This sparked a fire in Dalio to become a great investor. He went to college and started commodity trading before founding Bridgewater Associates in 1975, which grew to become the largest hedge fund in the world.
The guru is now at a stage in his life where he wants to share all the knowledge he has. In a July 2022 interview on The Tony Robbins Podcast, Dalio discussed his latest book, "Principles for Dealing With the Changing World Order," and how it may impact our investing from a macroeconomic perspective. In this post, I will give an in-depth summary and elaborated with my comments from reading the book. Let’s dive in.
Dalio is a major student of history and believes by studying past historical patterns, we can learn from them. This could be through the studying of stock market bubbles and crashes of yesteryear. For example, Dalio started investing professionally during the 1960s when the “nifty fifty” stocks reigned supreme. These stocks were deemed to be untouchable as they were classed as the 50 best and fastest-growing companies in the U.S. and were condisered a “safe bet.”
By the 1970s, however, these stocks started to slide and many investors lost huge sums of money. The moral of the story is there is “no safe bet” when investing. Every investment comes with risk and usually, the most popular investments tend to become overvalued. We saw something similar occur during the growth stock boom of 2020, before these stocks got decimated. As Mark Twain once said, “History doesn’t repeat itself, but it does rhyme.”
The changing world order
When investing, it is helpful to understand the macroeconomic environment and which countries are rising and falling. Dalio is an expert in this area, having studied the rise and fall of empires. He now believes the world order is changing.
To take a step back, an “order” is the current system that is operating. For example, a “domestic order” through a constitution and laws which continue until a civil war or revolution changes it to another system. There is also the “world order,” which is the global operating system.
According to Dalio, a change in world order usually occurs when conflicting parties of “close to or equal power have a fight” and the winner sets the new rules. The last time that happened was in 1945, when the allies beat Nazi Germany in World War II. At the end of the war, the United States had 80% of the world's money, which was backed by gold at the time. According to Dalio, the U.S. also had half of the world's economy and was a dominant military power. Similarly, at the end of World War I, the Treaty of Versailles determined the new system. After these wars, there was an era of “peace, prosperity and productivity” because nobody wanted to fight the dominant power.
The country with the world's reserve currency (in this case, the U.S. dollar), can borrow and print the world’s currency. As prosperity continues and asset prices go up (such as stocks, real estate, etc.), it encourages more borrowing, spending and betting on prosperity. This creates greater “wealth gaps,” which we are seeing today as the wealth is distributed unevenly. The wealth gap increases, as do levels of indebtedness. Then the competition increases. Today, we have a “rising power” in the form of China. In the past, the British were competitors with the Dutch, then after with Germany.
Dalio pointed out that the average lifespan of an empire is usually 150 years. His reasoning is that if you are aware now and plan in advance, you can allocate your investments effectively and thus, will have less to worry about in the future.
Eight key measures of power
Dalio believes there are eight key measures of power which countries compete on and helps to determine their life cycle. They are:
- Financial Center
- Military Strength
- Reserve Status
Starting with education, the more well-educated the people, the smarter the workforce, which helps increasing services, innovation and technology.
With regards to financial centers, Amsterdam was the financial center for the Dutch empire and was home to the world's first stock exchange. After that, London was the financial center for the British Empire. Then the baton was passed to the U.S. with New York as the main financial center.
The countries with the largest trade routes also tend to grow the largest military in order to protect these different routes. The U.S. has army bases in 70 countries as of 2022. According to Dalio, the Soviet Union was “never a total power” because it was only a military power and not an economic power. However, China currently is a “close rival” as it either leads or comes close on the eight factors mentioned above.
Big events that lead to a changing world order
According to the guru, there are three big events that can lead to a changing world order. They are as follows.
- Countries do not have enough money to pay their debts.
- Internal conflicts occur due to growing gaps in wealth and values.
- Increasing external conflict between rising powers and the leading powers.
The dollar is no longer backed by gold, so to raise money, governments must either raise taxes or print more money. If they raise taxes, Dalio said people “get angry” as it takes money away from them. Even if they raise taxes on the “rich,” this can cause them to move business operations overseas. So to keep everyone happy, governments print money, but then this devalues the currency and causes inflation, which causes buying power to be lost. We saw this happen in 2020 with a huge trillion-dollar stimulus injected into the economy and, as a result, we are now seeing 40-year high inflation rates.
Interestingly, Dalio pointed out that in ancient Roman times, the same thing happened. They started with gold coins and then started to “put less gold in the coins” to spend more, which caused inflation.
Five types of war
Dalio said there are five types of warfare countries can take part in, which are:
- Geopolitical Influence
- Capital and Economic War (Sanctions)
The U.S. is already battling around the first four points against Russia and China. An eerie lesson from history Dalio mentioned is that in the 1940s, the U.S. sanctioned Japan, froze its assets and limited its oil imports. This, along with several other factors, led to the Pearl Harbor attack and propelled the U.S. to enter World War II.
Rise of populism
From Dalio's study of history, he noted that prior to past wars and changing world orders, there was a rise in populism. A populist is a person who will fight for their side, left or right, and is not willing to compromise. For example, the Jan. 6 Capitol riot was spearheaded by extremist pro-Trump groups who stormed the U.S. Capitol building.
Normally, the world populist conflict is solved through war because there is no world court.
On civil wars
Civil wars have often been called “revolutions” historically. Dalio has analyzed the French Revolution, the Cuban Civil War and the Russian Civil War. According to him, these conflicts occur when you get “extreme political views” on both the left and the right. The “middle” is often considered as weak by peers, which can lead to negative outcomes.
Currently, the guru said “25% to 30%” of the population are extreme right in the U.S. and around “15%” are at the extreme left. The majority of Americans are in the middle, but they do not have a platform or political party to represent them.
In regard to the Russia-Ukraine conflict, Dalio observed that it has not been a chemical, cyber or even nuclear war yet, which is a major positive. He thinks a ceasefire will occur before 2023, as no side will want to show they have “lost.”
He also believes sanctions will affect the capital markets due to “inefficiencies” and countries will think twice about holding certain assets, such as U.S. currency, which could be frozen by sanctions.
China as a rival power
The Russia-Ukraine situation causes an alignment of countries on one side or the other. Dalio said it is likely China will be watching what happens with Ukraine as a “temperature test for Taiwan.”
He added that China is going to be a “comparable power” over the next few years. China’s population (1.4 billion people) is over four times the U.S. (~330 million). So, on average, if they had a per capita income of half the U.S., then its economy would be “twice the size.” This means twice the size of buying power, technology or military. To put things in perspective, China’s per capita income has increased by over 27 times since the 1980s.
Dalio did not discuss investing in China, but he recently sold out of his Alibaba (BABA, Financial) position in the second quarter after previously being a long-term bull on the country. I think Dalio believes China will continue to grow economically, but for investors, the different political views may cause losses. We are already seeing a potential delisting of many Chinese stocks from U.S. exchanges.
Dalio reiterated the prophecy that the “United States will fall and China will rise” is not set in stone. He believes it can still be changed by treating each other well both domestically and internationally, avoiding war and investing into factors such as education and infrastructure. In addition, both countries will benefit by having strong leadership in the middle of political issues as opposed to one extreme or the other.
Further, he thinks we should have a bipartisan president and the extreme political parties should be the odd ones out.
“To be successful, the system has to produce prosperity for most people, especially the working middle class,” he said.
Inflation may continue
The investor believes inflation may continue due to a trend toward “deglobalization.” Historically, companies would set up manufacturing for a product wherever it was cheapest (globalization), with 22% of the world's goods manufactured in China. But now due to increasing political concerns, many governments want self-sufficiency and thus, may choose to manufacture goods in their home country even though it is more expensive, which adds to inflation. An example of this is Intel Corp. (INTC, Financial), which is opening a new factory in Ohio.
Dalio said he wrote the book not to scare people, but to give them a clear and rational view of the world. There is a lot of macroeconomic uncertainty and many tensions between countries. Thus, it would be prudent to continue to diversify investments with a bias toward inflation-hedging assets in addition to investments in businesses, which are essential despite the economic conditions.