The current world order is undoubtedly changing. It’s happening right in front of our eyes today. Timely, legendary investor and hedge fund manager Ray Dalio published a new book called “The Changing World Order: Why Nations Succeed or Fail”. Alongside the book, he released an animated video presentation summarizing key concepts of the book. While the concepts, data and breakdown of financial history is great, I believe Ray Dalio missed a few things about the current long-term debt cycle.
When you hear someone talk about the changing world order, the first thing that probably comes to mind is some wacky conspiracy theory involving the Illuminati or Freemasons. But when a billionaire hedge fund manager and one of the most legendary investors of all times talks about the changing world order, I pay attention.
Ray Dalio has an incredible track record. He published several books including his opus magnum “Principles for Navigating Big Debt Crises”. In case you’ve never heard of him, you can watch this video.
It’s a summary of his book, which will provide you with context for this article.
But what is a debt cycle in the first place? Let’s take a closer look. In debt-based economies, which includes any economy that operates under a fractional reserve banking system, there are boom and bust cycles. A boom cycle is when individuals, companies and governments borrow money. Another way of thinking of this is that they are using leverage. When the economy is in a leveraging phase, credit is used to finance consumption and investment. The economy booms, but at some point the debt has to be reduced in a deleveraging phase.
There is also the Austrian business cycle theory, which Ray doesn’t necessarily subscribe to. It claims that a lot of the growth during a debt cycle might be artificial and the result of malinvestment.
What this means is that individuals, companies and governments that consume or invest based on credit, might misallocate capital due to distorted interest rates and price signals and make malinvestments that end up not being profitable, resulting in a bust.
Let’s take a look at the individual and macroeconomic level. When an individual lives off of credit cards, money is spent that didn’t exist before. This credit money is lent into existence by banks.
Spending this newly created money and maxing out a credit card leads to consumption and economic growth at first. But if the person isn’t able to pay back the debt, the money supply contracts in the future.
When many individuals, companies and governments use credit to finance consumption and investment at the same time, they all have to repay their debts at some point in the future. This might lead to a large deleveraging phase. During these times, the economy contracts. Individuals spend less on consumption. Businesses make less money. Investors are more risk-averse.
But how do these debt cycles lead to changes in world order? Let’s take a look at how governments, financial power and large debt cycles are all connected.
When the economy contracts after a period of growth, this is painful. To some extent, boom and bust cycles are normal. Just like there are seasons in nature, the economy ebbs and flows. But when a large part of economic growth is based on artificially low interest rates or printed money, this magnifies boom and bust cycles.
For example, during the Roaring Twenties, many banks overextended their loans. They didn’t keep enough reserves to pay back depositors in case a significant number of individuals or companies defaulted on loans or mortgages.
When the stock market crashed in 1929, panic gripped the markets and depositors began withdrawing their money from banks. Since the banks didn’t keep enough reserves, they quickly ran out of money. Many Americans defaulted on their loans and mortgages or lost all their life savings by speculating on stocks and real estate.
The boom or leveraging phase, which lasted all throughout the Roaring Twenties, resulted in a bust phase. I’m of course talking about the Great Depression.
President Roosevelt dealt with the Great Depression by issuing Executive Order 6102 and ending the gold standard. This allowed the US government to print more paper money and soften the landing.
The Roaring Twenties and Great Depression lasted two decades. Roughly one decade of boom followed by one decade of bust.
But if we zoom out, there are much larger debt cycles at play. These debt cycles are so large that they involve the rise and fall of empires. This is how long-term debt cycles that span over decades and even entire centuries can contribute to the changing world order.
Until 1944, the sterling pound was the world-reserve currency. And up until World War II, Great Britain was the dominant global power. If we go even further back in history, the dutch empire dominated the world order before the British. Before the Dutch it was the Portuguese. And before that, there were of course the Greek and Roman empires.
This shows us one thing. The world order is constantly changing. Throughout history, empires rise and fall all the time. But let’s not go too far back. For now, we’ll stick to the transition from the British empire to the United States as the dominant financial and military power. And of course, we’ll talk about what Ray Dalio thinks happens next.
But more importantly, we’ll look at what I believe Ray Dalio might be missing or what he got wrong in his otherwise great macroeconomic and historic analysis.
Britain was on the brink of losing the war against Nazi Germany, and arguably, it would have without the support of the United States.
After the bombing of Pearl Harbor, the United States directly entered World War II. One the one hand, this helped the United States completely get out of the Great Depression due to massive military spending. On the other hand, it set the stage for the United States to replace Great Britain as the dominant financial and military power.
By the end of World War II, the United States owned a majority of the global gold reserves. And it had the strongest military in the world. Towards the end of World War II, global leaders met and drafted a new agreement known as the Bretton Woods agreement.
The Bretton Woods agreement contained a plan for a new monetary system. Or in other words, Bretton Woods changed the world order. As part of the Bretton Woods system, the US dollar became the world-reserve currency. This made sense for two reasons. First of all, the United States possessed most of the world’s gold. As part of the Bretton Woods system, the US dollar was backed by physical gold owned by the United States government. All other countries that signed the Bretton Woods agreement pegged their currencies to the US dollar at fixed exchange rates.
The second reason it made sense for the US dollar to become world-reserve currency was because of the vast military power of the United States after World War II. With the strongest military in the world, the Untied States could defend the US dollar’s status as world-reserve currency. It could also protect its gold reserves.
Since 1944 until today, the United States remained the dominant financial and military power. While Great Britain still remains an important player in the global economy and geopolitical landscape, it is no where as powerful as it once used to be. This shift in the changing world order occurred in the mid 19th century and is significant and well documented by historians.
Interestingly, the Dutch and Portuguese, which at one time in history dominated the world order and issued the world-reserve currency, barely play any significant role in finance and geopolitics today. Greece and Italy, both massive empires in ancient history, play even less of a role. It seems that the more time passes since the fall of an empire, the less significant the remains of the empire become in the global world order.
As part of the long-term debt cycle, the United States has experienced many smaller debt cycles since the Great Depression. Whenever the Federal Reserve keeps interest rates artificially low to stimulate the economy, this leads to or prolongs smaller debt cycles.
For example, in the late 1990s, the Federal Reserve lowered the Federal Funds Rate. This coincided with a large boom in the stock market as cheap money found its way into technology stocks. After the Dotcom Bubble burst, Federal Reserve chairs Greenspan and later Bernanke lowered interest rates even more.
This cheap money found its way into the real estate market which led to the United States Housing Bubble. It burst during the 2008 Global Financial Crisis. This time, the Federal Reserve lowered interest rates to zero percent. But this was not enough to prevent a complete Great Depression-like bust. The Federal Reserve had to resort to a new and more exotic form of monetary policy called Quantitative Easing.
Another way of thinking of Quantitative Easing is as printing money. By printing money, the Federal Reserve could reflate the global economy and “keep the lights on”. But when governments resort to expanding the money supply, this can have consequences such as inflation and loss of trust in the government’s ability to pay back its debt.
When governments resort to printing excessive amounts of money in a deleveraging phase, this increases wealth inequality. Printing money leads to consumer and asset price inflation. It punishes those that live paycheck-to-paycheck, save money and own no assets.
Their purchasing power slowly and sometimes rapidly erodes while the prices of assets like real estate, stocks and commodities increase. This makes the rich richer and the poor poorer. The result of this wealth inequality is that society becomes more split. It leads to the rise of populist politicians.
Things like strikes, riots, movements like Occupy Wall Street and even revolts and revolutions like the French Revolution are examples of internal conflicts that stem from wealth inequality. But according to Ray Dalio, internal conflicts are often followed or accompanied by external conflicts.
As a once dominant empire debases its currency, wealth inequality and internal conflicts tear a country apart and weaken its financial and military power. This gives room for competing empires to rise up and challenge the dominant empire’s status, resulting in some form of external conflict. These external conflicts might be peaceful, but according to Ray Dalio, they’re mostly wars.
The United States became the dominant financial and military power after World War II. While the United States and Great Britain weren’t in conflict together, but rather allies in a war against a common enemy, it was nevertheless an external conflict that gave rise to a new world order.
One could argue that Bretton Woods was just the formal agreement of how the international monetary system should be structured after the United States arose as dominant superpower after World War II. At this point you might be asking yourself what comes next. If the world order changes, which nation will one day rise up and replace the United States?
According to Ray Dalio, China is a superpower on the rise while the United States is a superpower on the decline.
China has experienced tremendous economic growth in the past and pioneered the very fist Central Bank Digital Currency (CBDC). At the same time, many countries are seeking to break free from US dollar hegemony and are looking elsewhere.
Here are some reasons why China might replace the United States:
What we can take from this is that we are approaching the end of a long-term debt cycle that started in 1944 with the Bretton Woods system. There are several indicators that China might replace the Untied States as global superpower. Some of them are mentioned above.
But I would like to suggest an alternative scenario. Let’s first look at some of the reasons why China might not be next in line for the throne of global power.
There is a lot of talk about the Chinese economic miracle, but upon closer inspection, a lot of the growth that China experienced is unsustainable. James Rickards does a great job at explaining this in his book the Death of Money, in the chapter “China’s New Financial Warlords”.
He explains:
The rise of a parasitic elite is closely linked to the prevalence of malinvestment. The need for the Chinese economy to rebalance from investment to consumption, as urged by the IMF and other official institutions, has run headlong into the self-interest of the elites who favor infrastructure because it keeps the profits flowing at their steel, aluminum and other heavy industrial enterprises.
James Rickards on China
Before 1979, all corporations were state-owned. Later on, many of them became private while others were closed or merged into larger state-owned enterprises for increased efficiency.
A huge percentage of Chinese GDP stems from investment and not consumption. As of recently, around 43% of China’s GDP results from investment.
This includes immensely large and expensive infrastructure projects such as the Nanjing South Railway station. This massive and modern railway station was financed through government debt. Although impressive, the debt incurred by the project will never be able to be paid back with income generated by the railway station.
This is an example of malinvestment. And the Chinese economy, which relies almost to 50% on investments, is full of them. Although infrastructure projects like the Nanjing South Railway station employed over 20,000 workers and boosted the steel and aluminum industries, the main profiteers are the Chinese elites and government officials that run the state-owned corporations.
Although jobs and economic growth are created in the short-run, the long-term implications of such unprecedented levels of government-financed malinvestment are not sustainable forever. There are entire “ghost cities” in China, with skyscrapers and a famous replica of the Eiffel tower. These cities are completely empty and deserted. This shows the scale of malinvestment in China.
Another problem is that China is still a very centralized economy. Although China experienced massive growth since 1979, many corporations are still state-owned or at least heavily controlled and surveilled. As F. A. Hayek showed in his book “The Road to Serfdom”, centrally planned economies are always less efficient than economies based on free markets and competition.
The more central planning there is, the more price signals are distorted and the more malinvestment is made. This leads to more control and central planning and creates a vicious circle. While it may seem like China is able to outpace the United States on many fronts through centralization, this growth isn’t sustainable in the long-run.
For example, China censors most of the internet. Western countries, especially the United States, embraced the internet and allowed the free market and competition to create the best products based on this new technology.
As a result we have Google, Facebook, Apple, Amazon and other companies that have hugely increased GDP and improved productivity in the United States.
China, on the other hand, has its own versions of social media networks like WeChat, which in many ways is more advanced than Facebook. But it is only more advanced because it combines a whole variety of applications and services into one platform. Another way of looking at it is as a perfect tool for surveillance and state control.
Fast growth as well as centralized technological progress as seen in China’s FinTech sector, don’t always equate to sustainable growth. Who outside of China would use WeChat?
Given the privacy concerns, the only way to get someone to use these apps is by force or censoring alternative platforms.
This also applies to the digital yuan. We have already seen how easily legacy fiat currency can be frozen and confiscated in the case of the Canadian truckers and Russian sanctions. If people are flocking away from the US dollar due to the fear that a central instance could control, censor or confiscate your money, how do you think people and nations will feel about the digital yuan?
A Central Bank Digital Currency issued by a nation that is known for strict capital controls and censorship is probably the last place a person or sovereign government wants to store the bulk of its wealth.
This brings us to another important point. With the launch of its own CBDC, China banned all Bitcoin transactions and mining within the country. This is understandable and in line with things like censoring the internet in favor of their own technologies that they can control and surveil as needed.
But China made a big mistake when it outlawed bitcoin and essentially handed the bitcoin industry to the United States on a silver platter. Those are some of the reasons why I don’t believe China will replace the United States as the dominant superpower. But which country will? Or can the United States retain its financial and geopolitical power?
There is game-theoretical probability that bitcoin and not the digital yuan or any other currency will become the new world-reserve currency. Already during the Bretton Woods conference in 1944, John Meynard Keynes suggested the creation of a global reserve currency.
Keynes envisioned a global currency called bancor that wouldn’t be issued by a single country but by the World Bank and could be used for international trade. The idea was rejected in the end in favor of adopting the US dollar as world-reserve currency.
However, today we are approaching a similar crossroads that the world was at during the Bretton Woods conference. We are at the end of a long-term debt cycle. The United States, which issues the world-reserve currency, has reached an unsustainable level of debt.
In order to deal with this and avoid bankruptcy, the US government needs to deleverage and reduce its debt levels. The only way it can do this at this point is through monetizing the debt, or in other words, printing more money. Austerity and other deleveraging options are off the table. This means that inflation and loss of trust in the US dollar are not a question of if but when.
But where else will people put their money? What reserve asset will nations be willing to hold after freezing Russia’s dollar and euro reserves? The only two neutral, commodity-like and decentralized reserve assets that function as money are gold and bitcoin.
However, in terms of monetary properties bitcoin has superior qualities. It can be transported faster and more cheaply, among other advantages. Nobody sent $50,000,000 worth of gold to aid Ukraine. It would have been slow, expensive and maybe even impossible to bring it into the country in a timely manner.
But over $50,000,000 worth of Bitcoin was raised and donated to Ukraine within about a week, with comparably negligible fees.
In the past, it was usually the countries that had the biggest gold reserves or the strongest military, or both, that became dominant and issued the reserve-currency of choice other nations would hold and use for international trade.
That system worked well in a non-digital world. When money is just digits on a computer, things change. Today, currencies aren’t backed by gold anymore. So having the largest gold reserves doesn’t necessarily give a currency any special status like was the case during the Bretton Woods system.
At the same time, digits on a computer that are controlled by a bank or central bank can be frozen, confiscated and made completely unusable. All of this makes a strong case for a neutral, decentralized, commodity-like reserve currency that cannot be frozen, confiscated, censored or stopped.
The only hurdle for bitcoin to become the preferred reserve-currency is that it is less time-tested than gold and more volatile.
This is why it’s more likely that sovereign wealth funds and institutions will pile into bitcoin first until the asset matures more and the price becomes more stable. However, this is where game-theory comes into play.
If any nation with financial and military significance starts mining bitcoin or buying it as a reserve asset, other nations will be at a significant disadvantage if they don’t do the same thing. Everyone can laugh if El Salvador, a small and insignificant country, adopts bitcoin and buys it as reserve asset.
But what if Russia were to buy or mine bitcoin? What if a more significant country in South America acquires bitcoin as reserve asset, such as Mexico or Brazil? As soon as this happens, a game-theoretical financial arms race begins. Even if a nation doesn’t believe in bitcoin or see its potential, it must at least consider allocating a small portion of its reserves to bitcoin in the case that it’s wrong.
Not doing so, and being wrong, would lead to major financial and geopolitical disadvantages. At the same time, it would give tremendous strength to countries that adopt it first and a lot of it. If gold and military power prove to be less important in a digital-first world, the playing-field would become more even.
While unlikely, it is not completely impossible that a small and insignificant country like El Salvador gains tremendous financial and geopolitical strength if bitcoin becomes a desired reserve asset. But the biggest opportunity is for existing global superpowers to acquire bitcoin as a decentralized, censorship-resistant and unconscionable reserve currency.
In fact, the only way the United States might be able to maintain it’s position as global superpower is by aggressively mining or buying bitcoin in the future. But here is the interesting part. Unlike gold, bitcoin is transportable and liquid enough to serve as direct world-reserve currency similar to Keynes’ vision of the bancor.
The only difference is that bitcoin isn’t centrally issued by the World Bank, which would make it confiscatable, censorable and inflatable. It is truly decentralized and out of control of any particular nation or centralized instance.
This would decouple global super powers from having a monopoly on issuing the world-reserve currency. At the same time, if it’s not a nation that issues the global reserve currency, the relationship between military power and money would change. Military power wouldn’t be needed to defend a nation’s geopolitical position and currency hegemony.
While Ray Dalio is right about looking at history for clues about what the future might look like, he is neglecting monetary technology. We are at the end of a long-term debt cycle. Without technological changes, this would most likely lead to currency debasement, internal conflict, war and a reorganization of geopolitics and the monetary system.
At least this is what history tells us. The problem is that all this historic data stems from the pre-digital age. We have to remember that the internet was only invented in the 70s. Any past large debt-cycles took place during a different technological period.
This is the first time in history that we are at the end of a long-term debt cycle since the invention of the internet. Not only that, but we are at the beginning of a second technological cycle that started in 2009 with the invention of Bitcoin. This makes the current long-term debt cycle significantly different than past examples we can draw from.
One option Ray Dalio doesn’t seem to consider is that we might be moving towards a more decentralized, and potentially even more peaceful future. Instead of a single nation issuing the world-reserve currency and having to defend that status with a powerful military, we might be entering a new world order that deviates from past examples in history.
What that might look like is anyone’s guess. At first, countries might acquire a variety of reserve assets including different currencies, gold and bitcoin. They might also conduct international trade in these currencies, including oil trades, marking the end of the Petrodollar system.
Eventually, the percentage allocations might change, reducing state-issued currencies and acquiring mostly gold and bitcoin. Should bitcoin demonetize gold and turn it mostly into an industrial and ornamental metal, bitcoin could eventually become the predominant reserve asset.
At this point, it will be convenient to conduct all international trade in the most liquid and commonly accepted reserve asset. This would result in bitcoin being used as unit of account for pricing oil and conducting international trade.
Ray Dalio might be worried that governments will outlaw bitcoin or try to confiscate it and transfer wealth from citizens to the governments to increase their reserves.
This happened in 1933 when Roosevelt issued Executive Order 6102 and outlawed private gold ownership in America. All Americans had to hand over their gold and only the government was allowed to own gold and use it for international trade.
However, bitcoin is harder to confiscate than gold. Back in 1933, most people held their coins and bullion in bank vaults. A short government-issued bank holiday was enough to confiscate whatever gold was stored in bank vaults.
And those that held more than $1,000 worth of gold privately were threatened with fines and up to 10 years in prison in case of non-compliance. To be clear, Americans got paper dollars in return for their gold. It wasn’t just taken by the government. But the paper dollars that were given in exchange for the gold were a lot less valuable since the government decided to reprice gold and devalue the dollar.
So a real transfer of wealth from American citizens to the government did take place, and as such it can be called confiscation. Governments could try to do the same thing with bitcoin if they wanted to get an advantage in the financial arms-race of nation state bitcoin adoption.
The easiest way to get ahead would be to outlaw private ownership and confiscate as much bitcoin as possible by legally forcing exchanges to halt withdrawals and transfer all of their customers bitcoin to a government wallet.
However, game-theory and nation state competition might make this harder. In 1933, when Roosevelt confiscated privately owned gold, people couldn’t just take their gold, board an airplane and leave the country.
With bitcoin, people can just memorize 12 words, board an airplane, boat or train and access their wealth in another country. It doesn’t matter if it’s billions, millions or a few thousand dollars worth of bitcoin. This type of portability isn’t possible with gold.
Any government that were to repeat a confiscation-event like Executive Order 6102 would encounter massive capital flight and a huge brain drain. People would simply leave to a country that has not outlawed bitcoin. And there would be a strong incentive for countries to legalize bitcoin, given the huge inflow of capital, talent and taxes they could drain from a major country that is hostile to bitcoin.
Truly outlawing bitcoin would require a coordinated, world-wide confiscation event. A global Executive Order 6102, if you will. That’s relatively unlikely.
What’s likely is that some nations will outlaw bitcoin, mostly dictatorships and centrally planned economies. They will probably acquire bitcoin as a reserve asset and use it for international trade, but its citizens won’t be allowed to mine, hold or transact with bitcoin.
Other nations that are more free and open will allow both private bitcoin ownership and acquire it as a reserve asset. They might still issue their own fiat currencies in the form of CBDCs, and they will do their best to force people to use their fiat currencies. But if taxation and regulation become too restrictive, this will result in capital flight and a brain drain similar to outright outlawing bitcoin.
This means, nation states will have to remain competitive regarding how they tax and regulate bitcoin. If bitcoin is taxed as a commodity, every transaction could trigger a taxable event. This would make bitcoin mostly attractive as an investment or savings technology. But if other countries like El Salvador treat bitcoin as a currency and don’t impose any capital gain taxes on it, this could lead to people leaving countries that impose capital gain taxes on bitcoin.
The big question then remains if fiat currencies will survive in the form of CBDCs or if bitcoin itself, using the lightning network, becomes the primary and unified currency for domestic transactions and global trade.
Maybe the war for the new world order is already being waged. But it’s a war between centralization and decentralization. And it’s a fight between old technology and new technology.
It is comparable to the invention of digital downloads of music. And it has similarities to internet telephone technology. In both cases, legacy providers in the form of the music industry and telecom companies tried to fight the new internet-enabled technologies.
They tried to outlaw and criminalize music downloads or free phone calls using the internet. But eventually, technology won and the legacy industries had to adapt. The old and outdated ways of generating profit went away. The internet arguably completely destroyed the traditional music industry, which primarily thrived from selling records.
The same is happening with money. Since governments claim the monopoly on money, one of their main ways to profit is being challenged. When governments are able to create money that has a higher face value than the cost of producing it, this profit, known as seigniorage, goes into the pockets of the government.
Even if governments have to pay back money that central banks print for them, the government and those closest to the central bank benefit from the Cantillion Effect. Those who have access to freshly printed money first are able to benefit from a “hidden” wealth transfer. Newly printed money can be spent at pre-inflation prices. But once the money enters and circulates throughout the economy for a while, it can cause inflation and lead to rising price levels.
Another way of looking at this is as a transfer of purchasing power from the general public to the government.
Finally, even if governments are supposed to pay back their debts, they can keep interest rates below the inflation rate. As long as this is the case, the government’s debt burden is gradually reduced. The general public is indirectly paying for the government’s debt. It’s like a “hidden” tax, or a wealth transfer from citizens to the government in the form of inflation.
Bitcoin is disrupting seigniorage, the Cantillion Effect and financial repression. It’s the largest and most important industry that was ever disrupted by technology. It’s many orders of magnitude more significant than music downloads or internet phone calls.
As we have seen, bitcoin might literally be disrupting an entire history of long-term debt cycles. Technology is almost impossible to stop, as long as the benefit and idea behind the technology are big enough.
Nobody knows what the future looks like. U don’t have a crystal ball either, and all I can make are assumptions and best guesses based on history, research, game-theory and understanding technology. I might be wrong and bitcoin doesn’t play any significant role in the new world order. Or centralization wins against decentralization.
Maybe bitcoin is crushed, China becomes the new global superpower and we’re all forced to use a CBDC in a 1984-like surveillance state and economy.
I hope that’s not the case and believe there is a higher probability that the new technology, similar to digital music and internet phone calls, will prevail. I just don’t know yet exactly what that will look like.
Ray Dalio didn’t bring up bitcoin in the discussion about the changing world order. This might not be out of ill-intent. Ray has repeatedly expressed his interest in bitcoin, but mentioned that he believes it will be banned if it becomes too successful.
This acknowledges the technological revolution that bitcoin represents. But it also reveals a fundamental misunderstanding of certain important technological nuances. The main problem seems to be a failure to distinguish between pre-internet and post-internet history.
Ray sees bitcoin and notices its similarities to gold. He looks for examples in history and how governments dealt with gold and finds that they confiscated it, outlawed it and forced citizens to use government-issued paper money. But we must understand that the historic context today is different than in 1933.
The fact that Ray didn’t mention bitcoin or technology in his analysis of the changing world order is most likely simply a sign that he is of an older generation. But unlike Warren Buffet, Charlie Munger and Jamie Dimon, which Peter Thiel calls enemies of bitcoin and “financial gerontocracy”, all Ray Dalio might have to do is go a bit deeper down the rabbit hole than he has so far.
All in all, Ray Dalio’s breakdown of financial history and his principles for navigating the changing world order are spot on. Maybe he decided to refrain from looking at bitcoin in the context of the changing world order since he doesn’t feel like he’s enough of an expert on the subject matter. Or he might outright disagree with our take and believe that bitcoin will play no role in the changing world order.
Whatever the case may be, the future is uncertain and only time will tell how big of an impact technology, and especially bitcoin, has in the current long-term debt cycle.