The Changing World Order & Dalio’s 5 Principles – All You Need To Know

In this post, we’ll summarise the main points from the book The Changing World Order written by legendary investor Ray Dalio, which looks at past history of the rise and fall of empires and uses it as a way to create a map of the future.

What Is An Order?

An Order is a governing system for people dealing with eachother. There are three types of orders:

• Internal Orders are governing systems that apply to those within nations typically laid out in constitutions.
• External Orders are governing systems that apply to those between nations typically laid out in treaties.
• World Orders are governing systems that apply to the whole world.

These orders influence each other and are in constant flux.

The Changing World Order In Brief

All empires follow timeless and universal overlapping cycles that last roughly 250 years. Dalio terms this The Big Cycle.

The Big Cycle includes the long-term debt cycle which lasts roughly 100 years, the short-term debt cycle which lasts roughly 8 years and transition periods which last 10-20 years.

All Big Cycles are the same, but different. In the words of Mark Twain, “History doesn’t repeat itself, but if often rhymes.” They are the same in the sense that nations still rise and fall due to human nature (we still deal with fear, greed and jealousy as we have done since the dawn of time), but they are different in the sense that over time, people increase their wealth due to technology.

Increased wealth is due to increased human productivity, which is characterised by output per person and is driven by knowledge. The more we produce, the richer we get.

Why? Because of evolution. Evolution is the upward movement toward improvement that occurs because of adaptation and learning and is the single force that persists across time.

However, productivity is not the cause of changing empires; boom, busts, revolutions and wars are.

Broadly speaking, The Big Cycle consists of three phases:

• Firstly, The Rise which is characterised by a period of construction and marks the beginning of an empire.
• Secondly, The Top which is characterised by a period of excess and marks the peak of an empire.
• Thirdly, The Fall which is characterised by a period of destruction and marks the ending of an empire.

The swings between the rise and falls of empires is the rule, not the exception.

The Rise & Fall Of Empires Summary

The rise, top and fall of an empire can be summarised by the following determinants:

By looking at the determinants of a nation, we can assess its strength relative to the past, present and future and understand where it stands relative to the world order.

“The empire, long divided, must unite; long united, must divide. Thus it has ever been.” ― Luo Guanzhong

The Rise

The first phase in Dalio’s model ― The Rise ― is characterised by a period of construction and marks the beginning of an empire.

Strong education leads to better innovation which leads to being more competitive in world markets which is reflected in a nation’s growing economic output and rising share of world trade.

Interestingly, history shows that most successful empires used a capitalist approach to develop productive entrepreneurs and ultimately a thriving economy.

As a nation continues to grow globally, they must protect their trade routes and foreign interests from attack which forces them to strengthen their military. Done successfully, this leads to developing the world’s leading financial centres, allowing them to attract and distribute the capital of their times.

When a nation becomes the largest international trading empire, not only can its transactions be paid using its currency, making it the preferred global medium of exchange, but people are motivated to save in its currency, making it the preferred store of wealth and consequently the world’s reserve global currency. This marks the transition to The Top.

The Top

The second phase in Dalio’s model ― The Top ― is characterised by a period of excess and marks the peak of an empire.

As the citizens within a leading empire earn more, it makes them more expensive and less competitive relative to other nations who are willing to work for less. At the same time, other nations model the systems and technologies of the leading empire, which further reduces the leading empire’s competitiveness.

Moreover, as people become richer, they tend to get lazy and not work as hard, enjoying more leisure, pursuing the more finer things in life and at the extreme become decadent.

Values change from generation to generation during The Rise to The Top, from those who achieved wealth and power to those who inherited it. They become accustomed to the “easy life” which makes them more vulnerable to challenges.

As a nation and its citizens get used to doing well, they increasingly bet on the good times continuing, borrowing money in the process, which leads to a financial bubble. This increased prosperity distributes wealth unevenly so the wealth gap typically grows between the rich haves and the poor have-nots.

Wealth gaps are self-reinforcing because rich people use their recourses to reinforce their powers. Those less well off feel the system is unfair and resentments grow. However, as long as the living standards of most people continue rising, these gaps do not boil over into conflict.

Inevitably, the cost of maintaining and defending the empire becomes greater than the nation’s revenue, so having an empire becomes unprofitable. This marks the transition to The Fall.

The Fall

The final phase in Dalio’s model ― The Fall ― is characterised by internal economic weakness together with war (either civil or international or both). Typically, a nation’s fall comes gradually and then suddenly.

When debts become 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 domestic hardships and forces the nation to chose between defaulting on its debts or printing money. It always choses to print money, which devalues the money and raises inflation.

When the government has problems funding itself, when there are bad economic conditions, when living standards for most people are declining and when there are large wealth, value and political gaps, internal conflict between the rich and the poor as well as different ethnic, religious and racial groups increases. This leads to political extremism which appears as populism of the left or the right.

Those on the left seek to redistribute the wealth while those on the right seek to maintain the wealth in the hands of the rich. Typically in such times, taxes on the rich rise which forces them to move to places, assets and currencies that they feel safer in. These outflows reduce the empire’s tax revenue which leads to a classic self-reinforcing hollowing out process.

When the outflow 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 which causes conflict on how to divide the shrinking recourses. Populist leaders emerge from both sides and pledge to take control and restore order.

This is when democracy is most challenged because it fails to control the anarchy and is when the move to a strong populist leader who will bring order to the chaos is most likely.

As conflict within the nation escalates, it leads to some form of civil war or revolution to redistribute the wealth and force the necessary changes. This is either peaceful and leads to maintaining the existing order or, as is more often the case, it is violent and leads to creating a new order.

This internal conflict makes the empire weak and vulnerable to rising external rivals, who, seeing this domestic weakness, are more inclined to raise a challenge. This raises the risk of international conflict.

Defending one’s empire against rivals requires military spending, which has to occur as domestic economic conditions are deteriorating and the empire can least afford.

Since there is no viable system for peacefully resolving 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 either fighting or retreating. Fighting and losing is the worst outcome. Retreating cedes power to the rising rival and signals weakness to those nations deciding which side to be on.

Out of these internal and external conflicts come new winners and losers. Those holding the reserve currency and debt of the falling empire lose faith and sell them. This marks the end of the once dominant empire and the cycle begins again.

The Future

Just like we can assess an individual’s health by measuring specific physical determinants, we can assess a nation’s health, relative to the Changing World Order, by measuring specific financial and social determinants.

By using past history to understand the dynamics of Changing World Orders and by knowing the health of individuals nation, we can both anticipate and navigate the future more effectively.

“The farther back you can look, the farther forward you are likely to see.” — Winston Churchill

Summary

The Changing World Order looks at the history of civilisations to determine why nations succeed and fail. It provides us with a blueprint for the development of an empire and a manual against its decadence.

The Changing World Order consists of three phases; The Rise, The Top and The Fall. The Rise is marked by strong economic and social conditions. The Top is marked by excess. The Fall is marked by weak economic and social conditions. A shift then occurs from one world order to another when a new rising power becomes stronger than the falling one.

History has shown all countries’ success depends on sustaining the strengthening forces without producing the excess that leads to their fall.

We can use the knowledge of how empires rise and fall to anticipate and navigate the future more effectively.