The Changing World Order (Part 3 of 4)

THE ARCHETYPICAL BIG CYCLE:? Cycle Shifts in Wealth and Power

PAST CYCLE SHIFTS IN WEALTH AND POWER

The next chart (FIG 7) shows the relative wealth and power of the 11 leading empires over the last 500 years.

Each of these indices of wealth and power is a composite of different determinants. To very briefly summarise the story this chart shows:

• ?China was dominant for centuries (consistently out-competing Europe economically and otherwise), though it entered a steep decline starting in the 1800s.
• The Netherlands, a relatively small country, became the world’s reserve currency empire in the 1600s.

·???????The UK followed a very similar path, peaking in the 1800s.

• ?Finally, the US rose to become the world superpower over the last 150 years, though particularly during and after World War II.
• The US is now in relative decline while China is rising again.

Now let’s look at the same chart that extends the data all the way back to the year 600 (FIG 8).

An important thing to remember: while the leading powers covered in the study were the richest and most powerful, they weren’t necessarily the best-off countries. While wealth and power are what most people want and will fight over most, some people and their countries don’t think that these things are the most important and wouldn’t think of fighting over them.

EIGHT DETERMINANTS OF WEALTH AND POWER

The single measure of wealth and power that I showed you for each country in the prior charts is a roughly equal average of 18 measures of strength. The eight key strengths are as follows (FIG 9):

1) education, 2) competitiveness, 3) innovation and technology, 4) economic output, 5) share of world trade, 6) military strength, 7) financial centre strength, and 8) reserve currency status.

This chart (FIG 9) shows the average of each of these measures of strength across all the empires I studied, with most of the weight on the most recent three reserve countries (i.e., the US, the UK, and the Netherlands).

The lines in this chart do a pretty good job of telling the story of why and how the rises and declines took place. You can see how rising education leads to increased innovation and technology, which leads to an increased share of will trade in military strength, stronger economic output, the building of the world’s leading financial centre, and with the lag, the establishment of the currency as a reserve currency. And you can see how for an extended period most of these factors stayed strong together and then declined in a similar order. The common reserve currency, just like the world’s common language, tends to stick around after an empire has begun its decline because the habit of usage lasts longer than the strengths that made it so commonly used.?

I call this cyclical, interrelated move up and down ‘The Big Cycle’ (FIG 10). Strengths and weaknesses are mutually reinforcing.

THE ARCHETYPICAL BIG CYCLE

Broadly speaking, we can look at these rises and declines as happening in three phases:

• The Rise:
• The Top:
• The Decline

The Rise:

The rise is the prosperous period of building that comes after a new order. It is when the country is fundamentally strong because there are: a) relatively low levels of indebtedness, b) relatively small wealth, values, and political gaps between people, c) people working effectively together to produce prosperity, d) good education and infrastructure, e) strong and capable leadership, and f) a peaceful world order that is guided by one or more dominant world powers, which leads to…

The Top:

This period is characterised by excesses in the form of a) high levels of indebtedness, b) large wealth, values, and political gaps, c) declining education and infrastructure, d) conflicts between different classes of people within countries, and e) struggles between countries as overextended empires are challenged by emerging rivals, which leads to…

The Decline:

This is the painful period of fighting and restructuring that leads to great conflicts and great changes in the establishment of new internal and external orders. It sets the stage for the next new order and a new period of prosperous building.

Let’s look at each of these in more detail.

THE RISE

The rise face begins when there is…

• … Strong enough and capable enough leadership to gain power and design an excellent system to increase the country’s wealth and power
• ?… Strong education
• … Strong character, civility, and work ethic development.
• … Innovating and inventing new technologies.
• … Open to the best thinking in the world.
• … The workers, the government, and the military all work well together.

As a result of these things, the country…

• … Becomes more productive, and…
• … More competitive in world markets – which shows up in its…
• … Share of world trade rising – happening today with China, so it requires…
• … Greater military strength – to defend itself and protect its trade routes.

If done well, this virtuous cycle leads to…

• … Strong income growth… used to finance…
• … Investments in infrastructure, education, and research and development.
• The country must develop systems to incentivise and empower those who have the ability to make or get wealth.
• … Developing capital markets – allowing people to convert their savings into investments to fund innovation and development.
• … Becoming the world’s leading financial Centre, and…
• … Having the world’s leading reserve currency.

All of the empires that became the most powerful in the world followed this path to the top.

THE TOP

In the top phase, the country sustains the success that fuelled its rise but embedded in the rewards of the successes are the seeds of decline. Over time, obligations pile up, breaking down the self-reinforcing circumstances that fuelled the rise.

• As people in the country, which is now rich and powerful, earn more, that makes them more expensive and less competitive.
• Other countries naturally copy the methods and technologies of the leading power, which further reduces the leading country’s competitiveness.
• As people in the leading country become richer, they tend to not work as hard. They enjoy more leisure, pursue the finer and less productive things in life, and at the extreme become decadent. Making them more vulnerable to challenges.
• As people get used to doing well, they increasingly bet on the good times continuing – and borrow money to do that – which leads to financial bubbles.
• Financial gains come unevenly so the wealth gap grows. Rich people also influence the political system to their advantage and give greater privileges to their children – like better education – causing the gaps in values, politics, and opportunity to develop between the rich “haves” and the poor “have nots.” Those who are less well-off feel the system is unfair so resentment grows.
• As long as the living standards of most people are still rising, these gaps and resentments don’t boil over into conflict.

Reserve currency gives “exorbitant privilege” of being able to borrow more money; getting deeper into debt; boosting spending power over the short-term and weakening it over the long run; inevitably:

• The country begins borrowing excessively, which contributes to the country building up large debts with foreign lenders
• It weakens the country’s financial health – and weakens the currency – over the longer term. In other words, when borrowing and spending are strong, the empire appears very strong, but it’s finances are in fact being weekend because the borrowing sustains the country’s power beyond its fundamentals by financing both domestic overconsumption and international military conflicts.
• Having an empire becomes unprofitable.
• The richer countries get into debt by borrowing from poorer countries that save more.
• If the empire begins to run out of new lenders, those holding their currency begin to look to sell and get out rather than buy, save, lend, and get in – and the strength of the Empire begins to fall.

Ray Dalio

Next: THE DECLINE & SUMMARY:?A Preview of Where We Are Now