key Determinants Of Wealth and Power
The author found eight key determinants that explain the rises and declines of countries' wealth and power:
- Education
- Competitiveness
- Innovation and technology
- Economic output
- Share of world trade
- Military strength
- Financial center strength
- Reserve currency status
These factors are mutually reinforcing. For example, better education leads to more innovation, higher economic output, stronger trade and military, and the establishment of the currency as a reserve currency.
Section: 1, Chapter: 1
The Archetypical Big Cycle Of The Rise And Fall Of Empires
Empires tend to go through an archetypical "Big Cycle" that lasts around 250 years on average:
- The Rise - After a new order is established, there is peace, prosperity, low debt, small wealth gaps, effective leadership and governance.
- The Top - Wealth and power reach a peak, but excesses emerge in the form of high debt, large wealth gaps, declining education and governance, and overextended military. The empire faces challenges from emerging rivals.
- The Decline - The excesses reach a breaking point, leading to financial crises, intense internal conflict, and often destructive wars with rival powers. This painful period of restructuring establishes a new order.
Many of the most famous empires in history, from the Dutch to the British to the Americans, have followed this archetypical Big Cycle.
Section: 1, Chapter: 1
Human Nature Drives Repeating Cycles Of Prosperity And Decline
Many key drivers of empires' rises and declines are rooted in universal aspects of human nature. The desire to gain and retain wealth and power, the tendency to favour short-term gratification over long-term planning, and the cycles of generational psychology all contribute to the "Big Cycle" pattern repeating. While specific technologies, geographies and cultures shape the details, the overall stories rhyme across history because of these common human traits. Understanding these repeating patterns is essential to navigating the changing world order.
Section: 1, Chapter: 2
The Long-Term Debt Cycle Follows A Predictable Pattern
Long-term debt cycles, lasting 50-100 years on average, follow a predictable pattern:
- They begin with little debt and "hard money" like gold.
- Credit expands through claims on hard money.
- Debt levels rise as lending and borrowing increase.
- Debt crises emerge as debts exceed the ability to repay. Hard money constraints are abandoned in favor of fiat money.
- Fiat money is printed excessively, leading to the devaluation of money.
- Eventually a return to hard money occurs to restore confidence.
This cycle has repeated throughout history, from Ancient Rome to Medieval China to 20th century Europe and America. While new financial instruments emerge, the underlying dynamics persist because of the universal human tendency towards credit expansions and contractions.
Section: 1, Chapter: 3
All Currencies Are Devalued Or Die Over Time
Looking back over the last few centuries, all major currencies have either been devalued significantly or died altogether. Currencies are devalued when governments print excessive amounts of money, usually to finance budget deficits or service high debt levels. This reduces the purchasing power of money over time. Many currencies have been completely replaced, often after losing a war or during a political revolution. The only major currencies that have survived since 1850 are the U.S. dollar, British pound and Swiss franc - and even they have lost over 90% of their purchasing power due to devaluations.
Section: 1, Chapter: 4
Devaluation Often Happens Quickly During Debt Crises And Political Upheavals
While currency devaluation can seem like a gradual process, history shows it often happens abruptly during times of crisis. When government debts become unsustainable, devaluation is the only politically feasible solution. This happened in Weimar Germany in the 1920s, the U.S. and Europe in the 1930s, and many emerging economies in the late 20th century. Such rapid devaluations can destroy wealth stored in the currency, creating social and political unrest. Investors must be alert to signs of unsustainable debt and political disorder that could trigger a currency crisis.
Section: 1, Chapter: 4
Wealth And Values Gaps Drive Internal Conflicts Within Countries
All societies have internal struggles between different socioeconomic classes over wealth and power. These conflicts intensify when there are large gaps in wealth and fundamental values between the classes. Wealth gaps naturally emerge in capitalist systems, as some benefit more from productivity gains than others.
Values gaps emerge as people coalesce into "tribes" based on factors like religion, ethnicity, urban/rural status, and politics. When a country experiences economic hardships on top of these gaps, it often leads to a breaking point of revolution and/or civil war to restructure the internal order. Managing these internal gaps is essential for countries to maintain stability and avoid self-destructive conflicts.
Section: 1, Chapter: 5
Populist And Autocratic Leaders Emerge During Times of Internal Conflict
In the late stages of the internal cycle of conflict, countries often turn to populist and autocratic leaders who promise to restore order and take power away from entrenched elites.
This happened in the 1930s with the rise of fascist leaders like Hitler and Mussolini during the Great Depression. It also happened after the French Revolution with the rise of Napoleon, and in countless coups and revolutions in Latin America and Asia. Such leaders often come from outside traditional power structures and tap into resentment against the "establishment." While they can temporarily stabilize a country, they often end up leading it into damaging conflicts abroad. Being alert to the rise of populist autocrats is crucial to navigating the internal cycle.
Section: 1, Chapter: 5
External Order Is Driven By Raw Power Dynamics
The external order between countries is fundamentally different from internal order within countries. Internationally, there are no reliable mechanisms to adjudicate disputes or enforce agreements. Countries ultimately pursue their interests through raw power - economic, financial, and military.
When one country becomes dominant, it can impose its preferred external order on others. But this order lasts only as long as that country remains dominant. When a rival country becomes powerful enough to challenge the dominant one, and has incompatible interests, it leads to a struggle that reshapes the external order. This is how the British external order of the 19th century gave way to the American order of the 20th century.
Section: 1, Chapter: 6
The Five Main Types Of Conflict Between Countries
There are five primary ways that rival powers come into conflict:
- Trade wars - Conflicts over tariffs and trade restrictions
- Technology wars - Conflicts over access to key technologies
- Geopolitical wars - Conflicts over spheres of influence and alliances
- Capital wars - Conflicts over cross-border investment and financial flows
- Military wars - Direct armed conflict
While only military wars involve overt violence, all five types of conflict can be enormously destructive to wealth and human welfare. In the run-up to major military wars, countries often engage in the other four types of conflict first. Being alert to the severity of these conflicts is crucial to anticipating major power transitions.
Section: 1, Chapter: 6
Wealth And Power Are Gained By Producing More Than You Consume
For countries and individuals, wealth and power accumulate when production exceeds consumption. Being able to produce more valuable goods and services than you consume is what allows you to save and invest for the future. Likewise, great empires and economies emerge when they are highly productive in creating things the world wants.
The most powerful countries have the economic output and trade surpluses to finance strong militaries and global influence. When countries turn to over-consumption and under-production, running chronic deficits, it inevitably leads to a decline in relative wealth and power. Investors must watch whether countries are living within their means or borrowing excessively from the future.
Section: 1, Chapter: 6
The Four Drivers Of Asset Returns
The author argues all asset returns and market movements can ultimately be explained by four factors:
- Growth - The rate of increase in economic activity and cash flows
- Inflation - The rate of increase in prices
- Risk Premiums - The return required to hold risky assets over risk-free assets
- Discount Rates - The rate used to convert future cash flows into present values
Changes in these factors drive asset prices. Stocks tend to rise when growth and inflation are higher than expected, and fall when risk premiums and discount rates rise more than expected. Bonds tend to lose value when inflation and interest rates rise more than expected. By studying how shifts in economic and political conditions affect these four core drivers, investors can navigate changing markets.
Section: 1, Chapter: 7
To Preserve Wealth, Be Wary Of Unsustainable Debt And Financial Repression
History shows that when government debts get too high, they are rarely paid back in real terms. Instead, governments use "financial repression" - capping interest rates below inflation and economic growth rates - to effectively default on debts.
This preserves the nominal value of debts while wiping out their real value, at the expense of savers and bondholders. Other stealthy forms of debt default include capital controls, wealth taxes, and outright asset confiscation. Successful long-term investors must be alert to whether a country's debts are sustainable and whether its government is likely to resort to financial repression. Holding productive assets and diversifying globally are key defenses.
Section: 1, Chapter: 7
2. How The World Has Worked Over The Last 500 Years
The Vital Lessons Of The Last 500 Years
Chapter 8 provides a high-level overview of the key events and patterns in world history over the last 500 years. Some key points:
- In 1500, the world was very different - countries as we know them didn't exist, the world seemed much larger, religions and religious leaders were more powerful, and the world was less egalitarian.
- Major empires from 1500-1800 included the Habsburg dynasty in Europe, the Ming dynasty in China, the Mughal Empire in India, and the Ottoman Empire in the Middle East.
- Key events shaping the world included the Commercial Revolution starting in the 1100s, the Renaissance in the 1300s-1600s, the Age of Exploration starting in the 1400s, the Reformation in the 1500s, and the 30 Years' War followed by a new world order in 1648.
Section: 2, Chapter: 8
How The Dutch Empire Rose To Preeminence
Chapter 9 traces the rise of the Dutch Empire in the 17th century:
- The Dutch successfully revolted against Spain in the 80 Years' War, asserting independence in 1581. This allowed them to create a more open, inventive society.
- The Dutch pioneered key innovations like joint-stock companies, stock markets, and central banking that provided fuel for commerce and expansion. The Dutch East India Company became the world's first mega-corporation.
- The Dutch had strong education, a culture emphasizing saving and hard work, and invested in their military to protect trade routes. Amsterdam became the world's financial center and the Dutch guilder emerged as the first reserve currency.
- At their peak around 1650, the Dutch had the highest incomes in Europe and dominated world trade.
Section: 2, Chapter: 9
The Slow Decline Of The Dutch And Rise Of The British
The second half of Chapter 9 examines the gradual weakening of the Dutch Empire and the emergence of Britain as the leading power by the late 18th century:
- The Dutch became very wealthy but started to lose their competitive edge and get drawn into more military conflicts to defend their empire. Economic growth slowed.
- The British gained economic power, especially after launching the Industrial Revolution in manufacturing in the late 1700s. London surpassed Amsterdam as the leading financial center.
- The Dutch fought several Anglo-Dutch Wars in the late 17th century over trade and colonial interests. The British defeated the Dutch in the Fourth Anglo-Dutch War in the 1780s, leading to a financial crisis and the fall of the Dutch guilder as the top reserve currency.
- The French Revolution and Napoleonic Wars engulfed Europe in the early 19th century. The British ultimately defeated Napoleon, emerging as the clear leading empire.
Section: 2, Chapter: 9
Britain's Rise To Global Dominance In The 19th Century
Chapter 10 details how Britain became the unrivaled global superpower in the 1800s after defeating Napoleon and establishing a new European order in 1815:
- Britain underwent a dramatic economic and social transformation with the Industrial Revolution, leading the world in manufacturing and technological innovation. British living standards and trade volumes soared.
- The British Empire expanded around the world, establishing colonies and spheres of influence across Europe, Asia, Africa and the Americas. The empire secured access to raw materials and markets.
- London became the undisputed global financial center and the pound sterling emerged as the world's reserve currency. Britain attracted huge capital inflows and foreign investment.
- By the late 19th century, Britain accounted for 20% of world GDP, 40% of manufactured exports, and ruled over 25% of the world's population and territory. The "Pax Britannica" represented the peak of Britain's imperial power.
Section: 2, Chapter: 10
The Vulnerabilities Of The British Empire
Despite Britain's dominance by the late 1800s, key weaknesses started to emerge that would contribute to its decline in the early 20th century:
- The US and Germany started to catch up to and even surpass Britain in industrial output and technological capabilities. Britain started to lose its economic edge.
- Inequality skyrocketed in Britain, with the top 1% owning over 70% of national wealth by 1900. This fueled social and political unrest and the rise of new ideologies like socialism.
- Britain faced challenges from rival powers to its colonial holdings and dominance of global trade. Geopolitical tensions escalated, especially with Germany, leading to a naval arms race.
- These stresses came to a head with World War I from 1914-1918, which devastated Britain financially and in human costs, planting the seeds for its imperial decline.
Section: 2, Chapter: 10
The Rise Of The American Empire After World War II
Chapter 11 explains how the US displaced Britain as the dominant global power in the 20th century, especially after 1945:
- The US emerged from World War II with the world's largest economy and as the clear military leader. It shaped the post-war global order through new institutions like the UN, IMF, and World Bank.
- The dollar displaced the British pound as the top reserve currency under the Bretton Woods monetary system. New York became the world's leading financial center.
- The US promoted a system of free trade, foreign aid, and military alliances to counter the Soviet Union in the Cold War. US-backed organizations like NATO cemented American leadership of the "free world."
- Domestically, the US middle class prospered in the post-war boom. But inequality started to rise again by the late 20th century, as globalization and technology brought economic disruption.
Section: 2, Chapter: 11
Why All Empires Decline - And The Mounting Risks To The US
Dalio examines the common factors behind the decline of dominant powers, with troubling signs for the US today:
- Societies tend to become more divided as the costs of maintaining an overstretched empire grow and inequality rises. The US faces deep internal conflicts, political dysfunction, and polarization.
- Leading empires lose their economic edge as rivals catch up. US manufacturing has eroded and it faces economic competition from other powers, especially China.
- The huge costs of foreign wars and growing debt burdens eventually undermine the empire's finances. US federal debt has exploded and it has become reliant on global demand for the dollar.
- Many great powers throughout history found themselves in relative decline around 100-150 years after their peak, from the Romans to the British. That lines up with where the US stands today.
Section: 2, Chapter: 11
The Turbulent Modern History Of China
Dalioprovides an overview of China's modern history, a period marked by foreign subjugation, revolution, and eventual resurgence:
- In the 19th century, the Qing Dynasty went into severe decline as the British and other Western powers established spheres of influence in China. The "Century of Humiliation" saw China lose control over vast swathes of territory.
- The 20th century brought political upheaval, with the fall of the Qing, years of civil war, and the eventual victory of Mao Zedong's Communists in 1949. Mao consolidated power but his radical policies like the Great Leap Forward and Cultural Revolution caused immense suffering.
- After Mao's death in 1976, Deng Xiaoping launched China on a path of economic reform and opening up. Through careful management and experimentation, China achieved rapid growth and development over the 1980s-2000s.
- In the 21st century, China has emerged as a major global power, with the world's second-largest economy and an increasingly assertive foreign policy under President Xi Jinping. But it faces challenges like high debt levels, inequality, and strategic rivalry with the US.
Section: 2, Chapter: 12
Key Elements Of The Chinese Political And Economic System
Some of the distinctive features of China's governance model and economic strategy:
- China's political system utilizes a merit-based civil service. Provincial and local officials are held accountable for meeting economic and social targets.
- Confucian values like social harmony, deference to authority, and the primacy of the collective over the individual continue to shape Chinese politics and society. This contrasts with the individualism prized in the West.
- In the economic realm, China has adopted a hybrid model blending market-based incentives and competition with strong state direction over key industries and the financial system. Capitalism subordinated to Communist Party control.
- China's leadership takes a long-term view of its development, with grand plans like the Belt and Road Initiative aiming to extend its economic reach across Eurasia. It has also focused heavily on boosting its technological capabilities to avoid dependence on the West.
Section: 2, Chapter: 12
A New Era Of US-China Rivalry
Dalio explores the evolving relationship between the US and China, which has moved from cooperation to confrontation in recent years. The US and China developed a close economic relationship in the 1980s-2000s, with the US providing a market for cheap Chinese exports while China recycled its surpluses into US debt securities. But many in the US saw this as unfair.
Under Xi Jinping, China has become more assertive in challenging the US-led global order. US leaders have identified China as the top threat to American primacy. A bipartisan consensus has emerged in favor of "getting tough" with Beijing.
The two powers are now engaged in a multi-front struggle encompassing trade, technology, finance, and geopolitics. The US has imposed tariffs on China, sanctioned Chinese tech champions, and sought to limit China's access to the dollar system. China has responded with its own restrictions. Taiwan remains the most dangerous flashpoint, as China views the island as a core interest while the US maintains a policy of "strategic ambiguity" over whether it would defend Taiwan militarily.
Section: 2, Chapter: 13
The Dangerous Economic And Financial Dimensions Of US-China Competition
The US has weaponized the dollar's global primacy to restrict China's access to the international financial system. This has incentivized China to develop alternative payment channels and make its own currency more internationally accessible. China holds over $1 trillion in US Treasury debt, which some fear it could dump in a crisis. This would be highly disruptive to global markets.
More broadly, the US-China trade war and moves toward "decoupling" disrupt the intricate supply chains that have fueled global prosperity. Businesses face pressure to relocate out of China. A world split into rival economic blocs would be less efficient and dynamic. A key question is whether China can reduce its dependence on Western technologies in critical areas like semiconductors. The risk is a destabilizing race for technological superiority with military applications.
Section: 2, Chapter: 13
Applying Historical Patterns To Understand The US-China Rivalry
Dalio offers several key lessons from history that can help us make sense of the current US-China competition:
- Dominant powers tend to last around 200-300 years, suggesting the US is now in a phase of relative decline while China is ascendant.
- When a rising power threatens to displace a ruling one, war is a common outcome (the "Thucydides Trap"). But nuclear weapons make direct military confrontation unimaginably destructive, so economic and technological competition is likely to be the main battlefield.
- Domestic challenges like inequality and political division are as big a threat to the US as foreign rivals. In fact, internal decay is usually what does dominant powers in. Dalio suggests that the odds of an outright US civil war in the coming decade, while still low, are rising to a worryingly high level.
- Our current moment is as a "changing world order" akin to the 1930s-40s. A key priority for the US is getting its own house in order so that it can manage its rivalry with China from a position of domestic strength and resilience.
Section: 2, Chapter: 13
3. The Future
The Critical Drivers Of A Nation's Health And Competitive Position
Dalio lays out the key factors he uses to assess a country's current and future strength:
- Inventiveness and innovation: The ability to develop new technologies and ways of doing things. Currently led by the US and China.
- Human capital and education: Both quantity and quality matter. China is producing vastly more STEM graduates.
- Competitiveness: Relative cost efficiency. China has the edge.
- Infrastructure and investment: China far outpaces the US in infrastructure spending.
- Rule of law and corruption: The US and Europe outrank China but this could shift.
- Debt and financial stability: The US benefits from issuing the world's reserve currency but is heavily indebted. China faces a debt overhang from its investment boom.
Section: 3, Chapter: 14
What History Can (And Can't) Tell Us About The Future
Dalio cautions that even the most sophisticated forecasting has limitations. Some key principles for thinking about the future:
- It's critical to consider a wide range of possibilities and scenarios. Focus especially on the "tail risks" - low-probability, high-impact events.
- Diversification is essential. As with investing, you want a mix of bets so that you're not wiped out if any one of them goes badly wrong.
- Pay more attention to trends and trajectories than to absolute levels. The rate of change is usually more important than the current state. The US is still very powerful but its relative position is declining.
- History can be a great guide to what's possible, even if the details are impossible to predict.
Section: 3, Chapter: 14
The Opportunities And Dangers Of The Next 10 Years
Continued rapid technological progress will bring immense benefits but also risks in the 2020s. Artificial intelligence could be as disruptive as the Industrial Revolution, while automation could displace workers faster than new jobs appear. The next decade is also likely to see at least one major global economic crisis, based on historical patterns. The huge debt loads in the US and China make them vulnerable. Dalio expects more money-printing by central banks, which risks currency debasement.
Geopolitically, the US and China will remain the two dominant powers, even as their relationship grows more contentious. Outright military conflict is unlikely but a "Cold War"-style standoff is a real possibility. Other powers like Russia and India will jockey for advantage. At the same time, global problems like climate change and pandemics will require more international cooperation, even as such cooperation becomes harder due to geopolitical competition. The ultimate trajectory, Dalio argues, depends on the quality of leadership in the key countries.
Section: 3, Chapter: 14
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