WHO IS RAY DALIO?

Ray Dalio is one of the most successful investors of our time. He founded Bridgewater Associates in 1975 and turned it into one of the largest and most successful hedge funds in the world. Over the years, he has developed a unique investment philosophy that is grounded in principles such as radical transparency, systematic decision-making, and a deep understanding of the economic machine.

WHAT IS THE CHANGING WORLD ORDER?

The Changing World Order refers to the shift in balance of power between nations, where one empire falls and a new empire takes over. This phenomenon has occurred throughout history, with the average cycle lasting about 250 years for great empires, with the same factors eventually leading to their fall. 

The current world order, commonly called the American world order, formed after the allied victory in World War 2 when the US emerged as the dominant world power. 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.  Having the world reserve currency plays a key role in a country becoming the richest and powerful empire.  

Before the US empire and US dollar held world reserve status, the empires that held the previous reserve currencies were the British empire and pound in the 1800s, and before that, it was the Dutch empire and guilder in the 1600s.  As you can see, all reserve currencies in the past have been overturned by new ones eventually. Today, this is a relevant issue for investors to consider, as some are beginning to wonder whether, when and why the dollar will decline as the world’s leading reserve currency, what might replace it, and how that would change the world. To help answer these questions, it helps to take a look at what happened in the past. 

What causes these major world leading empires to eventually lose their power? 

In his study, Ray identified 8 key metrics to measure an empire’s power. 

Those 8 metrics are: education, inventiveness and technology development, competitiveness in global markets, economic output, share of global trade, military strength, the power of their financial center for capital markets, and the strength of their currency as the world’s reserve currency.

Because each of these factors are measurable, we can use them to see how strong each country is today, compared to where it was in the past and whether they are rising or declining. This is important for understanding the change in power, by seeing which stage countries are in, it can help determine and anticipate future rises and declines of nations. 

As example, Ray notes that, “For the first time in my life, the US is encountering a true rival power. China has become a rival power to the United States in most ways and is becoming strong in most ways at a faster rate. If trends continue, China will be stronger than the United States in the most important ways that an empire becomes dominant. Or at the very least, it will be a worthy competitor.”

This issue is becoming more relevant now as there is an increasing trend of countries de-dollarizing, meaning they are using less US dollars in the international financial system and markets. BRICS Countries, also known as Brazil, China, Russia, and India, have already taken steps to bypass the US-dominated global trade and financial system such as by trying to strike deals with other oil producing countries including Iran and Saudi Arabia to buy oil in yuan instead of USD. 

Some experts warn that this poses a potential threat to the US as the world’s reserve currency, as this trend of de-dollarization continues. As example, the use of the yuan has increased over the past few years where it has now become the fifth largest payment as well as reserve currency, and the third largest in trade settlements.

WHAT IS THE BOOK THE CHANGING WORLD ORDER ABOUT?

Ray noticed three things that happened in recent years that led him to study changing world orders: 

1. First, countries didn’t have enough money to pay their debts, even after lowering their interest rates to zero. Because of this, central banks began printing a lot of money. 
2. Second, big internal conflicts emerged due to growing gaps in wealth and values. This showed up in political populism between the left and right. 
3. Third, increasing external conflict between a rising great power and the leading great power, as is now happening with China and the US. 

He realized that all these events had happened together many times before in history. Almost every time, it led to changing domestic and world orders. 

Ray explains a cyclical pattern known as the “big cycle,” which includes the emergence of a new dominant power and monetary system leading to the establishment of a fresh world order. This cycle occurs in a timeless and universal manner.

In a nutshell, the big cycle typically begins after a major conflict, often a war, which establishes the new leading power and the new world order. For example, the US rose to become the world’s superpower particularly after World War II.

This leads to the second stage of the cycle, where the resource-allocation systems and governments are built and refined. 

Then, because no one can or wants to challenge this new power, there is typically a period of peace and prosperity, which is the third stage. 

However, the cycle progresses to the fourth stage, which is characterized by people getting used to this peace and prosperity, increasingly betting on it continuing, so they borrow more money than they earn, 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 and poor. All of this eventually leads to a financial bubble. 

Eventually, the financial bubble bursts, which leads to very poor financial conditions, intense conflict between the rich and poor and results in the printing of money. 

The empire begins to struggle with this internal conflict, and 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 external and internal wars, emerge new winners and losers. The winners then create the new world order. 

The cycle begins again. 

As Ray looked back in history, he saw that these same cause and effect relationships drove the rises and declines of empires all the way back to the Roman empire.

What are some practical takeaways from studying these historical cycles? 

Ray shares two important principles that investors can use to help them make more informed decisions. 

 

Principle 1: When central banks print a lot of money, buy stocks, gold, and commodities

One of the first principles Ray talks about in the book that he learnt after studying 500 years of history is that  when central banks print a lot of money, buy stocks, gold and commodities because their value will rise, and the value of paper money will fall. 

This happened in 1933 when paper dollars were linked with gold, which the US was running out of because there were spending more paper money than they had gold to exchange for, and then in 1971 when the US ran out of money again, defaulted on its debt and broke the paper currency’s link with gold, as well as it happened in 2008 to relieve the mortgage driven debt crisis, and most recently in 2020 to relieve the pandemic driven economic crisis. 

In all cases, this allowed the US to continue to spend 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 an increase in productivity, they went to buy lots of stocks, gold commodities, causing their prices to rise. 

As he studied history, Ray observed the exact same thing happened in 1960 in the US, in 1850 in the UK, in 1650 in the Netherlands. He believes it will continue to happen again in the future. 

 

Principle 2: To understand what is coming at you, you need to understand what happened before you. 

Studying these important historical events led Dalio to come to a very important conclusion, which was that understanding history can be the greatest teacher and sometimes predictor of the future. This realization led him to study how the roaring twenties bubble turned into the 1930s depression. Studying this event gave Ray the lessons and knowledge to profit from the 2007 bubble, which then turned into the 2008 bust. 

Understanding where we are in the cycle today can help anticipate where we might  be in the future. While many famous investors like Warren Buffett and Charlie Munger often say that most economic and macro data is noise in the investment process, Ray Dalio provides an alternative view and believes that paying attention to these macro trends and specifically understanding cycles throughout history are crucial to not only his success as an investor, but can help all investors anticipate what’s ahead and make informed investment decisions.

WHAT IS AN EXAMPLE OF THE CHANGING WORLD ORDER?

One example of the changing world order is when the American world order formed after World War 2.  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.  

Before the American world order and US dollar held world reserve status, the empires that held the last three reserve currencies were the British empire and pound in the 1800s, and before that, it was the Dutch empire and guilder in the 1600s.  

Having a reserve currency enables a country to be able to borrow more than other countries. This is a huge advantage because people will be eager to lend out their dollars and if a country that is the world reserve currency, runs out of money, they can just print more. However, this privilege of having a reserve currency leads to increased borrowing and large debts with foreign lenders. This boosts spending power over the short term, but it weakens the country’s financial health and the currency over the long term. 

In this cycle, the richer countries eventually get deeper into debt by borrowing from poor countries that save more, which is one of the early signs of a wealth and power shift. This started in the US in the 1980s when it had a per capita income 40 times that of China’s and started borrowing from the Chinese who wanted to save in dollars because of the dollar’s world reserve currency status. Similarly the British borrowed a lot of money from its much poorer colonies, and the Dutch did in their era. 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. 

This is when the strength of the empire begins to decline. 

Of the roughly 750 currencies that have 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 couldn’t pay back the massive debts they built up during it. This led to a run on the bank of Amsterdam, leading to a desperate sell off and forcing massive money printing which devalued the currency and the empire into irrelevance. For the British, this happened after World War 2, 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 sell offs in the British pound as the US and the dollar emerged dominant and created a new world order. 

At this time, the US has massive amounts of debt, most on record, and spends more than it earns, funding this deficit with more borrowing, and printing huge amounts of new money, the big sell off in dollars and dollar debts hasn’t yet begun. That said, some experts believe it may be beginning. Particularly as there has been a shift in economic power from the West to the East and the trend of de-dollarization is occuring. 

Over the past few decades, countries such as China and India have experienced rapid economic growth, and have emerged as major players on the global stage. These countries, along with the other BRICS countries (Brazil, Russia, India, China, and South Africa) that account for over 40% of the world’s population and just over a quarter of the global GDP have formed an alliance, and their collective actions to try to de-dollarize may pose a threat to the US as the world reserve currency.

FREQUENTLY ASKED QUESTIONS ABOUT THE CHANGING WORLD ORDER