Ray Dalio: Part 2 Of A Two-Part Look At Principles For Navigating Big Debt Crises

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Part 2 of a Two-Part Look at: 1. Principles for Navigating Big Debt Crises, and 2. How These Principles Apply to What’s Happening Now

If we don’t agree on how things work, we won’t be able to agree on what’s happening or what is likely to happen. For that reason I like to begin by describing how I believe things work to see if we can agree on that.

In Part 1, I provided a simplified description of how I believe the money-credit-debt-markets-economic “machine” works that’s available here. It is a part of my more comprehensive description of the cause/effect relationships that lead countries and their markets to rise and decline.

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That more comprehensive description was laid out in my book Principles for Dealing with the Changing World Order. I hope you will examine my description of the cause/effect relationships that drive how things work to assess whether you by and large agree with it.

In this Part 2, I will briefly review some of the timeless and universal cause/effect relationships that drive how “the machine” works, then I will review what happened from 1945 until now to compare what actually happened with my template, and then I will focus on what’s happening now and what this template leads me to believe about the future.

While I’d love for you to read the whole thing because I think it’s packed with valuable stuff, if your goal is to blast through it and glean the highlights quickly, there are highlights that I put in bold or you can skip to what you’re interested in by looking at the subject headings. By the way, I put the principles that I believe are timeless and universal truths in italics.

The Big Picture

If you want to see how and why big events have unfolded, be careful not to focus precisely on small events. People who try to see things precisely typically miss the most important things because they are preoccupied with looking for precision.

Also, if you look at things up close, you will never see the most important big things. Instead, when looking for the big things pay attention to the big things.

The world order that began at the end of World War II, which was shaped by the United States being the dominant power, is now changing to produce a very different type of world order. This transition is happening in classic ways that drove how transitions occurred throughout history.

Throughout history there have always been rich and powerful countries and poor and weak countries and there have always been changes in their relative strengths that occurred for logical and measurable reasons that have changed the world order.

To benefit from these changes rather than be hurt by them, one must understand the cause/effect relationships behind them and adapt to these changes, ideally being ahead of them rather than being significantly behind them.  

Because there is too much that is important that is happening in too many places for me to be able to stay on top of in my head, I have systemized data that describes the most important measures of strength and shows how they’re changing.

I have found that 18 types of strength have driven almost all changes in countries. I monitor these in 24 countries. They are described in my book Principles for Dealing with the Changing World Order and updated on my website www.economicprinciples.org.

The five most important drivers of changes that are important to understand are:

  • The debt-money-economic dynamic
  • The internal conflict dynamic
  • The external conflict dynamic
  • Acts of nature (droughts, floods, and pandemics)
  • Human invention and technology development 

In this report I will focus just on these five and just in the biggest countries. I should however point out that some of the most attractive pictures that I am seeing reflected in both these measures and in my firsthand contact are coming from some smaller countries that aren’t on this top 24 list.

In Part 1, I briefly reviewed the mechanics of money and debt cycles and the principles for dealing with them well. In this Part 2, I will very briefly review my template, show how events have been transpiring relative to this template, and then show what’s happening now and what I think about it.

A Brief Review of My Template

I have a template for explaining how “the machine” works that I hope to convey in an easy-to-understand way so you and others can assess it for yourselves. Very simply a) money (i.e., the access to resources) + b) talented people + c) an environment that is conducive to conjuring up and building out developments = d) economic success (and economic success contributes to all sorts of other successes such as health, education, social, and military).

In fact, any two of these ingredients will be enough (though all three together is best). For example, talented people in the right environment will earn or attract the money/resources that they need to succeed, and money with the right environment will attract talented people.  

As explained in Part 1, I’d like to start by describing money because it’s of paramount importance and it’s what I know best. I believe that the money-credit-debt-markets-economic dynamic is the most important dynamic to understand and to stay on top of both for investing and for understanding the changing world order, so I will start with that.

As explained in Part 1, it is driven by borrower-debtors, lender-creditors, and central bankers that both produce and respond to incentives to lend and borrow that lead to two interrelated cycles—a short-term one that has averaged about six years in length +/- three years and a long-term one that has averaged about 75 years +/- 25 years—which evolve around an upward trend line in productivity that is due to humanity’s inventiveness.

By “short-term debt cycle” I mean the cycle of 1) recessions that lead to 2) central banks providing a lot of credit, which creates a lot of debt that initially leads to 3) market and economic booms that lead to 4) bubbles and inflations, which lead to 5) central bankers tightening credit that leads to 6) market and economic weakening. There have been 12.5 of these since 1945.

By “long-term debt cycle,” I mean the cycle of building up debt assets and debt liabilities over long periods of time to amounts that eventually become unmanageable. This leads to a combination of big debt restructurings and big debt monetizations that produce a period of big market and economic turbulence. I believe that we are now roughly about 85% through the one that began in 1945. 

As for the mechanics of this dynamic, history has shown and logic dictates that the return relative to the inflation rate (the real return) will follow the strength of the borrowers with a lag. That is because the financial ability of debtors to meet their obligations to pay back is the most important determinant of the value of the debt.

If their finances aren’t good, they won’t be able to fully pay back and the only question is which way they won’t pay back to be relieved of their debt burdens. That’s largely up to the central banks and the central governments.

If central banks keep interest rates high and money tight, creditors will get less real money because of debt defaults and debt restructurings. On the other hand, if central banks keep interest rates low and/or print money, creditors will get the money promised but at a depreciated value (i.e., the money will have less buying power.)

For this reason, when there are a lot of debt assets and debt liabilities, it’s a risky situation for both debtors and creditors that puts central bankers in the difficult position of trying to simultaneously

1) keep real interest rates high enough and money tight enough to satisfy the lender-creditors without

2) having real interest rates so high and money so tight that it hurts the borrower-debtors intolerably.

Getting this balance right is critical because if real interest rates are not high enough and money is not tight enough borrower-debtors will over-borrow and lender-creditors won’t adequately lend and will sell the debt assets they own, forcing the central bank to have to choose between

a) allowing real interest rates to rise to high enough levels to bring about a supply-demand balance that will have devastating effects in markets and the economy, or

b) printing a lot of money and buying the debt assets that others won’t buy which will lower real interest rates and devalue the money.

In either case, when there are a lot of debt assets and debt liabilities it isn’t good to hold debt assets except for short tactical moments.

Whether central banks are tight or loose will however make a difference in which debt assets are good. If central banks go the tight money route, credit spreads will widen because risky debtors need to devote more of their income to debt service.

Meanwhile, those debt assets that are default-protected by the central government and central bank will still perform poorly but won’t be hurt as much. If they go the easy money route, there will be less differentiation because credit spreads won’t increase as much, though all debt is likely to be devalued in real terms.

So, as a general rule, when there are a lot of debt assets and liabilities outstanding relative to both the debtors’ abilities to service the debt and the creditors’ abilities to get a good real return from the debt assets, watch out. For a much more complete look at this dynamic and many case studies over several hundred years see Chapters 3 and 4 in my book Principles for Dealing with the Changing World Order.

As explained in that study of past cases, in all cases where there have been big debt crises and the debt is denominated in currencies that central banks can print, central banks have always printed the money and bought the debt because this is the least painful way to deal with the debt restructuring. In any case, the reduction in the debt assets and debt liabilities occurs and a new cycle can begin.

These cycles move markets and economies around an upward-sloping trend line of rising living standards that is due to people’s inventiveness and the increases in productivity that come from it.

The incline of its upward slope in productivity is primarily driven by the inventiveness of practical people (e.g., entrepreneurs) who are given adequate resources (e.g., capital) and work well with others (their coworkers, government officials, lawyers, etc.) to make productivity improvements.

Over a short period of time (i.e., one to 10 years) the cycles are dominant. Over a long period of time (i.e., 10 to 30 years and beyond) the upward-sloping trend line has a much bigger effect. Conceptually, the way this dynamic transpires looks like this to me:


During the big money-credit-debt-market-economic cycles (which I will henceforth, for brevity, call debt cycles), different monetary regimes come and go mostly to accommodate and facilitate continued credit and economic growth. Within each of these money/currency regimes there were sub-phases that I call paradigms.

For example, the 1970s paradigm was one of high inflation and slow growth while the 1980s paradigm was one of falling inflation and strong growth, while both occurred in the same monetary regime.

Over time, from one cycle to the next, debt liabilities and debt assets have virtually always increased to make the long-term debt cycle expansion. In all cases that has continued until the debt burdens have become unsustainably large or the debt assets have become intolerably low-returning, at which time there are big reductions in debt liabilities and debt assets that take place through some mix of debt restructurings and debt monetizations.

These are the big debt crisis periods. These big debt restructurings and debt monetizations end the prior big debt cycle by reducing debt burdens and eliminating the prior monetary order, leading to the next new big debt cycle and monetary order.

They take place much like big changes in domestic political orders and big changes in world orders—like seismic shifts due to the old orders breaking down. That is a simplified version of what the first of the five big forces—i.e., the money-credit-debt-market-economic cycle—looks like to me.

The Other Four Big Forces Affect How This Debt Cycle Transpires Just as This Debt Cycle Affects How the Other Four Forces (and All of the 18 Previously Mentioned Forces) Transpire Together

More specifically, 1) the money-credit-debt-markets-economic cycles, 2) the cycles of peace and conflict that take place within countries, 3) the cycles of peace and war that take place between countries, and 4) the acts-of-nature shocks of droughts, floods, and pandemics create big swings in conditions around 5) a productivity-driven uptrend that is due to humanity’s ability to invent and produce. The interactions between these forces drive how conditions change.

They tend to reinforce each other both upwardly and downwardly. For example, periods of financial and economic crisis tend to reinforce periods of internal conflict, and periods of internal conflict worsen financial and economic conditions.

Similarly, periods of internal financial problems and internal political conflicts both weaken the country that they are happening in and increase the likelihood of external conflicts. Together these forces create the Big Cycles of ups and downs in countries and the big changes in domestic and world orders.

These big rises and declines are easy to see by monitoring the 18 forces (particularly the big five) that I’m sharing with you. For example, you can see the big evolutionary decline of great powers and their monies reflected in 1) the decline of many indicators of health (e.g., education, infrastructure, law and order, civility, government effectiveness, class and ethnic conflict, etc.) relative to those other world powers, and 2) the unwavering rises of indebtedness accompanied by the steady weakening of the types of monetary systems used to restrain credit-and-debt-growth-motivated attempts to raise credit and economic growth. 

While I won’t now delve into how all these work—both because doing that would be too much of a digression and because it’s better explained in my book or even in my relatively brief video, both titled Principles for Dealing with the Changing World Order—I now will move from describing this template to looking at what has actually happened over the 78 years since 1945 when the money and political world order last changed.

That way you will go from looking at my theoretical template to looking at what happened and why. It will also give you a perspective that I think will help you imagine the future.    

While I think the next section is important because it shows how this template and actual developments have worked and it explains how we got to where we are and it helps to understand where we are, if you don’t want to read it all read what’s in bold and quickly get to the 2020-2022 section to set the stage for seeing where we are and then read the section on looking ahead.

A Brief Review of What Actually Happened Relative to My Template: 1945 until Now

In order to paint the big picture of how things work, what happened, and where we are, I will start in 1945 and will quickly bring you through what I believe are the most important things up to now.

Since the money part of what happened was most important in shaping what happened, I will look at what happened through the lens of the previously described money-economic lens of the short-term and long-term debt cycles evolving around the productivity-living standard uptrend.

I will divide the post-1945 period into four phases that correspond with the four monetary regimes that drove the credit-debt dynamic since 1945.

1945 was the year the war ended so it was the first year of the new monetary and geopolitical world orders. Because the United States was the strongest economic, geopolitical, and military power, these new orders had US money and US geopolitical power at the heart of them. 

Phase 1: 1945 to 1971—A Gold-Linked Monetary System

  • From 1945–1971 there was a gold-linked monetary system in which dollars (which were considered like checks with no intrinsic value) were exchangeable for gold (which was considered the real money) at a fixed exchange rate and other currencies were exchangeable for dollars at agreed-upon and changeable rates. During this 26-year period there were five short-term debt-economic cycles, which were wiggles around an uptrend in GDP and indebtedness.
  • From 1945 until 1970 Great Britain declined, and Germany and Japan rose economically, so the British pound fell and the German deutschemark and Japanese yen rose in importance.
  • In 1956 something called artificial intelligence was invented. In 1957 key inventions included lasers, personal computers, and satellites. In the ’60s came high-speed rail, Kevlar, the technical foundations of the internet, and the pocket calculator.
  • During this 1945-1970 period the US overspent and financed that overspending by borrowing, especially in the 1960s on the Vietnam War and the War on Poverty, so debt assets and debt liabilities increased far more than incomes and the quantity of gold that the US had in the bank. The civil rights movement conflicts added to the tensions. Some of those who held dollar assets (such as France under President Charles de Gaulle), which were claims on gold, chose to turn in their dollar assets for gold. This created the beginning of a balance of payments problem and a tightening of monetary policy that led to a recession in 1970. Because the dollar claims on gold had become much larger than the gold in the bank and that became more apparent, a “run on the bank” occurred. It took the form of holders of debt assets turning them in for money to get the gold which led this monetary order to break down in 1971. That is when the first of the post-war monetary orders broke down.

Phase 2: 1971 to 2008—A Fiat Money, Interest-Rate-Driven Monetary Policy (MP1)

  • 1971 was the transition year when the gold-linked monetary system was replaced by a fiat monetary system in which central banks ran a monetary system that stimulated and restrained money/credit/debt growth by changing interest rates. I call this type of monetary system—i.e., one in which fiat currencies are managed via interest rate changes—Monetary Policy 1 (MP1). There are two other types of monetary policy that take place at the different stages of the long-term debt cycle that I call Monetary Policy 2 (MP2) and Monetary Policy 3 (MP3). If you are interested in learning more about them, I describe them beginning on Page 36 of my book Principles for Navigating Big Debt Crises, which you can get in PDF form here.

While the gold-dollar-based system broke down, the US remained the dominant world power economically, militarily, and in most other respects, and most world trade and global lending was done in dollars so the dollar remained the world’s leading currency.

Because of the big devaluation of the dollar (and all other currencies) versus gold in 1971 and because of the way the new fiat monetary system was managed (with low real interest rates and plenty of credit availability) being a borrower-debtor was rewarded so there was a large increase in money/credit/debt that produced a lot of inflation with slow growth in the 1971-1980 period.

Lots of money was lent to emerging countries, especially those in Latin America. That 10-year period consisted of two short-term money-credit-debt-economic cycles that each transpired in classic ways with the Fed’s decisions to ease or tighten monetary policy driving them, though the second money/credit/debt and inflation surge was much bigger than the first.

Naturally the pendulum swung in the classic way to the opposite extreme—i.e., easy money and credit causes very high inflation which led to an equal and opposite reaction in monetary policy, so money and credit was very easy early in the period which led to high inflation which led to the greatest tightening of monetary policy “since Jesus Christ” (according to German Chancellor Helmut Schmidt) to fight inflation at the end of the 10-year period.

As always this tightening took the form of a sharp rise in real rates that shifted the conditions from benefiting borrower-debtors early in the decade to benefiting lender-creditors in a big way at the end of it. That ended the decade-long stagflation paradigm and began the 1980s decade-long disinflationary growth paradigm.

  • In the 37 years from 1971 until 2008 there were five short-term credit-debt-economic cycles. These cycles occurred within the greater long-term debt cycle trend of rising debt levels supported by declining short-term real and nominal interest rates.
  • After the two large tightenings in the ’70s and early ’80s until 2008, every cyclical peak and every cyclical trough in interest rates was lower than the one before it. These declines supported asset prices and economic activity. The declining trend of real and nominal interest rates shifted conditions from those that benefited lender-creditors back to those that favored borrower-debtors, which allowed debt/income levels to rise until there was the 2008 debt-economic crisis and interest rates hit 0%. Hitting zero eliminated central banks’ abilities to ease and stimulate the next wave of credit/debt/economic expansion through interest rate cuts, so they turned to MP2.

During this time period, the geopolitical landscape changed as the Soviet Union fell, China rose, and wealth gaps increased.

The big inventions were the microprocessor, video game consoles, laptop computers, GPS, lithium-ion batteries, satellite television, DNA profiling, the internet, search engines, smartphones, social media, apps, digitalization of thinking, and the earliest blockchains.

Phase 3: 2008 to 2020—Fiat Money, Debt Monetization, Independent Monetary Policy (MP2)

  • In late 2008 the interest-rate-driven monetary system (which I call Monetary Policy 1) couldn’t be used for easing anymore because interest rates couldn’t be lowered enough to create a credit-debt-economic expansion. As a result, the prior type of monetary system (MP1) was replaced by central banks printing money and buying debt in large quantities (MP2) which ushered in the era of “debt monetization” or “quantitative easing” as they are now called. Said differently, central banks started to become big lender-creditors making up for the shortage of free-market lender-creditors. They needed to do this to keep the expansion phase of the big credit-debt-economic cycle going. That was the first time this set of circumstances and this monetary policy happened since 1933 (i.e., 75 years earlier). Such moves to debt monetization have occurred throughout history and are symptomatic of being in the late phase of the long-term debt cycle.
  • This buying of financial assets by the Fed helped push up the prices of financial assets and push down their yields. The stimulative monetary policies that flowed through the system freely favored the rich who had financial assets that rose and good access to borrowed money. These developments and rising wealth gaps increased class conflict. The government bailing out the banks contributed further to the environment of animosity toward the capitalists.

Also, because the Chinese and other emerging market producers had become more competitive which took away jobs at the same time that new technologies took away jobs which contributed to the hollowing out of the middle class, that also increased class warfare.

People who were hurting economically believed that the “elites” running things and the system were rigged against them. That led to the rise of populist sentiment and nationalism. These developments were also analogous to those that happened in the early 1930s and many times before under similar circumstances.

  • In the US these developments led to Donald Trump’s election and his moves to nationalism which included aggressive trade, technology, and geopolitical policies to confront and contain China.
  • In this 2008-2020 period there were two short-term credit-debt-economic cycles (including the one we’re currently in) with each amount of debt creation and each amount of debt monetization greater than the one before it.
  • During this period China continued to rise and the wealth and opportunity gaps continued to rise.
  • Technologically, computer chips rapidly advanced, cryptocurrencies were launched, self-driving car features began to be rolled out, movie streaming became more widespread, 4G (and then 5G) wireless began, and reusable rocket ships began to be used. Climate change began to garner greater attention.
  • In 2020, the world was hit with the COVID pandemic. That necessitated a change in monetary policy to what I call Monetary Policy 3. 

Phase Four: Since 2020—Big Fiscal Deficits Monetized (MP3)

  • Monetary Policy 3 is the type of monetary policy in which there is coordination of fiscal and monetary policies because this type of monetary policy is required to get money and credit in the hands of those who would not get it in a free-market capital markets system. That is because free-market capitalism naturally provides capital to those who are financially well-off. Throughout history MP3 has happened under similar circumstances in similar parts of the long-term debt cycle.
  • Since 2020 we have experienced the big easing part and most of the big tightening part of the short-term debt cycle.
  • The big easing part happened in 2020 because of the combination of COVID-induced debt and economic crises, large wealth gaps, and political moves to the left via the elections of a Democratic president, a Democratic-controlled House of Representatives, and a Democratic-controlled Senate. These things together led to huge government spending increases, huge increases in government fiscal deficits, and huge increases in the amounts of debt that governments had to sell to finance these deficits. This selling of debt assets was much greater than free-market lender-creditors would buy which required central banks, most importantly the Fed, to buy/monetize the debt. That increased the amount of money/credit/debt/spending a lot. This massive MP3 type of coordination of fiscal and monetary policies to allow the central government to both tax and direct money as it chooses via the central bank buying its debt with printed money is explained starting on Page 37 of my book about debt crises if you’re interested in knowing more and seeing past cases. That is what happened in 2020-21; it has happened repeatedly for similar reasons throughout history.
  • The 2020-2021 debt monetization was the fourth[1] and the largest big debt monetization since the original big debt monetization/QE in 2008 (which was the first since 1933). Since 2008 the nominal Treasury bond yield was pushed down from 3.7% to 0.5%, the real Treasury bond yield was pushed from 1.4% to -1.1% and non-government nominal and real bond yields fell a lot more (because credit spreads narrowed). As money and credit became essentially free and plentiful the environment became great for borrower-debtors and terrible for lender-creditors which led to new bubbles forming. My bubble indicator, which was at only 8% in 2010, rose to 82% at the end of 2020, showing the bubbles in companies and assets that had little or no profits and were funded by selling equity and/or borrowing money based on promises of doing well in the future and speculative buying fever. It was analogous to the “Nifty-Fifty” bubble in the 1970-72 period, the “Japan bubble” of 1989-90, and the “dot-com bubble” of 1999-2000. That decline in interest rates took them so low that they couldn’t continue to fall. I estimate that the interest rate decline raised stock prices about 75% more (compared to pre-financial-crisis peak) than they would have risen without that decline. In addition, profit margins on average doubled as a result of technologies and globalization which also boosted profits and with them asset prices in unsustainable ways (because profit margins are now more likely to decline than to rise). Corporate and personal taxes declined which helped asset prices, and they are now more likely to rise than decline which will be a negative for asset prices over the next 10 years. All these factors drove asset prices up to levels that were extremely stretched. From the post-crisis lows of 2009 to 2020 the nominal value of wealth in US financial assets (i.e., “paper wealth”) rose from $22 trillion to $88 trillion, so there was a quadrupling of paper wealth.
  • That money/credit/debt surge in 2020 produced a huge increase in inflation which was exacerbated by the external conflicts (i.e., which is the third of the five major forces that I will touch on later).
  • That led to the short-term cycle pendulum swinging back to a big tightening via the Fed and other central banks raising interest rates and curtailing their debt monetizations. That flipped the short-term debt cycle from the easing mode to the tightening mode. 
  • Nominal and real interest rates went from levels that were overwhelmingly favorable to borrower-debtors and detrimental to lender-creditors, to levels that are more balanced. Since the tightening began, US Treasury bond nominal yields have risen from 0.5% to over 4%, real yields have risen from about -1.1% to 1.6% and credit spreads have risen significantly, all of which hurt most asset prices, particularly those with weak or negative profits and/or needs for new equity funding. Naturally that shift especially hurt prices of assets that were in bubbles. My bubble index fell from 82% to 30% and the bubble stocks in the index have fallen an average of 75%. The nominal value of wealth in stocks and bonds has fallen by ~12% in the US and the real value of wealth fell by nearly 18%, which are the greatest declines since 2009. Since these peaks in rates were reached in October these nominal and real interest rates have declined a bit which has helped markets to rally a bit. 
  • More specifically, due to the Fed’s rapid tightening, dollar-denominated debt assets and debt liabilities, and all assets affected by them, very quickly repriced as short-term nominal and real interest rates were brought to levels that were/are relatively attractive for lender-creditors and relatively unattractive for borrower-debtors. The rising of interest rates and tightening of money had the very classic effect of lowering the present values of future cash flows as the discounted interest rate rose and it strengthened the dollar relative to the currencies of other countries whose central bankers were slower to tighten. In other words, the Fed’s quick movement brought US dollar-denominated cash to relatively attractive levels in relation to most assets, cash denominated in other currencies, and gold—i.e., cash went from “trash” to “attractive.” As usual that hurt interest-rate-sensitive sectors like commercial and residential real estate, as well as low or negative cash flow bubble companies, both public and private, though public more so. For example, the FAANG stocks and the NASDAQ are down from their peaks by around 30% and 25% respectively. Non-public market assets—private equity, venture capital, and real estate assets—have not been marked down commensurately as there is a great reluctance to accept the markdowns. Write-downs and having down fundraising rounds became too painful for both the companies and the venture capital and private equity managers in these markets, so there is a standoff in which sellers and buyers can’t agree on prices and transaction volumes have plunged. Now negative cash flow companies are figuring out how much cash they have on hand to survive and how to cut costs to wait out the market. In my opinion they will never see prices rise to levels that won’t require them to have write-downs and down rounds. That means selling stocks for prices that are less than when the stock was last sold which leads those who bought it last time to have losses, shows that the company is falling short of expectations, and means that the venture capital and/or the private equity managers have to report poor performance numbers. For those reasons the incentives are not to have the write-downs. I believe these assets will generally be well below their historic highs for a very long time because I believe we will never see nominal and real interest rates go to such levels and cash be given away so freely again. 
  • The internal and external conflicts intensified during this 2020-2022 period and moved the world much closer to the brinks of civil war and international war. However, most recently there have been small steps back from the brinks as the fears of going over them have become more vivid and terrifying to those involved.
  • Regarding the internal conflicts between the extremists, while their increasing intensity showed up in elections and in other ways—especially in the US, Italy, Brazil, and throughout Latin America—and while they began to surface in strikes in Europe, by and large there was a stepping back from the brinks rather than a moving toward them. In the US midterm elections, for example, extremists of both the right and the left lost to moderates so there was a small stepping back from the brink.
  • Regarding external conflicts, while over the 2020-present period there was significant movement closer to brinks of catastrophic economic and military warfare, that movement brought into focus to all parties that crossing these brinks would be disastrous, which has led to restraints. More specifically we have seen a) Russia, Ukraine, the US, and NATO go into a military war that they have thus far contained geographically to be in Ukraine and in severity by using only conventional weapons and b) the US and China’s geopolitical war regarding Taiwan and China’s support of Russia, while having moved closer to the brinks of terribly damaging economic and military war during the 2020-2022 period, exhibited great restraints to prevent going over these brinks. At the same time Iran-Israel-US and related countries face a big decision as Israel (and the US) will be considering whether to militarily destroy Iran’s nuclear capabilities and/or Iran’s leadership to prevent Iran from becoming a nuclear power or if they will let Iran become a nuclear power.   
  • As for the use of capital and economic warfare, US sanctions against Russia proved ineffective but they raised the worry of a number of countries’ leaders that holding dollar debt assets could be risky. This came at the same time as the internationalization of the RMB—i.e., China increasingly denominating trade and capital flows in RMB—advanced. While these developments can undermine the long-term demand for dollars and dollar assets, they have not yet become large enough to drive markets. 
  • Seeing how these wars transpired in 2020-2022 has given us some indications of how they might transpire in the future. For example, over the last couple of years it has become clearer how countries would probably line up against each other and how far each would go and in what ways these conflicts would play out. Indications came in the form of UN votes and what countries traded what items with whom. The ways these “wars” transpired in 2020-2022 made clear that a) while the two sides—the US and NATO countries on the one side and Russia and China on the other side of their “wars” (most importantly over Ukraine and Taiwan)—were willing to go to the brink, they are afraid of going over it, b) virtually all other countries didn’t want to be drawn into these wars, and c) those countries that are uninvolved and rising powers, such as India, Singapore, the rising ASEAN countries such as Indonesia and Vietnam, Saudi Arabia, and the UAE have benefited from what is going on. This dynamic is creating clarity about where the good places are and where the riskier places are. More specifically we have seen that my three criteria for identifying places that would do relatively well in this new environment—i.e., those that 1) earn more than they spend so they have strong income statements and good balance sheets, 2) have internal order and other favorable conditions for prosperity, and 3) are unlikely to be involved in a bad international war—have thus far proven to be valuable. 

A Few More Evolutionary Developments over the Whole 1945-to-Now Period

While I showed you some of the big evolutionary developments that occurred since 1945 and focused a bit on what has happened recently, there are a few important big evolutions that I’d like to point out. The ones that I think are most important are: 

  • While I made clear that major monetary regimes in the world’s reserve currencies became progressively less restrictive which has led debt assets and debt liabilities to grow to dangerously high levels in the United States, Europe, and Japan without any prospect of being seriously restrained, what is not yet clear enough is how big changes in wealth have taken place. Wealth changes, which are very important, are not given adequate attention because most people mistakenly focus more on GDP than wealth. Think of it this way. GDP is like revenue that shows up in the income statement and tells you essentially nothing about wealth or profitability. Wealth, which shows up in the balance sheets, goes down when liabilities increase faster than assets. An examination of real wealth changes shows that there has been a very big decline in the relative wealth levels of Americans, Europeans, and Japanese relative to Chinese and many other nationalities such as Norwegians, Indians, Saudis, and Indonesians because the debts that have funded the three major reserve currency areas have increased faster than the assets. While borrowing allowed these countries to spend more than they earned, paying back will require them to spend less than they earn. That day of reckoning will certainly come.

Another big shift in wealth has been from central governments and central banks to the private sector (especially to the household sector)—i.e., the government sectors worsened their balance sheets to improve the household sector’s balance sheets.

This is cushioning the negative effects that the tightening is having on the household sector. This shift in wealth happened via central governments borrowing a lot and central banks printing a lot of money and buying a lot to get money in the hands of those in households. These shifts affect the money-credit-debt-economic dynamic a lot.

For example, since central governments supported by central banks don’t have default risks and since central bank losses from buying bonds that have gone down in price don’t have losses that squeeze them in any way, this dynamic has created less credit risk and more ability to borrow than would have existed, and that has created more “value of money” inflation risk than would have existed.

These shifts in wealth will become extremely important when creditors start moving to getting back and converting these debt assets into real goods and services. That it will happen is not questionable, though when it will happen is questionable. While I am not anticipating its timing, I am able to identify it when it starts to happen and begins to accelerate.

It will look like a classic run on a bank in which there is big selling of debt assets which will put central banks in the position of having to choose between a) real interest rates rising fast and a lot and damaging the markets and the economy, and b) printing a lot of money and buying a lot of debt which will devalue money a lot.  

  • The vulnerability of the dollar and dollar-denominated debt has been steadily increasing because of a) the supply of dollar-denominated debt being much larger than the free-market demand for it which has been requiring central banks to buy large quantities of the debt with money and credit they print, b) the growing desire of foreign countries to diversify their central bank and sovereign wealth fund holdings away from the dollar because they are too concentrated in dollars and diversification is prudent, c) foreign countries doing more trade and capital transactions with China than with the United States, meaning it’s natural from both China’s and other countries’ perspectives to denominate more transactions in China’s RMB, d) US sanctions having raised the concerns of some foreign holders of dollar bonds about these holdings being sanctioned, and e) US political and social conflicts, including the handling of the debt limits, undermining confidence in the US and its policies. 
  • Some countries have been ascending while some have been declining. China is the most important ascending power to understand, but other, less-watched ascending powers also warrant greater attention. Let’s look at China and then look at the others. 
  • Seeing the whole evolutionary arc of China and its impact on the world is important. Since it doesn’t come across by looking at it in pieces, I will briefly review it here. From 1945 until around 1980 China was unimportant to the world because its economy was insignificant in size and isolated from the rest of the world. Then in 1978 Deng Xiaoping came to power and pursued his “open door” and “reform” policies which led to China having huge economic effects, which changed not only China but the whole world. From around 1980 until now, China went from being a poor, weak country to being a rich (judging by its total, rather than its per capita, GDP and wealth levels) powerful country. Peoples’ reactions also evolved with China’s success, which is having a big effect on the world order. When China entered the world economy around 1980 and it was small and trying to be integrated into the world community, it was perceived favorably because it brought its inexpensive labor and high productivity gains to provide the world with attractively priced manufactured goods. The US and most of the world liked getting attractively priced manufactured goods, especially because China used a lot of its earnings to lend money to those who bought the merchandise. Those sales built up China’s income and allowed it to both get stronger and lend to the United States. Then, during the 2008-2016 period, the pendulum of sentiment toward China began to swing from positive to negative because of lost employment, especially in middle class manufacturing jobs as Chinese could do these jobs less expensively. To Americans, deals previously thought of as good seemed exploitative, intellectual property theft became a contentious issue, and restrictions against highly competitive foreign (especially US) companies being allowed to freely enter the Chinese market and freely compete were contentious issues. Also, China’s economic power grew, which gave it the resources to develop its military, geopolitical influence, and technology powers, which led it to become more assertive. The combination of these developments not only had an economic effect but it also contributed to the emergence of populism, nationalism, and anti-Chinese sentiment. As a result, US-China policies shifted from cooperation and opening up to confrontation and closing down. The United States and China are now—and will likely continue to be for the next 10 years or more—locked in a classic great power conflict. How that transpires will have a huge impact on these two countries and the world so it’s important to follow this closely.
  • While what is going on in the United States, China, and, to a lesser extent, Europe garners most of the attention, it’s time that we start focusing on rising countries with strong fundamentals (as reflected in my 18 measures) such as India, ASEAN countries such as Singapore, Indonesia, and Vietnam, the UAE, and Saudi Arabia, which have benefited by being neutral vis-à-vis the power conflicts. A number of them are at take-off points in their developmental cycles because their people, governance systems, and capital markets are approaching being capable of competing in ways that didn’t previously exist. Also, the wars between the United States and China are making the United States and China less desirable places to be which is driving capital, businesses, and talented individuals to these places. All these countries are experiencing the Big Cycle changes in the 18 indicators, with some ascending while others are declining.
  • Hurtful acts of nature in the forms of climate change, loss of biodiversity, and pandemics have been increasing. 
  • As previously expressed, the greatest of all forces is the force of human innovation. At no time in history, including the Renaissance and Industrial Revolution, has this force been as powerful as it is now. The unwavering evolutionary development of thinking technologies such as computers, expert systems, machine learning, AI, and quantum computing started in the middle of the 20th century and will radically change how we think and use that thinking to create new inventions that will move us forward. Over the next five years you will see mind-blowing advancements in many areas. Because these thinking tools help thinking in almost all areas, we are seeing revolutionary advances in almost all areas. I and others at Bridgewater have experienced and capitalized on this (r)evolution via the computerization of investment decision making, so I’m excited by what will be happening. I believe that we are now at the brink of a new era in which machine thinking will replace human thinking in many ways in the same way that machine labor replaced human labor during the Industrial Revolution. Just as we have seen doing math in our heads and remembering facts become much less important with the invention of computerized tools that do these things, and just as we go to Google (or its equivalents) to find information rather than gathering information in more traditional ways, we will soon be going to computers to get instructions on what to do when we are in different situations because the computer will come up with better guidance more quickly than we can. For these reasons, while I’m concerned about the value of money and debt assets, the internal and external conflicts, and acts of nature, I am very excited and optimistic about the revolutionary improvements that are likely to take place as the result of inventive/practical people put together with capital that gets them the resources that they need (perhaps most importantly, these new thinking technologies), operating in great environments that are conducive to advancement. Of course, new technologies are double-edged swords. For example, they have advanced how we can do each other harm as well as how we can do each other good.

Looking Ahead

First of all, I want to re-emphasize that what I don’t know, especially about the future, is much greater than what I do know, and for that reason diversification among seemingly good bets is of paramount importance.

As for what seem to be the good and bad bets, it appears to me that the big power countries that are plagued with the big problems that I described, and the world as a whole, are in what I call Stage 5 of the Big Cycle—i.e., near the brinks of financial/economic crises and big internal conflicts/wars, and in the early part of an evolving, costly climate crisis—at the same time as the world is near the brink of having amazing technological breakthroughs that will affect our daily lives. Stage 5 is the last-chance stage before going into Stage 6 which is the financial crisis and war part of the cycle. It seems to me that that will make the environment very challenging for those who are following the traditional leveraged long approach to investing in traditional areas, while it will provide great opportunities in those geographic and subject areas that are benefiting from these changes.

Re: 1) The Money-Credit-Debt-Markets-Economic Cycles

In my opinion the tightening that began in March 2022 ended the last paradigm in which central banks gave away money and credit essentially for free, which was great for the borrower-debtors.

We are now in a new paradigm in which central banks will strive to achieve balance in which real interest rates will be high enough and money and credit will be tight enough to satisfy lender-creditors without interest rates being too high and money and credit being too tight for borrower-lenders.

In my opinion this will be a difficult balance to achieve which will take the form of slower-than-desired growth, higher-than-desired inflation, and lower-than-expected real returns of most asset classes. 

Regarding where exactly we are in the short-term debt cycle, it appears to me that we are now approaching the end of the tightening phase but not approaching the easing phase that is priced into the markets. While all these short-term debt cycles are basically the same in the most important ways, each one is a bit different.

This one is severe for some and mild for others and overall pretty mild. More specifically, in this short-term debt cycle, the over-levered, cash-short, interest-rate-sensitive, and/or bubble companies and those investors who invest in them are being hurt while corporates and banks are being squeezed but not in trouble, and the household sector is doing pretty well.

The household sector is doing pretty well because there was a big shift in wealth to the household sector from the government sector which is now carrying a lot of the debt. This happened in most developed economies, most importantly in the reserve currency economies—the US, Japan, and the Eurozone—via the central governments’ borrowing a lot to make distributions to households and central banks lending them a lot.

Said differently, this came about because central governments and central banks deteriorated their balance sheets so that households could improve theirs. This has created a safer environment because, unlike the private sector, central governments and central banks don’t get squeezed for money and don’t have to worry about market losses causing them financial trouble.

Regarding where we are in the long-term debt cycle it appears that we are in the late stages, about 85% through it, but I can’t say exactly. I guesstimate that the likelihood of a major restructuring of debt assets and debt liabilities denominated in the major reserve currencies happening over the next 10 years to be something like 60%.

That is because the debt assets and debt liabilities are already very large, and they are projected to rise to significantly higher levels that will make it increasingly difficult to have interest rates high enough and money tight enough to satisfy the lender-creditors without having interest rates too high and money too tight to not hurt the borrower-debtors. 

Re: 2) Internal Conflicts and 3) External Conflicts

As for the internal and external conflicts, I have conveyed my concerns which are also reflected in the conflict gauges I use to measure and anticipate different types of wars. Based on these I now estimate the probability of a profoundly disruptive civil war to be about 35-40% and the probability of a profoundly disruptive international war also being about 35-40% over the next 10 years.

I don’t expect a big military war between nuclear countries because it is widely recognized that using nuclear weapons would lead to mutually assured destruction. For that reason, based on what I know, I expect the United States and China to avoid an all-out military war.

The only way I can see any side winning a war is by secretly building a technology of overwhelming power that can be inflicted without triggering an intolerable retaliation so that simply demonstrating it to the other side would lead to some form of capitulation by the country not having it—like the secretive development of the atomic bomb and demonstration of its power to the Japanese via the attacks on Hiroshima and Nagasaki.

To be clear, I am not ruling out such a scenario because I know that there are developments of mind-blowingly powerful technologies that remain unknown to us.  

Regarding my estimated probabilities, please understand that they are unreliable, though the measures of the risk levels are higher than at any time in the post-1945 period because the number of militarily powerful (e.g., nuclear) countries and the measured conflict levels between them are both greater than at any time since the last world war.


Re: 4) Acts of Nature

In the years ahead it’s likely that acts of nature, most importantly climate change, will be very costly in one way or another—i.e., either because we expend the amounts of money and endure the inefficiency costs to make fast enough progress to minimize the environmental and adaptation costs in the future or we don’t spend the money now and endure the costs later.

The climate problem is one of those classic types of problem that isn’t well-handled because the pain is increasing at a pace that is too slow to prompt action and because what’s good for the whole isn’t the same as what’s good for all of the parts so agreeing on how to share the costs is damn near impossible. 

Re: 5) New Technologies

It appears to me virtually certain that many big changes fueled by artificial intelligence working with human intelligence will lead to shocking advances in many areas over the next 10 years (in fact over the next three years).

For example, OpenAI and products that are competitive with it will be shocking game changers that you will see imminently. I think such technological developments will be mind-blowing in changing how we think and what we think in ways that are enormous and probably far more good than bad.

For example, I think that this sort of OpenAI technology (ChatGPT) is a technology that will in many cases give wisdom that can only come from seeing across subject matters, geographies, and histories and that is currently impossible for the human brain to gain, with these perspectives being void of different cultural and religious biases.

This is a subject for another time. However, from an investment perspective it is not clear how much profit will come in relative to the costs that will go out to invest in and create these new technologies.

I think there will be exceptionally big differences between the performance levels of countries, investors, and companies that will penalize those who choose poorly and reward those who choose well enormously.

Stepping back from all these things to see them from a big-picture level, it seems that events are continuing to track the Big Cycle template due to the most important and most classic cause/effect relationships continuing to work in the same logical ways that they worked in the past. 


[1] Counting QE1, QE2, QE3, and then QE during COVID lockdowns.

Article by Ray Dalio, via LinkedIn