July 25, 2023
Dear Friends and Family,
This segment builds on the Big Cycle theory of the previous segment by describing how the patterns of the world’s leading power repeated themselves over the past 400 years of world history. It looks specifically at the rise, top and decline aspects of the cycles of such powers: the Dutch and its currency the Guilder (1625 – 1795), the British Empire and the Pound (1700 – 1945) and the United States and the Dollar (1775 – present). Additionally, it looks at the rise of China and the Renminbi (1949 – present).
The reasons for the rise of all four are fairly consistent including education advances, rule of law establishment, innovative technology application, strong economic output and trade, military advancement and power, plus a being a strong world financial power with a reserve currency and world financial center.
The reasons for decline of the decline of the first three are educational and technological decline versus competing powers, economic overextension and over-indebtedness, internal conflicts, weakened military, loss of reserve currency, and strong external threats.
Relative to China the excerpts conclude the country is very much on the rise as a world power, which is defined as getting themselves in a comparable position of strength to the reigning power. Dalio’s assessment of China in 2021 when he published his book was: China is now roughly tied with the U.S. in being the leading power in trade, economic output, in innovation and technology, and is a strong and quickly rising military and educational power. It is also an emerging power in the financial sector but is lagging as a reserve currency and world financial center.
Up to this point in the series I think we have captured several points of wisdom for America:
Harley
Dear Friends and Family,
This segment builds on the Big Cycle theory of the previous segment by describing how the patterns of the world’s leading power repeated themselves over the past 400 years of world history. It looks specifically at the rise, top and decline aspects of the cycles of such powers: the Dutch and its currency the Guilder (1625 – 1795), the British Empire and the Pound (1700 – 1945) and the United States and the Dollar (1775 – present). Additionally, it looks at the rise of China and the Renminbi (1949 – present).
The reasons for the rise of all four are fairly consistent including education advances, rule of law establishment, innovative technology application, strong economic output and trade, military advancement and power, plus a being a strong world financial power with a reserve currency and world financial center.
The reasons for decline of the decline of the first three are educational and technological decline versus competing powers, economic overextension and over-indebtedness, internal conflicts, weakened military, loss of reserve currency, and strong external threats.
Relative to China the excerpts conclude the country is very much on the rise as a world power, which is defined as getting themselves in a comparable position of strength to the reigning power. Dalio’s assessment of China in 2021 when he published his book was: China is now roughly tied with the U.S. in being the leading power in trade, economic output, in innovation and technology, and is a strong and quickly rising military and educational power. It is also an emerging power in the financial sector but is lagging as a reserve currency and world financial center.
Up to this point in the series I think we have captured several points of wisdom for America:
- Our country is in a state of decline and if the trend continues history would indicate we will likely be in a major war within the next decade.
- If we wish to remain a major power in the world, we need to protect the dollar as the world’s reserve currency.
- China is an emerging world power and is close to being able to match the United States in military and economic power.
Harley
SEEKING WISDOM FOR AMERICA – SEGMENT 3
HOW THE WORLD HAS WORKED THE PAST 400 YEARS – EXCERPTS
NOTE: All the excerpts in the segment are from The Changing World Order by Ray Dalio (2021)
THE BIG CYCLE RISE AND DECLINE OF THE DUTCH EMPIRE AND THE GUILDER: From 1625 until their collapse in 1795, the Dutch Empire rose for all the classic reasons peaking around 1650 in what is now remembered as the Dutch Golden Age.
The Rise: From 1581 until around 1625, the Dutch Empire was built following the classic steps of a rising empire. The Dutch successfully revolted against Spain in the Eighty Years’ War, which resulted in the Dutch Republic asserting its independence in 1581.
The Dutch invented ships that could go around the world to collect riches, capitalism that could finance these and other productive endeavors, and many more breakthroughs that made them rich and powerful. The Dutch created the world’s first mega-corporation, the Dutch East India Company, which accounted for about one-third of world trade. Dutch openness to new ideas, people and technology helped them rise quickly. To support trade the Dutch government increased military investments, which allowed the country to control still more trade by holding off the British in a number of military conflicts.
The Dutch also created the world’s first reserve currency other than gold and silver, the Dutch guilder, supported by an innovative banking and currency system put into place via the establishment of the Bank of Amsterdam. As a result of these classic and sound fundamental steps, the Dutch became rich – income per capita in the Netherlands rose to over twice that of most other European powers. The Dutch continued to invest heavily in education and infrastructure to build on their successes. In short, the Dutch were superbly educated people who were very hardworking and inventive. The Dutch invented capitalism as we know it. This was great for the Dutch and great for the world.
The Top: The Dutch Golden Age led the Dutch to shift their attentions to “living the good life” in a way that weakened their finances. Other powers rose too and began to challenge them. The arrival of capitalism, combined with the new approaches of the Enlightenment, led to an economic transformation called the Industrial Revolution, which was centered in Britain. At the top, the Dutch saw a reversal of many of the classic ingredients.
The Dutch educational and technological edge eroded. They became uncompetitive in general and via the decline of the Dutch East India Company. In the 1700s, the Industrial Revolution led the British to overtake the Dutch as the preeminent economic and financial power in Europe. Increasing military conflicts (in attempts to protect their vast wealth around the world) left the Dutch overextended and overindebted. This all set the stage for the decline in the guilder’s reserve currency status, which ultimately deteriorated after the Dutch lost a war (and with it, important assets) to the British.
In the final and Fourth Anglo-Dutch War (1780-84) against the British (in retaliation for Dutch support of the colonies in the American Revolution) ended in a significant defeat for the Dutch, ushering in the end of the guilder as a reserve currency.
The Decline: Around 1750 the British (and the French) became stronger than the Dutch, both because their own power had grown and because the Dutch had become weaker. As is classic, the Dutch a) became more indebted, b) experienced a lot of internal fighting over wealth, and c) weakened militarily. All this made them vulnerable to decline and attack.
Financial losses and large debts led to the classic move by the central bank to print more money.
The decline of the Dutch Empire led to the next Big Cycle in world history: the rise and decline of the British Empire and its reserve currency, which is basically the same story, just a century or so later.
THE BIG CYCLE RISE AND DECLINE OF THE BRITISH EMPIRE AND THE POUND: Changes in the world order come about when two or more countries (or alliances of countries) of comparable power fight and one wins and becomes dominant enough to set the new rules, which is the new world order. Before this happens, the rising country needs to get itself into a comparable position of strength relative to the reigning country, so the story of any great country’s rise begins long before it becomes a great power.
The Rise: In Europe there was great devastation and change that resulted from the Thirty Years’ War because it was a war between ideologies, religions, and economic classes that created a new European order through the Peace of Westphalia. This treaty established countries as we know them and created a fractured Europe, which led to different choices in different countries.
The English Civil War (1642 – 1652) specifically led to the king (Charles I) being tried and executed and the monarchy being replaced by the Commonwealth of England under the rule of the general who led the revolt, Oliver Cromwell. These conflicts established rule of law rather than rule of the monarchy and they created a new balance of power between the king and Parliament. At the core of this new, human-centric philosophy was the idea that society should be based on reason and science and that the government’s power comes from the people, not from God.
Debate and skepticism were encouraged. Improvements in basic education (which caused literacy rates to rise), the dissemination of ideas via printed materials (the first encyclopedias and dictionaries were printed en masse), and a growing number of transnational elites (who were well read and cultivated cross-border contacts) created a new and wider “public sphere” of political and social thought.
Over time the British system’s respect for the rule of law, combined with strong education, gave it the foundation to gain competitive advantages in commerce and innovations that followed and led to the rise of the British Empire.
The Industrial Revolution: A well-educated population together with a culture of inventiveness and the availability of capital to financially support the developments of new ideas – especially about how machines could more efficiently do what many were laboring to do – created a great wave of competitiveness and prosperity. This shift changed Europe from a primarily rural and agrarian society in which most people were poor, and power resided with landowning elites to an urban and industrial society in which people as a whole got a lot richer and power resided with central government bureaucrats and capitalists. Geopolitically, these strengths led it to overtake the Dutch as the preeminent economic and financial power in Europe around 1750, 30 years before the UK defeated the Dutch in battle and clearly became the world’s leading empire.
The UK’s military strength – especially its navy – helped it establish its colonies and take over those of the European powers, as well as secure its control over global trade routes. The profitability of the empire more than paid for its military spending because it supported economic activities. London became the world’s financial center and the pound sterling the world’s reserve currency. In other words, Great Britain followed the classic Big Cycle steps of a rising empire.
The Top: The UK’s share of global exports rose with the Industrial Revolution and the spread of the empire, peaking around 1850 at about 40% of global exports. Even as the British Empire continued to expand its territorial and financial reach over the final decades of the 19th century, the seeds of its fall were evident, driven by the classic factors of 1) declining competitiveness, 2) rising inequality and conflict, and 3) the rise of new rival, particularly Germany and the U.S.
The rivalry between the UK and Germany was just one of many building across Europe – France and Germany were at odds, Germany was increasingly concerned about Russian industrialization, and Austria and Russia were struggling for influence in the Balkans. Though these countries were intertwined through marriage and commerce more than ever before, and despite most people believing it wouldn’t happen, in 1914 the powder keg exploded into all-out war. This was the first world war because this was the first time the world had become so small and so interconnected that most of the major parts of the world were involved in one way or another.
In 1919, the victors – the US, Britain, France, Japan, and Italy – met at the Paris Peace Conference to lay out the new world order in the Treaty of Versailles. The United States, now recognized as a leading power, played a big role in the negotiations. Elsewhere, much of the world entered a decade of peace and prosperity, the Roaring ‘20s. As is typical, the debts and the wealth gaps that were built up burst in 1929, causing the Great Depression. These two big boom and bust cycles came unusually close together, though they followed classic stages.
The Great Depression coupled with the large wealth gaps led to a rise in populism and extremism in nearly every major country. In some countries – e.g., the US and the UK – this led to big redistributions of wealth and political power while capitalism and democracy were maintained. In others, particularly those with weaker economies (Germany, Japan, Italy, Spain), populist dictators seized control and sought to expand their empires. Classically, before all-out wars begin, there is typically about a decade of economic, technological, geopolitical and capital skirmishing.
World War II, just two decades after World War I, was even more costly in lives and money. Germany and Japan lost and the US, the UK, and the Soviet Union won, though economically the UK and the Soviet Union lost too, and the US gained enormously in relative wealth. As is typical, the winners of the war got together and determined a new world order in 1945.
The Decline: The Allied victory in 1945 produced a tremendous shift of wealth and power, with the US emerging as the world’s dominant empire just as the British had after the Napoleonic Wars. It took another 20 years for the British pound to fully lose its status as an international reserve currency. But the pound had been losing status since the end of the war. The decline in the British pound was a protracted affair that involved several significant devaluations.
Europe after World War II: The most important geopolitical elements of the post-war order were:
THE BIG CYCLE RISE AND DECLINE OF THE UNITED STATES AND THE DOLLAR:
The Rise: The US went through the usual revolution and post-revolution process in which it created a new domestic order as 1) a coordinated group of strong leaders fought to gain control, 2) that group won and consolidated control, 3) the new leadership had a vision supported by the population, but 4) it split into factions that had conflicts over how the government should work to implement that vision. Eventually, these factions 5) figured out that system for control and laid it out in agreements (in the US case, at first in the Articles of Confederation and then in the Constitution), 6) set up the parts of government (e.g., the money and credit system, the legal system, the legislative systems, the military, etc.), and 7) put people in jobs and made it work well. The US did these things in a uniquely peaceful way through negotiations, near-total respect for agreements, and good designs for governance that gave it a great start.
The economic gains were financed through a system of free-market capitalism that, as is classic, produced both lots of wealth and big wealth gaps. The US went through many boom/bust cycles, in which classically a flurry of debt-financed investments (into land, railroads, etc.) became overextended, leading to credit losses and a credit crunch. As a result, banking system panics were extremely common. Like London, New York was well-established as a trading center long before it became a global financial center, a development that didn’t occur until after the turn of the 20th century.
The second half of the 19th century was a boom period of peace and prosperity that has been called “the Gilded Age” because it was the period in which capitalism and innovation flourished, wealth gaps widened enormously, decadence was apparent, and resentment build. Then World War I, the war few people expected to happen, and nobody expected to last so long, began in 1914 and ended in 1918.
As is typical, after the war years and with the new world order came a period of peace and prosperity fueled by great innovations and productivity and a capital markets boom that produced big debts and big wealth gaps late in the upswing. In the Roaring ‘20s a lot of debt (promises to deliver paper money that was convertible to gold) was created to buy speculative assets (particularly stocks). To curtail that, the Federal Reserve tightened monetary policy in 1929, which caused the bubble to burst and the global Great Depression to begin. It brought economic suffering to virtually all nations, which led to fighting over wealth within and between countries, which led to the hot wars that began a decade later. On a relative basis the US came out the big winner because the US sold and lent a lot before and during the war, basically all of the fighting took place off of US territory, so the US wasn’t physically damaged, and US deaths were comparatively low in relation to those of most other major countries.
The Top: Following the standard script, the victorious powers met to determine the new world order and its new money and credit systems.
The Post-War Monetary and Economic Systems: As a result of the Bretton Woods Agreement, the dollar became the world’s leading reserve currency. This was natural because the two World Wars had made the US the richest and most powerful country by far. Following a brief post-war recession that was due to the decline of military spending, the US entered a prolonged period of peace and prosperity as is typical when a new Big Cycle begins. There was enough money for the US to improve education, invent fabulous technologies and a lot more. Americans never thought about how much the space program, the War on Poverty, and the Vietnam War would cost. Because they felt so rich, and the dollar seemed secure as a reserve currency Americans assumed they could afford a “guns and butter” fiscal policy indefinitely.
Because dollar-denominated debt was considered as good as gold, was convertible to gold, and was higher-earning because it provided interest, central banks shrank their gold holdings relative to their dollar-denominated debt holding from 1945 to 1971. That is what led to the breakdown of the gold-linked Bretton Woods monetary system. The Nixon administration vowed not to “devalue” the dollar, but in August 1971, the US defaulted on its commitments to pay in gold, offering paper money instead. Rather than seeing these problems as signs of things to come, Americans viewed them as nothing more than a temporary setback. Yet as the decade progressed, economic problems contributed to political problems and vice versa. Early in the 1970s, most Americans had never experienced inflation, so they weren’t wary of it and allowed it to blossom. By the end of the decade, they were traumatized by it.
After the 1971 delinking of the dollar and other currencies from gold, the world moved to an unanchored fiat monetary system and the dollar fell in value against gold, other currencies, stocks, and eventually just about everything. It led Americans to borrow money and immediately take their paychecks to buy things to “get ahead of inflation.” This whole 1971-91 up-and-down debt cycle, which profoundly affected just about everyone in the world, was the result of the US going off the gold standard, the inflation that followed it, and having to break the back of the inflation through tight monetary policies that led to the strength in the dollar and the dramatic fall in inflation.
Meanwhile, because of its economic failures, the Soviet Union (the U.S.’s only contending power) could not afford to support a) its empire, b) its economy, and c) its military in the face of Reagan’s arms-race spending. This resulted in ending the “Cold War.”
Since then, three economic cycles have brought us to where we are at the time of my writing – one that peaked in the 2000 dotcom bubble that led to the recession that followed, one that peaked in the 2007 bubble that led to the 2008 global financial crisis, and one that peaked in 2019, just before the 2020 coronavirus-triggered downturn. In addition to the decline of the Soviet Union, this period also saw the rise of China, globalization, and advances in technologies that replaced people, which was good for corporate profits, but widened wealth and opportunity gaps. This was a period in which workers in other countries, especially those in China, and machines replaced middle-class workers in the United States.
In March 2020 the coronavirus pandemic hit, and incomes, employment, and economic activity plunged as the country (and much of the world) went into lockdown. The US government took on a lot of debt to give people and companies a lot of money, and the Federal Reserve printed a lot of money and bought a lot of debt. So did other central banks.
WHERE THE U.S. IS NOW IN ITS BIG CYCLE: The stats in my model suggest that the US is roughly 70% through its Big Cycle, plus or minus 10%. The United States has not yet crossed the line into the sixth phase of a civil war/revolution, when the active fighting begins, but internal conflict is high and rising. History has shown that greater polarization equals either a) greater risk of political gridlock, which reduces the chances of revolutionary changes that rectify the problems or b) some form of civil war/revolution. The three most important markers I am watching now are: 1) the rules being disregarded, 2) both sides emotionally attacking each other, and 3) blood being spilled.
THE BIG CYCLE RISE OF CHINA AND THE RENMINBI: Unlike the cycles for the Dutch, British, and American empires, which began with their rises and were followed by their protracted declines, China’s cycle over the past 200 years was a long decline followed by a rapid rise.
The Rise from 1949 until Now: Though it’s a bit of an oversimplification, we can think of China’s evolution from 1949 until now as occurring the three phases.
Now let’s take a closer look.
Phase One: Between the People’s Republic of China (PRC) founding in 1949 and Mao’s death in 1976, the Chinese economy grew rather quickly, at an average annual rate of about 6%, with an average annual inflation rate of around 1-2 percent, accumulating around $4 billion dollars in foreign exchange reserves. This represented a modest improvement, but China remained poor. And there was a lot of volatility along the way.
Phase Two: From 1978 until he died in 1997 Deng Xiaoping’s most important policies were conveyed in a single phase: reform and opening up. “Reform” meant market reforms, using markets to help allocate resources in incentivizing people, and “opening up” meant interacting with the outside world to learn, improve, and trade. Capitalism became a part of the communist mix. He made it clear that China would have a “socialist market economy,” which he also referred to as “socialism with Chinese characteristics.” During his term, Deng also reformed the decision-making structure of government. These reforms enabled the first orderly transition of power to the next generation.
During this period of globalization, a symbiotic relationship developed between China and the US in which the Chinese manufactured consumer goods in an extremely cost-effective way and loaned the US money to buy them. It was a hell of a “buy now, pay later” deal for the Americans, and the Chinese liked it because they built their savings in the world’s reserve currency.
Deng died on February 19, 1997, having transformed China almost beyond recognition. When he came to power 90% of the population lived in extreme poverty; at the time of his death that number had fallen by more than half, and as of the most recent data is below 1%. From the start of his reforms in 1978 until his death in 1997, the Chinese economy grew at an average rate of 10% a year, sextupling in size while experiencing an average inflation rate of just 8%. Deng’s successors continued the reforms and the advances through many ups and downs (though more ups than downs).
As is typical of post-war periods of peace and prosperity, when the leading power isn’t threatened, emerging countries can learn a lot from the leading powers as they work together in a symbiotic way, until the emerging power becomes powerful enough to threaten the leading power. In addition to benefiting from the learning, they benefit from trading with each other, and they benefit from using the capital markets to their mutual benefit.
More specifically, the 1978-2008 period of fast growth in China came about because 1) the world was still in the peace and prosperity phase of the Big Cycle in which globalization and capitalism – i.e., the belief that goods and services should be produced wherever is most cost-effective, there should be free flows of talented people without prejudice toward their nationalities, nationalism is bad, and global equal opportunity and profit-seeking capitalism are good – were understood to be the widely accepted paths to a better world, while at the same time 2) Deng Xiaoping swung the pendulum from communist and isolationist policies that worked terribly to market/state-capitalist and open-door policies that worked terrifically. That led China to learn a lot, attract a lot of foreign capital and become a giant exporter and big saver.
Phase Three: The era of peace, prosperity and globalization began to wane, giving way to an era of conflicts between the rich and the poor within countries and between the rising country (China) and the dominant world power (the US). In 2012, Xi Jinping came to power and a new administration was chosen.
When Xi Jinping came to power, he improved China’s debt and economic management dramatically, continued growth in innovation and technologies, strengthened education and the military, and encountered greater conflict with the US. China is now roughly tied with the US in being the leading power in trade, economic output and innovation and technology and it is a strong and quickly rising military and educational power. It is an emerging power in the financial sector but is lagging as a reserve currency and financial center.
As far as foreign policy is concerned, China has become stronger and more forceful while the US has become more confrontational. More specifically, from 2012 until the time of my writing China’s strengths have grown, which has become increasingly apparent and more openly shown. Basically, China does not want to be contained and the United States (and some other countries) want to contain it.
As a result of all of this and other assertions, the perception of China as a threat/enemy has emerged, globalization has reversed, and “wars” have intensified, starting with the trade and economic wars, expanding to the technology and the geopolitical wars and, most recently, to the capital war. All remain relatively mild in relation to what they could be, but they should be watched closely. Eventually the actual powers of a country that are recognized become consistent with the actual powers that exist.
In conclusion, this modern era for China has led to some of the most rapid improvements in basic living conditions in history as well as an obvious climb in the factors that create powerful empires. In all respects, China is now a major and expanding power.
Source: The Changing World Order by Ray Dalio (2021).
The unabbreviated version of the above can be found in the pdf document below.
HOW THE WORLD HAS WORKED THE PAST 400 YEARS – EXCERPTS
NOTE: All the excerpts in the segment are from The Changing World Order by Ray Dalio (2021)
THE BIG CYCLE RISE AND DECLINE OF THE DUTCH EMPIRE AND THE GUILDER: From 1625 until their collapse in 1795, the Dutch Empire rose for all the classic reasons peaking around 1650 in what is now remembered as the Dutch Golden Age.
The Rise: From 1581 until around 1625, the Dutch Empire was built following the classic steps of a rising empire. The Dutch successfully revolted against Spain in the Eighty Years’ War, which resulted in the Dutch Republic asserting its independence in 1581.
The Dutch invented ships that could go around the world to collect riches, capitalism that could finance these and other productive endeavors, and many more breakthroughs that made them rich and powerful. The Dutch created the world’s first mega-corporation, the Dutch East India Company, which accounted for about one-third of world trade. Dutch openness to new ideas, people and technology helped them rise quickly. To support trade the Dutch government increased military investments, which allowed the country to control still more trade by holding off the British in a number of military conflicts.
The Dutch also created the world’s first reserve currency other than gold and silver, the Dutch guilder, supported by an innovative banking and currency system put into place via the establishment of the Bank of Amsterdam. As a result of these classic and sound fundamental steps, the Dutch became rich – income per capita in the Netherlands rose to over twice that of most other European powers. The Dutch continued to invest heavily in education and infrastructure to build on their successes. In short, the Dutch were superbly educated people who were very hardworking and inventive. The Dutch invented capitalism as we know it. This was great for the Dutch and great for the world.
The Top: The Dutch Golden Age led the Dutch to shift their attentions to “living the good life” in a way that weakened their finances. Other powers rose too and began to challenge them. The arrival of capitalism, combined with the new approaches of the Enlightenment, led to an economic transformation called the Industrial Revolution, which was centered in Britain. At the top, the Dutch saw a reversal of many of the classic ingredients.
The Dutch educational and technological edge eroded. They became uncompetitive in general and via the decline of the Dutch East India Company. In the 1700s, the Industrial Revolution led the British to overtake the Dutch as the preeminent economic and financial power in Europe. Increasing military conflicts (in attempts to protect their vast wealth around the world) left the Dutch overextended and overindebted. This all set the stage for the decline in the guilder’s reserve currency status, which ultimately deteriorated after the Dutch lost a war (and with it, important assets) to the British.
In the final and Fourth Anglo-Dutch War (1780-84) against the British (in retaliation for Dutch support of the colonies in the American Revolution) ended in a significant defeat for the Dutch, ushering in the end of the guilder as a reserve currency.
The Decline: Around 1750 the British (and the French) became stronger than the Dutch, both because their own power had grown and because the Dutch had become weaker. As is classic, the Dutch a) became more indebted, b) experienced a lot of internal fighting over wealth, and c) weakened militarily. All this made them vulnerable to decline and attack.
Financial losses and large debts led to the classic move by the central bank to print more money.
The decline of the Dutch Empire led to the next Big Cycle in world history: the rise and decline of the British Empire and its reserve currency, which is basically the same story, just a century or so later.
THE BIG CYCLE RISE AND DECLINE OF THE BRITISH EMPIRE AND THE POUND: Changes in the world order come about when two or more countries (or alliances of countries) of comparable power fight and one wins and becomes dominant enough to set the new rules, which is the new world order. Before this happens, the rising country needs to get itself into a comparable position of strength relative to the reigning country, so the story of any great country’s rise begins long before it becomes a great power.
The Rise: In Europe there was great devastation and change that resulted from the Thirty Years’ War because it was a war between ideologies, religions, and economic classes that created a new European order through the Peace of Westphalia. This treaty established countries as we know them and created a fractured Europe, which led to different choices in different countries.
The English Civil War (1642 – 1652) specifically led to the king (Charles I) being tried and executed and the monarchy being replaced by the Commonwealth of England under the rule of the general who led the revolt, Oliver Cromwell. These conflicts established rule of law rather than rule of the monarchy and they created a new balance of power between the king and Parliament. At the core of this new, human-centric philosophy was the idea that society should be based on reason and science and that the government’s power comes from the people, not from God.
Debate and skepticism were encouraged. Improvements in basic education (which caused literacy rates to rise), the dissemination of ideas via printed materials (the first encyclopedias and dictionaries were printed en masse), and a growing number of transnational elites (who were well read and cultivated cross-border contacts) created a new and wider “public sphere” of political and social thought.
Over time the British system’s respect for the rule of law, combined with strong education, gave it the foundation to gain competitive advantages in commerce and innovations that followed and led to the rise of the British Empire.
The Industrial Revolution: A well-educated population together with a culture of inventiveness and the availability of capital to financially support the developments of new ideas – especially about how machines could more efficiently do what many were laboring to do – created a great wave of competitiveness and prosperity. This shift changed Europe from a primarily rural and agrarian society in which most people were poor, and power resided with landowning elites to an urban and industrial society in which people as a whole got a lot richer and power resided with central government bureaucrats and capitalists. Geopolitically, these strengths led it to overtake the Dutch as the preeminent economic and financial power in Europe around 1750, 30 years before the UK defeated the Dutch in battle and clearly became the world’s leading empire.
The UK’s military strength – especially its navy – helped it establish its colonies and take over those of the European powers, as well as secure its control over global trade routes. The profitability of the empire more than paid for its military spending because it supported economic activities. London became the world’s financial center and the pound sterling the world’s reserve currency. In other words, Great Britain followed the classic Big Cycle steps of a rising empire.
The Top: The UK’s share of global exports rose with the Industrial Revolution and the spread of the empire, peaking around 1850 at about 40% of global exports. Even as the British Empire continued to expand its territorial and financial reach over the final decades of the 19th century, the seeds of its fall were evident, driven by the classic factors of 1) declining competitiveness, 2) rising inequality and conflict, and 3) the rise of new rival, particularly Germany and the U.S.
The rivalry between the UK and Germany was just one of many building across Europe – France and Germany were at odds, Germany was increasingly concerned about Russian industrialization, and Austria and Russia were struggling for influence in the Balkans. Though these countries were intertwined through marriage and commerce more than ever before, and despite most people believing it wouldn’t happen, in 1914 the powder keg exploded into all-out war. This was the first world war because this was the first time the world had become so small and so interconnected that most of the major parts of the world were involved in one way or another.
In 1919, the victors – the US, Britain, France, Japan, and Italy – met at the Paris Peace Conference to lay out the new world order in the Treaty of Versailles. The United States, now recognized as a leading power, played a big role in the negotiations. Elsewhere, much of the world entered a decade of peace and prosperity, the Roaring ‘20s. As is typical, the debts and the wealth gaps that were built up burst in 1929, causing the Great Depression. These two big boom and bust cycles came unusually close together, though they followed classic stages.
The Great Depression coupled with the large wealth gaps led to a rise in populism and extremism in nearly every major country. In some countries – e.g., the US and the UK – this led to big redistributions of wealth and political power while capitalism and democracy were maintained. In others, particularly those with weaker economies (Germany, Japan, Italy, Spain), populist dictators seized control and sought to expand their empires. Classically, before all-out wars begin, there is typically about a decade of economic, technological, geopolitical and capital skirmishing.
World War II, just two decades after World War I, was even more costly in lives and money. Germany and Japan lost and the US, the UK, and the Soviet Union won, though economically the UK and the Soviet Union lost too, and the US gained enormously in relative wealth. As is typical, the winners of the war got together and determined a new world order in 1945.
The Decline: The Allied victory in 1945 produced a tremendous shift of wealth and power, with the US emerging as the world’s dominant empire just as the British had after the Napoleonic Wars. It took another 20 years for the British pound to fully lose its status as an international reserve currency. But the pound had been losing status since the end of the war. The decline in the British pound was a protracted affair that involved several significant devaluations.
Europe after World War II: The most important geopolitical elements of the post-war order were:
- The US was the dominant power which made it the de facto global police force.
- The United Nations was established to resolve global disputes.
- The Bretton Woods monetary system, which established the dollar as the world’s reserve currency.
- The IMF and the World Bank, designed to support the new global financial system.
- New York as the new global financial center.
THE BIG CYCLE RISE AND DECLINE OF THE UNITED STATES AND THE DOLLAR:
The Rise: The US went through the usual revolution and post-revolution process in which it created a new domestic order as 1) a coordinated group of strong leaders fought to gain control, 2) that group won and consolidated control, 3) the new leadership had a vision supported by the population, but 4) it split into factions that had conflicts over how the government should work to implement that vision. Eventually, these factions 5) figured out that system for control and laid it out in agreements (in the US case, at first in the Articles of Confederation and then in the Constitution), 6) set up the parts of government (e.g., the money and credit system, the legal system, the legislative systems, the military, etc.), and 7) put people in jobs and made it work well. The US did these things in a uniquely peaceful way through negotiations, near-total respect for agreements, and good designs for governance that gave it a great start.
The economic gains were financed through a system of free-market capitalism that, as is classic, produced both lots of wealth and big wealth gaps. The US went through many boom/bust cycles, in which classically a flurry of debt-financed investments (into land, railroads, etc.) became overextended, leading to credit losses and a credit crunch. As a result, banking system panics were extremely common. Like London, New York was well-established as a trading center long before it became a global financial center, a development that didn’t occur until after the turn of the 20th century.
The second half of the 19th century was a boom period of peace and prosperity that has been called “the Gilded Age” because it was the period in which capitalism and innovation flourished, wealth gaps widened enormously, decadence was apparent, and resentment build. Then World War I, the war few people expected to happen, and nobody expected to last so long, began in 1914 and ended in 1918.
As is typical, after the war years and with the new world order came a period of peace and prosperity fueled by great innovations and productivity and a capital markets boom that produced big debts and big wealth gaps late in the upswing. In the Roaring ‘20s a lot of debt (promises to deliver paper money that was convertible to gold) was created to buy speculative assets (particularly stocks). To curtail that, the Federal Reserve tightened monetary policy in 1929, which caused the bubble to burst and the global Great Depression to begin. It brought economic suffering to virtually all nations, which led to fighting over wealth within and between countries, which led to the hot wars that began a decade later. On a relative basis the US came out the big winner because the US sold and lent a lot before and during the war, basically all of the fighting took place off of US territory, so the US wasn’t physically damaged, and US deaths were comparatively low in relation to those of most other major countries.
The Top: Following the standard script, the victorious powers met to determine the new world order and its new money and credit systems.
The Post-War Monetary and Economic Systems: As a result of the Bretton Woods Agreement, the dollar became the world’s leading reserve currency. This was natural because the two World Wars had made the US the richest and most powerful country by far. Following a brief post-war recession that was due to the decline of military spending, the US entered a prolonged period of peace and prosperity as is typical when a new Big Cycle begins. There was enough money for the US to improve education, invent fabulous technologies and a lot more. Americans never thought about how much the space program, the War on Poverty, and the Vietnam War would cost. Because they felt so rich, and the dollar seemed secure as a reserve currency Americans assumed they could afford a “guns and butter” fiscal policy indefinitely.
Because dollar-denominated debt was considered as good as gold, was convertible to gold, and was higher-earning because it provided interest, central banks shrank their gold holdings relative to their dollar-denominated debt holding from 1945 to 1971. That is what led to the breakdown of the gold-linked Bretton Woods monetary system. The Nixon administration vowed not to “devalue” the dollar, but in August 1971, the US defaulted on its commitments to pay in gold, offering paper money instead. Rather than seeing these problems as signs of things to come, Americans viewed them as nothing more than a temporary setback. Yet as the decade progressed, economic problems contributed to political problems and vice versa. Early in the 1970s, most Americans had never experienced inflation, so they weren’t wary of it and allowed it to blossom. By the end of the decade, they were traumatized by it.
After the 1971 delinking of the dollar and other currencies from gold, the world moved to an unanchored fiat monetary system and the dollar fell in value against gold, other currencies, stocks, and eventually just about everything. It led Americans to borrow money and immediately take their paychecks to buy things to “get ahead of inflation.” This whole 1971-91 up-and-down debt cycle, which profoundly affected just about everyone in the world, was the result of the US going off the gold standard, the inflation that followed it, and having to break the back of the inflation through tight monetary policies that led to the strength in the dollar and the dramatic fall in inflation.
Meanwhile, because of its economic failures, the Soviet Union (the U.S.’s only contending power) could not afford to support a) its empire, b) its economy, and c) its military in the face of Reagan’s arms-race spending. This resulted in ending the “Cold War.”
Since then, three economic cycles have brought us to where we are at the time of my writing – one that peaked in the 2000 dotcom bubble that led to the recession that followed, one that peaked in the 2007 bubble that led to the 2008 global financial crisis, and one that peaked in 2019, just before the 2020 coronavirus-triggered downturn. In addition to the decline of the Soviet Union, this period also saw the rise of China, globalization, and advances in technologies that replaced people, which was good for corporate profits, but widened wealth and opportunity gaps. This was a period in which workers in other countries, especially those in China, and machines replaced middle-class workers in the United States.
In March 2020 the coronavirus pandemic hit, and incomes, employment, and economic activity plunged as the country (and much of the world) went into lockdown. The US government took on a lot of debt to give people and companies a lot of money, and the Federal Reserve printed a lot of money and bought a lot of debt. So did other central banks.
WHERE THE U.S. IS NOW IN ITS BIG CYCLE: The stats in my model suggest that the US is roughly 70% through its Big Cycle, plus or minus 10%. The United States has not yet crossed the line into the sixth phase of a civil war/revolution, when the active fighting begins, but internal conflict is high and rising. History has shown that greater polarization equals either a) greater risk of political gridlock, which reduces the chances of revolutionary changes that rectify the problems or b) some form of civil war/revolution. The three most important markers I am watching now are: 1) the rules being disregarded, 2) both sides emotionally attacking each other, and 3) blood being spilled.
THE BIG CYCLE RISE OF CHINA AND THE RENMINBI: Unlike the cycles for the Dutch, British, and American empires, which began with their rises and were followed by their protracted declines, China’s cycle over the past 200 years was a long decline followed by a rapid rise.
The Rise from 1949 until Now: Though it’s a bit of an oversimplification, we can think of China’s evolution from 1949 until now as occurring the three phases.
- The Mao phase: From 1949 until he died in 1976, Mao consolidated power; built China’s foundation of institutions, governance, and infrastructure and ruled China as a communist emperor.
- The Deng and Deng’s successors phase, from 1978 to 2012 when Xi Jinping came to power.
- Xi Jinping came to power in 2012 presiding over a richer, more powerful China that was becoming overly indebted, too corrupt, and increasingly at odds with the United States.
Now let’s take a closer look.
Phase One: Between the People’s Republic of China (PRC) founding in 1949 and Mao’s death in 1976, the Chinese economy grew rather quickly, at an average annual rate of about 6%, with an average annual inflation rate of around 1-2 percent, accumulating around $4 billion dollars in foreign exchange reserves. This represented a modest improvement, but China remained poor. And there was a lot of volatility along the way.
Phase Two: From 1978 until he died in 1997 Deng Xiaoping’s most important policies were conveyed in a single phase: reform and opening up. “Reform” meant market reforms, using markets to help allocate resources in incentivizing people, and “opening up” meant interacting with the outside world to learn, improve, and trade. Capitalism became a part of the communist mix. He made it clear that China would have a “socialist market economy,” which he also referred to as “socialism with Chinese characteristics.” During his term, Deng also reformed the decision-making structure of government. These reforms enabled the first orderly transition of power to the next generation.
During this period of globalization, a symbiotic relationship developed between China and the US in which the Chinese manufactured consumer goods in an extremely cost-effective way and loaned the US money to buy them. It was a hell of a “buy now, pay later” deal for the Americans, and the Chinese liked it because they built their savings in the world’s reserve currency.
Deng died on February 19, 1997, having transformed China almost beyond recognition. When he came to power 90% of the population lived in extreme poverty; at the time of his death that number had fallen by more than half, and as of the most recent data is below 1%. From the start of his reforms in 1978 until his death in 1997, the Chinese economy grew at an average rate of 10% a year, sextupling in size while experiencing an average inflation rate of just 8%. Deng’s successors continued the reforms and the advances through many ups and downs (though more ups than downs).
As is typical of post-war periods of peace and prosperity, when the leading power isn’t threatened, emerging countries can learn a lot from the leading powers as they work together in a symbiotic way, until the emerging power becomes powerful enough to threaten the leading power. In addition to benefiting from the learning, they benefit from trading with each other, and they benefit from using the capital markets to their mutual benefit.
More specifically, the 1978-2008 period of fast growth in China came about because 1) the world was still in the peace and prosperity phase of the Big Cycle in which globalization and capitalism – i.e., the belief that goods and services should be produced wherever is most cost-effective, there should be free flows of talented people without prejudice toward their nationalities, nationalism is bad, and global equal opportunity and profit-seeking capitalism are good – were understood to be the widely accepted paths to a better world, while at the same time 2) Deng Xiaoping swung the pendulum from communist and isolationist policies that worked terribly to market/state-capitalist and open-door policies that worked terrifically. That led China to learn a lot, attract a lot of foreign capital and become a giant exporter and big saver.
Phase Three: The era of peace, prosperity and globalization began to wane, giving way to an era of conflicts between the rich and the poor within countries and between the rising country (China) and the dominant world power (the US). In 2012, Xi Jinping came to power and a new administration was chosen.
When Xi Jinping came to power, he improved China’s debt and economic management dramatically, continued growth in innovation and technologies, strengthened education and the military, and encountered greater conflict with the US. China is now roughly tied with the US in being the leading power in trade, economic output and innovation and technology and it is a strong and quickly rising military and educational power. It is an emerging power in the financial sector but is lagging as a reserve currency and financial center.
As far as foreign policy is concerned, China has become stronger and more forceful while the US has become more confrontational. More specifically, from 2012 until the time of my writing China’s strengths have grown, which has become increasingly apparent and more openly shown. Basically, China does not want to be contained and the United States (and some other countries) want to contain it.
As a result of all of this and other assertions, the perception of China as a threat/enemy has emerged, globalization has reversed, and “wars” have intensified, starting with the trade and economic wars, expanding to the technology and the geopolitical wars and, most recently, to the capital war. All remain relatively mild in relation to what they could be, but they should be watched closely. Eventually the actual powers of a country that are recognized become consistent with the actual powers that exist.
In conclusion, this modern era for China has led to some of the most rapid improvements in basic living conditions in history as well as an obvious climb in the factors that create powerful empires. In all respects, China is now a major and expanding power.
Source: The Changing World Order by Ray Dalio (2021).
The unabbreviated version of the above can be found in the pdf document below.
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