Picture: Pudong District, Shanghai. Shanghai reflects China’s path over the past 500 years described by Ray Dalio; once dominant power under the Ming and Qing dynasties, the country experienced sharp decline from 1850’s to 1978 before re-opening and re-becoming the world largest economy.
Ray Dalio last chapters are arguably the most important of his book because related to today’s situation. Three issues are raised: the ascension and decline of the US Empire, the re-rise of China and the possible outcome of the American-Chinese global rivalry.
The ascension and decline of the US Empire
The United States of America’s ascension as a superpower is more known because more recent. It is also the fastest in History.
The Ascension
The Big Cycle of the United States becomes after the American Revolutionary War (1775-1783) which results in the creation of the United States and their independence from United Kingdom and the establishment of the typical pro-education and pro-growth institutions: the American Constitution and institutions strictly protect individual rights, property rights, the separation of powers and a relative freedom in the expression of ideas and in the development of schools etc. The citizens population at this time, is composed of highly-educated English colons’ descendants, like other Protestant countries.
As seen above with the evolution of 8 factors of wealth and power of the US, increasing relative advantage in education and competitiveness resulted in a boom of innovation, trade power and economic output, particularly starting the 1850’s. With Germany, the US initiated the second Industrial Revolution centered on electricity and the combustion engines. Most these new technologies are reliant on oil, which replaces coal as the new core energy and which the US was the biggest producer until the 1960’s.
In 1913, the United States held technological, economic, and trade dominance, surpassing the UK at a similar stage in the Big Cycle. However, its banking system, reserve status, and military were less developed. The global wars from 1914 to 1945 propelled the US to become a major military power, and its banking and financial systems were gradually organized and centralized, notably with the creation of the Federal Reserve in 1913.
The Peak
The 1950’s are US’ peak, the country is by far the first in all indicators of wealth and power and all these indicators were mutually self-reinforcing. On the world stage, the US implements a new world order, including the Bretton Woods monetary system.
This system is typical of what Ray Dalio describes through the big cycle of Long-term debt. Following almost 2 decades of money printing in every country to fund wars and economic stimulus to depression, most countries’ currencies have lost over 70% of their value in 1945. There is a need to anchor these currencies to a hard asset like gold to restore confidence. As the US emerged as the dominant power and held most gold world reserves (75%) many countries decided to guarantee the convertibility of their money to the dollar at a fixed rate (example: 4 Deutsch Mark per 1$) and the dollar itself would be convertible to gold at the fixed rate of 35$ per troy once. Countries exporting to the US would receive dollars which they could either require the Fed to convert into gold, or invest these reserves into interest-rate paying debt like US treasuries Bonds, which they can also exchange for gold.
The Bretton Woods I system (1945-1971) corresponds to the phase 1 to 4 of the Long-term debt cycle described by Ray Dalio. This period balanced growth of debt supported by the US’ supply of dollar with the limitation of money creation since the dollar and its pegged currencies had a fixed convertibility to gold.
The Decline
But in the conditions of prosperity lie the seeds of decline. Late 1960’s, the US started to finance costly projects, notably the War on Poverty (social programs) and the Vietnam War, while at the same time being caught up industrially speaking by Western Europe and Japan. The US’ balance of payment started being structurally in deficit in 1969-1970.
Foreign countries and investors realized that their assets ( the dollar-denominated US debt ) which are claims on US’ stock of gold exceeded by far the Fed’s current stock of gold, which was rapidly decreasing as the US was importing more than it was exporting (the difference was paid in gold). A run on the bank occured as foreign investors and countries decided to exchange their debt securities to gold the US no longer had. As a consequence, in summer 1971, the Nixon Administration unilaterally put an end to the convertibility of the dollar to gold, which in other words means that the US defaulted on its commitments to pay in gold.
Since 1971, Central Banks and commercial banks of the US and of most countries are in theory unlimited in the creation of credit. If we leave apart the decade of high inflation in the US (1971-1980) followed by the tightening of monetary policy and the crush of inflation and growth (1980-1982), we clearly observe from mid-1985 until today 2020 all the signs of the fiat money system (or full credit money system) described by Ray Dalio:
boom in the creation of debt , and debt grows faster than incomes: global debt (private + public) to GDP ratio rose from 160% to 372% between 1980 and 2021.
the increase of debt-to-income ratio implies two things: structurally declining interest rates so the service of debt is kept moderate for borrowers and the constant depreciation of money as its quantity increases. These two trends are shown below.
-as money gets cheap and credit is accessible, there is a structural boom of all financial assets’ prices, which is below obvious for stocks (S&P 500 is the index of America’s 500 most important capitalizations)
These financial trends go hand in hand with other deteriorating factors of US’ wealth and power, which are:
-deteriorating trade deficit and budget deficit, which is directly linked to US’s growing debt.
-declining education levels imperfectly measured by the PISA ranking.
-structural deterioration of long-term economic growth at each recession, which proves Ray Dalio’s connection between the increasing monetary stimulus to crisis and their weakening effect on the economy.
-the soaring inequalities which is partly due to the appreciation of financial assets and their concentration in the end of the top 1% of incomes.
-as a consequence of inequalities, rising values gap and political extremism in the US, close to the levels before the US civil war.
This decline as underlined before worsens dramatically by stages. There is clearly an acceleration of most trends following the burst of the dotcom bubble in March 2000, following the burst of the subprimes bubble in July 2009, and following the first wave of COVID virus , in March 2020.
All of this leads Ray Dalio to estimate the US has reached 70% of its Big Cycle and stands at the stage 5, i.e before intense political conflict and economic crisis. At the same time, the US is facing with a strengthening global competitor – China.
The Re-rise of the Chinese Empire
A few words about China’s history and values
Before describing the rise of emergence of China at the beginning of the 21st century, Ray Dalio provides an in-depth description of Chinese History and Political Philosophy, which is very important and interesting to know, because as he underlines, China’s past and philosophy have much greater influence on current Chinese leaders’ way of thinking than the US’ history and Western philosophy has influence on today’s American leaders. Here are the relevant takings:
-China has always been among the most powerful empires in the world, consistently accounting for around 20% of the world population and 20-35% of the world GDP. Before Western industrialization began, China was by far the biggest goods manufacturer and a trade giant. However, Chinese dynasties’ frequent return to isolationism during their decline coupled with an indifference to long-distance trade and colonial expansion explain why China never developed powerful financial markets and promoted a world currency, nor developed a world-class cultural influence. Aguably, China is itself already a world surrounded by mountains and sea that often was self-sufficient.
-China as the geographical and political entity we know today is the most ancient in the world, i.e some political features have survived from the first imperial dynasty that unified China 2200 years ago until today. As a consequence, Chinese leaders’ relationship to historical time is much more long-term oriented.
-All major Chinese dynasties Ray Dalio studied – in chronological order, the Tang, Song & Yuan, Ming and Qing dynasties – followed the typical stages of the Big Cycle and lasted roughly 300years. Though China didn’t invent capitalism, it created paper money and early forms of banks and corporations, so it also experienced the typical long-term monetary cycles.
-China political philosophy is based on a) Confucianism which claims that harmony is reached when each individual know and successfully play its role in the social hierarchy and if the elites are selected on a meritocratic basis, b) Taoism, which promotes a good society through the balancing of opposites in everything (the ying and the yang) and c) Legalism, which insists on unification of the population and its obedience to a central power, which is the best insurance in a kill-or-be-killed world.
-As a consequence, China is steeped in fundamentally hierarchical, collectivist and non-egalitarian values which puts it at odds with the Western liberal democracy. At the same time, there’s nothing in Chinese culture and history telling it fundamentally opposes capitalist values like personal accumulation, competition etc. As consequence, Ray Dalio notes that today’s Chinese regime and economy is quite in line with Chinese identity: politically non-liberal and non-democratic, autocratic and top-down managed but capitalist with an strong presence of the State.
-As for the foreign policy, Chinese leaders often abide by the inherited tradition of winning a war not by fighting but by quietly developing one’s power and using all other non-military assets (psychological, trade, economic war) to the point the opponent will have no choice but to already capitulate. China has also traditionally applied “tributary system” in foreign policy, i.e it required to weaker states to regularly recognize China’s hegemony through gifts in exchange of guarantees of peace, cooperation and trade and a strict non-interference in the subordinated country’s culture and internal politics.
China’s Big Cycle follows the exact steps Ray Dalio describes:
• The stage one lasts between the proclamation of the People’s Republic of China in 1949 and the death of its first ruler, Mao Zedong, in 1976. Mao Zedong is the typical leader of this stage, in the sense he stabilized his country after one century of internal conflicts and decline and he aggressively consolidated power through purges in its hands and in the hands of the new leadership, the Chinese Communist Party (CCP). He also implemented most of administrations and institutions that still rule China today.
• The stage 2, which corresponds to Deng Xiaoping and its successors phase (1978-2012) begins with the implementation of economic reforms – introduction of capitalism and integration in globalization – which boosted China’s economic growth while keeping Debt-to-GDP ratio stable. He also shifted the CCP towards a collective decision-making approach, limited its own mandate to two terms of five years and expanded in the new constitution more freedom of religion, opinion and speech. At that time and until 2008, China was considered as a reliable partner by the US in the new globalization. The Chinamerica tandem was a win-win partnership in which American companies were maintaining high profitability and American consumers were maintaining their purchasing power by the outsourcing of production to cost-competitive China. China was exporting to the US and receiving $ it invested in US Treasury Bonds that could thus finance US deficits.
• The stage 3 (2012-today) corresponds to Xi Jinping’s arrival to office. China’s aggressive fiscal and monetary policy following the 2009 crisis considerably shored up its status of global manufacturing power while making its economic model more reliant on debt-financed real estate and infrastructures. Chinese leaders are conscious of that, which explains they mostly let the real estate bubble deflate, so that the economy’s resources are relocated towards high-end industries. The progression of Chinese financial markets reforms and the shift from exports to internal consumption are also the leadership’s new orientations. It goes with a tightening control of Xi Jinping over the system, with notably the formal end of the collegial decision-making process within the CPP, increased repression of the top 1% and big corporations, etc. Globally, both US and China became more confrontational each other since 2009, because the mutual interest of free trade of goods, ideas and technologies have disappeared, China competing with the US on its core assets of power (the $, crucial technologies and military hegemony in Asia).
The possible outcome of the American-Chinese global rivalry.
Ray Dalio explains in his chapter about the cycle of external order and disorder that the rising competition between an established power and an ascending power historically ends up in several kinds of conflicts: first the trade/economic war, followed by the technological war, the geopolitical war and the financial war, which possibly culminates into a military war. More broadly, this period of disorder sees the emergence of hot wars and more minors conflicts between other powers that are allied with the established or the ascending power.
What worries Ray Dalio is that the Chinese-American relationship has reached the later stage of conflict, just before the military war:
-the trade war between the US and China has begun with each country imposing mutually tariffs on some goods. One has to keep in mind that Donald Trump’s protectionism and hostility towards China is not a personal obsession, but one of the few policies receiving bipartisan support and that was deepened under the Biden Administration.
-the technological war also began under the Trump Administration, with the sanctions against Huawei, then a few other companies. The Biden Administration has gone further, with export controls of NVIDIA and AMD’s key semiconductor technologies to China, and massive subsidies to the semiconductor and green economy sectors (renewables, EVs), respectively through the CHIPS act ($52bn) and the Inflation Reduction Act ($1.2trn of real cost). China has also sanctioned and sued a few American companies while banning the export of 2 rare earth materials it controls. It has strengthened its financial support of strategic sectors and technology, notably AI.
-the geopolitical war is the progressive shaping of a bipolar world and the militarization of some issues (Taiwan, claims in the Chinese Sea) that could be resolved by diplomacy instead. Over the past few years, US’ allies like Japan, South Korea and the European Union have increasingly adopted US views on China, while Russia following the Ukraine War has brokered an partnership with China that knows “no limits”. China has been quite successfully gaining the support or at least the neutrality of the “Global South”, through the expansion of the BRICS, the brokerage of a peace deal between Iran and Saudi-Arabia and the promotion of its investment program across Asia and Africa, the Belt Road Initiative (BRI).
-the capital war refers mainly to the use of a country’s currency reserve status to impose financial sanctions. Following the invasion of Ukraine, the US has unleashed a capital war on Russia whose billions of dollar-denominated assets were frozen and seized. The country also undergoes an embargo on most of its exports and a ban to access the banking communication system SWIFT, under US control. Though China is not directly concerned, these sanctions were widely seen in Beijing and in most of the Global South as a proof of the definitive weaponization of dollar, for which there is no back to the past. China quietly but obviously starts to promote the yuan as a currency for global transactions and its massive purchases of gold and commodities lead experts think the country may be developing a commodities and gold-backed currency.
Ray Dalio argues if their current irreconcilable views and interests on Taiwan, technology or monetary system don’t evolve, the two countries are heading towards a direct or indirect (proxy war), in the 10 next years, with a probability of 35% to 50%.
He reminds however some very recent short-lived improvements in the US-China relationship, as well as their tight interdependence which would make a direct clash very costly.
Even without the triggering of a global conflict, some trends that will invariably occur: an economic crisis in the West linked to an over-exhausted monetary system, the weakening credibility of the dollar, inevitable radical change in American political system (for the better or the worse), the continued (but short-lived?) rise of China in key technologies and a fragmentation/mutation of globalization. History is not end.
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