The Big Multigenerational Psychological Cycle

In the “Determinants” chapter from my book “Principles for Dealing with The Changing World Order,” I described a number of determinants that repeatedly drove the rises and declines of empires.?I explained that I would embellish on some of them in subsequent posts showing how they pertain to what is now happening in the world.??The next one covered today is the big, multi-generational cycle of psychology that drives how people and nations’ experiences determine how they think and what they do—which affects what happens and therefore shapes the next generations’ experiences and actions and so on in a cycle that has repeated throughout history.?In this post I describe that cycle and ask you to assess where you and we collectively as a society are in it.??

The rises and declines of countries correspond to these psychological and economic cycles in the following ways and stages. Because these stages are so useful in understanding the behavior of a country’s people and leaders, I am always trying to assess what stages different countries are in.

Stage 1: People and Their Countries Are Poor and They Think of Themselves as Poor. In this stage, most people have very low in- comes and subsistence lifestyles. As a result they don’t waste money because they value it a lot, and they don’t have much debt because nobody wants to lend to them. Some people have potential and some do not, but in most cases their poverty and lack of resources prevent them from gaining the education and other capabilities that would allow them to pull themselves up. One’s inherited circumstances and approach to life are the biggest determinants of who emerges richer from this stage and who does not.

How fast countries evolve through this stage depends on their cultures and their abilities. I call countries in this stage “early-stage emerging countries.” Those that advance typically work hard and gradually accumulate more money than they need to survive, which they save because they worry about not having enough in the future. The evolution through this stage to the next typically takes about a generation. Starting about 40 years ago until about 10 to 15 years ago the “Asian Tigers” of Hong Kong, Singapore, Taiwan, and South Korea and then China were examples of economies in this stage.

Stage 2: People and Their Countries Are Rich but Still Think of Themselves as Poor. Because people who grew up with financial in- security typically don’t lose their financial cautiousness, people in this stage still work hard, sell a lot to foreigners, have pegged exchange rates, save a lot, and invest efficiently in real assets like real estate, gold, and local bank deposits, and in bonds of the reserve currency countries. Because they have a lot more money, they can and do invest in the things that make them more productive—e.g., human capital development, infrastructure, research and development, etc. This generation of parents wants to educate their children well and get them to work hard to be successful. They also improve their resource-allocation systems, including their capital markets and their legal systems. This is the most productive phase of the cycle.

Countries in this stage experience rapidly rising income growth and rapidly rising productivity growth at the same time. The productivity growth means two things: 1) inflation is not a problem and 2) the country can become more competitive. During this stage, debts typically do not rise significantly relative to incomes and sometimes they decline. This is a very healthy period and a terrific time to invest in a country if it has adequate property rights protections.

You can tell countries in this stage from those in the first stage be- cause they have gleaming new cities next to old ones, high savings rates, rapidly rising incomes, and, typically, rising foreign exchange reserves. I call countries in this stage “late-stage emerging countries.” While countries of all sizes can go through this stage, when big countries go through it, they are typically emerging into great world powers.

Stage 3: People and Their Countries Are Rich and Think of Themselves as Rich. At this stage, people’s incomes are high, so labor becomes more expensive. But their prior investments in infrastructure, capital goods, and research and development are still paying off by producing productivity gains that sustain their high living standards. Priorities shift from an emphasis on working and saving in order to protect oneself from bad times, to savoring the finer things in life. People become more comfortable spending more. Arts and sciences typically flourish. This change in the prevailing psychology is reinforced as a new generation of people who did not experience the bad times become an increasingly large percentage of the population. Signs of this change in mindset are reflected in statistics that show reduced work hours (e.g., typically there is a reduction in the workweek from six days to five) and big increases in expenditures on leisure and luxury goods relative to necessities. At their best, these periods are early- and mid-stage “Renaissance periods.”

Large countries in this stage almost always become world economic and military powers.[1] Typically, they develop their militaries in order to project and protect their global interests. Prior to the mid-20th century, large countries at this stage literally controlled foreign governments and created empires from them to provide the cheap labor and cheap natural resources they needed to remain competitive. Starting in the early to mid-20th century, when the US Empire began ruling by “speaking softly and carrying a big stick,” American “influence” and international agreements have allowed developed countries to have access to emerging ?countries’ ?cheap ?labor ?and ?investment ?opportunities ?without ?directly controlling their governments. In this stage countries are on top of the world and are enjoying it. I call countries in this stage “peak health countries.” The United States was in this stage from 1950 to 1965. China is now moving into it. The key is to maintain the determinants leading to strength for as long as possible.

Stage 4: People and Their Countries Are Poorer and Still Think of Themselves as Rich. In this stage, debts rise relative to income. The psychological shift behind this leveraging up occurs because the people who lived through the first two stages have died off or become irrelevant and those whose behavior matters most are used to living well and not worrying about the pain of not having enough money. Because the workers in these countries earn and spend a lot, they become expensive, and because they are expensive, they experience slower real income growth rates. Since they are reluctant to constrain their spending in line with their reduced income growth rates, they lower their savings rates, increase their debts, and cut corners. Because their spending continues to be strong, they continue to appear rich, even though their balance sheets are deteriorating. The reduced level of efficient investments in infrastructure, capital goods, and research and development slows their productivity gains. Their cities and infrastructure become older and less efficient than in the two previous stages. They increasingly rely on their reputation rather than on their competitiveness to fund their deficits. Countries typically spend a lot of money on the military at this stage to protect their global interests, sometimes in very large amounts because of wars. Often, though not always, countries run “twin deficits”—i.e., both balance of payments and government deficits. In the last few years of this stage, bubbles frequently occur.

Whether because of wars[2] or bursting financial bubbles or both, what typifies this stage is an accumulation of debt that can’t be paid back in non-depreciated money. I call countries in this stage “early declining countries.” While countries of all sizes can go through this stage, when big countries go through it, they are typically approaching their decline as great empires.

Stage 5: People and Their Countries Are Poor and They Think of Themselves as Poor. This is when the gaps described in Stage 4 cease to exist and the reality of the country’s situation is hitting home. After bubbles burst and deleveragings occur, private debts grow, while private sector spending, asset values, and net worths decline in a self-reinforcing negative cycle. To compensate, government debt and government deficits grow, and central bank “printing” of money typically increases. Central banks and governments cut real interest rates and increase nominal GDP growth so that it is comfortably above nominal interest rates in order to ease debt burdens. As a result of these low real interest rates, weak currencies, and poor economic conditions, their debt and equity assets perform poorly. Increasingly, these countries have to compete with less expensive countries that are in earlier stages of development. Their currencies depreciate and they like it be- cause it makes the deleveraging less painful. As an extension of these economic and financial trends, countries in this stage see their power in the world decline further. I call countries in this stage “clearly declined countries.” It typically takes a long time—if it ever happens— for clearly declined empires’ psychologies and attributes to go through the full cycle that brings them to their old peaks again. The Romans and the Greeks never have, though the Chinese have a few times.

?[1] Japan from 1971 to 1990 is an exception with regards to the military.

[2] Germany in World War I and the UK in World War II are classic examples.