Cross-Posting from Ray Dalio, on what's coming:
Watching what is now happening is like watching a movie that I have seen many times before. My perspective comes from my over 50 years of being a global macro investor and my study of the last 500 years of history.
In my book Principles for Dealing with The Changing World Order, which came out in 2021, I described a template that one could use to compare with actual developments to help understand how the world order is evolving. I also explained the timeless and universal cause-effect relationships of the big cycles that produce the changing world order. That template led me to believe that there was a high chance of a convergent breakdown of the monetary order, the domestic political order, and the international geopolitical order. Unfortunately, events are transpiring consistent with that template. The purpose of this note is to help you view recent developments in context of my template, especially as it explains the breaking down of the domestic order (which I describe as some form of “civil war,” though it doesn’t have to mean people killing each other).
Chapter 5 of the book describes “The Big Cycle of Internal Order and Disorder.” It transpires in a big cycle that goes through 6 stages that each have distinctive characteristics. With government’s debt problems and the riots in Los Angeles now being suppressed by President Trump sending in the National Guard, I thought it would be a good time to remind you of this template. If you are interested in reviewing the whole cycle and all its 6 stages, you should read all of Chapter 5. That’s too much to include here, but since I believe we now are in Stage 5 of the cycle, which describes the pre-civil war stage, I am sharing just my description of it along with Stage 6, the civil war stage.
I believe these are good guides for what's probably ahead. As always, I welcome any questions or comments that you have.
Stage 5: When There Are Bad Financial Conditions and Intense Conflict
The most important influence that transpires in a Big Cycle is that of debt, money, and economic activity. Because I covered that cycle comprehensively in Chapters 3 and 4, I won’t explain it here in detail. But to understand Stage 5, you need to know that it follows Stage 3, in which there is peace and prosperity and favorable debt and credit conditions, and Stage 4, in which excess and decadence begin to bring about worse conditions. This process culminates in the most difficult and painful stage—Stage 6—when the entity runs out of money and there is typically terrible conflict in the form of revolution or civil war. Stage 5 is the period during which the interclass tensions that go along with worsening financial conditions come to a head. How different leaders, policy makers, and groups of people deal with conflict has a major impact on whether the country will undergo the needed changes peacefully or violently.
You can see signs of this happening now in a number of countries. Those that have adequate financial conditions (i.e., have incomes that are greater than their expenses and assets that are greater than their liabilities) are in relatively good shape. Those that do not are in relatively bad shape. They want money from the others. The problem is that there are many more who are in bad shape relative to those that are in good shape.
You can also see that these different conditions are big drivers of the differences in what is now happening to most aspects of these countries, states, cities, companies, and people—e.g., their education, healthcare, infrastructure, and well-being. You can also see big cultural differences in how countries approach their stressful conditions, with some approaching them more harmoniously than others who are more inclined to fight.
Because Stage 5 is such a pivotal stage in the internal cycle and because it’s the stage that many countries, most importantly the US, are now in, I will devote some time to going through the cause/effect relationships at play during it and the key indicators to watch in examining its progression. Then I will turn more specifically to where the United States stands.
The Classic Toxic Mix
The classic toxic mix of forces that brings about big internal conflicts consists of 1) the country and the people in the country (or state or city) being in bad financial shape (e.g., having big debt and non-debt obligations), 2) large income, wealth, and values gaps within that entity, and 3) a severe negative economic shock.
That confluence typically brings about disorder, conflict, and sometimes civil wars. The economic shock can come about for many reasons, including financial bubbles that burst, acts of nature (such as pandemics, droughts, and floods), and wars. It creates a financial stress test. The financial conditions (as measured by incomes relative to expenses and assets relative to liabilities) that exist at the time of the stress test are the shock absorbers. The sizes of the gaps in incomes, wealth, and values are the degrees of fragility of the system. When the financial problems occur, they typically first hit the private sector and then the public sector. Because governments will never let the private sector’s financial problems sink the entire system, it is the government’s financial condition that matters most. When the government runs out of buying power, there is a collapse. But on the way to a collapse there is a lot of fighting for money and political power.
From studying 50-plus civil wars and revolutions, it became clear that the single most reliable leading indicator of civil war or revolution is bankrupt government finances combined with big wealth gaps. That is because when the government lacks financial power, it can’t financially save those entities in the private sector that the government needs to save to keep the system running (as most governments, led by the United States, did at the end of 2008), it can’t buy what it needs, and it can’t pay people to do what it needs them to do. It is out of power.
A classic marker of being in Stage 5 and a leading indicator of the loss of borrowing and spending power, which is one of the triggers for going into Stage 6, is that the government has large deficits that are creating more debt to be sold than buyers other than the government’s own central bank are willing to buy. That leading indicator is turned on when governments that can’t print money have to raise taxes and cut spending, or when those that can print money print a lot of it and buy a lot of government debt. To be more specific, when the government runs out of money (by running a big deficit, having large debts, and not having access to adequate credit), it has limited options. It can either raise taxes and cut spending a lot or print a lot of money, which depreciates its value. Those governments that have the option to print money always do so because that is the much less painful path, but it leads investors to run out of the money and debt that is being printed. Those governments that can’t print money have to raise taxes and cut spending, which drives those with money to run out of the country (or state or city) because paying more taxes and losing services is intolerable. If these entities that can’t print money have large wealth gaps among their constituents, these moves typically lead to some form of civil war/revolution.
At the time of this writing, this late-cycle debt dynamic is now playing out in the United States at both the state and federal levels, with the main difference between them being that state governments can’t print money to pay their debts while the federal government can. The federal government and many state and city governments have large deficits, large debts, and large wealth gaps, and the central bank (the Federal Reserve) has the power to print money. So, at the time of this writing, the central bank is printing a lot of money and buying a lot of federal government debt, which finances the government spending that is much bigger than the federal government’s intake. That has helped the federal government and those it is trying to help, though it has also cost those who are holding dollars and dollar debt a lot in real purchasing power.
Those places (cities, states, and countries) that have the largest wealth gaps, the largest debts, and the worst declines in incomes are most likely to have the greatest conflicts. Interestingly, those states and cities in the US that have the highest per capita income and wealth levels tend to be the states and cities that are the most indebted and have the largest wealth gaps—e.g., cities like San Francisco, Chicago, and New York City and states like Connecticut, Illinois, Massachusetts, New York, and New Jersey.
Facing these conditions, expenditures have to be cut or more money has to be raised in some way. The next question becomes who will pay to fix them, the “haves” or the “have-nots”? Obviously, it can’t be the have-nots. Expenditure cuts are most intolerable for those who are poorest, so there needs to be more taxation of people who can afford to pay more and there is a heightened risk of some form of civil war or revolution. But when the haves realize that they will be taxed to pay for debt service and to reduce the deficits, they typically leave, causing the hollowing-out process. This is currently motivating movements from some states to others in the US. If bad economic conditions occur, that hastens the process. These circumstances largely drive the tax cycle.
History shows that raising taxes and cutting spending when there are large wealth gaps and bad economic conditions, more than anything else, has been a leading indicator of civil wars or revolutions of some type.
To be clear, they don’t have to be violent, though they can be. I see these cycles transpiring in my personal interactions. For example, I live in the state of Connecticut, which has the highest per capita income in the country, the largest wealth gap and income gap in the country, and one of the largest per capita debt and unfunded pension obligations in the country. I see how the haves and the have-nots are focused on their own lives and spend little time worrying about the other because they don’t have much contact. I have windows into what the lives of both the haves and the have-nots are like because I have contact with the people in our community of haves and because the work my wife does to help disengaged and disconnected high school students in disadvantaged communities brings her into contact with people who live in the communities of the have-nots. I see how terrible the conditions are in those have-not communities and how the haves (who appear rich and decadent to the have-nots) don’t feel rich. I see how they are all focused on their own struggles—with the haves struggling with work/life balance, making sure their kids are well-educated, etc., and the have-nots struggling with finding income, food security, avoiding violence, trying to get their kids a quality education, etc.
I see how both groups are more likely to have critical, stereotypical impressions of each other that make them more inclined to dislike each other than to view themselves empathetically as members of one community in which they should help each other. I see how difficult it can be to help each other because of these stereotypes and because the haves don’t feel that they have more than enough or that the have-nots deserve their financial support, and I fear what the future might hold because of the existing circumstances and how they are likely to worsen. I have seen close up how COVID-inflicted health and budget shocks have brought to the surface the terrible conditions of the have-nots and are worsening the financial gaps that could bring about the classic toxic mix dynamic.
Averages don’t matter as much as the number of people who are suffering and their power.
Those who favor policies that are good for the whole—e.g., free trade, globalization, advances in technology that replace people—without thinking about what happens if the whole is not divided in a way that benefits most people are missing the fact that the whole is at risk.
To have peace and prosperity, a society must have productivity that benefits most people. Do you think we have this today?
What does history show as the path that bankrupt governments can follow to raise productivity that benefits most people? It shows that restructuring and/or devaluing enough of the previously created debt and non-debt obligations helps a lot. That is classic in Stages 5 and 6. Once the restructuring or devaluation reduces the debt burdens, which is typically painful at the time, the reduced debt burdens allow for a rebuilding.
An essential ingredient for success is that the debt and money that are created are used to produce productivity gains and favorable returns on investment, rather than just being given away without yielding productivity and income gains. If it is given away without yielding these gains, the money will be devalued to the point that I won’t leave the government or anyone else with much buying power.
History shows that lending and spending on items that produce broad-based productivity gains and returns on investment that exceed the borrowing costs result in living standards rising with debts being paid off, so these are good policies.
If the amount of money being lent to finance the debt is inadequate, it is perfectly fine for the central bank to print the money and be the lender of last resort as long as the money is invested to have a return that is large enough to service the debt. History shows and logic dictates that investing well in education at all levels (including job training), infrastructure, and research that yields productive discoveries works very well. For example, big education and infrastructure programs have paid off nearly all the time (e.g., in the Tang Dynasty and many other Chinese dynasties, in the Roman Empire, in the Umayyad Caliphate, in the Mughal Empire in India, in Japan’s Meiji Restoration, and in China’s educational development programs over the last couple of decades), though they have long lead times. In fact, improvements in education and infrastructure, even those financed by debt, were essential ingredients behind the rises of virtually all empires, and declines in the quality of these investments were almost always ingredients behind empires’ declines. If done well, these interventions can more than counterbalance the classic toxic mix.
The classic toxic mix is usually accompanied by other problems. The more of the following conditions that are in place, the higher the probability of having a severe conflict like a civil war or revolution.
Decadence
While early in the cycle there is typically more spending of time and money on productive things, later in the cycle time and money go more toward indulgent things (e.g., the finer things, like expensive residences, art, jewelry, and clothes). This begins in Stage 4 when such spending is fashionable, but by Stage 5 it begins to appear grotesque. Often, that decadent spending is debt-financed, which worsens the financial conditions. The change in psychology that typically goes along with these changes is understandable. The haves feel that they have earned their money so they can spend it on luxuries if they like, while the have-nots view such spending at the same time they are suffering as unfair and selfish. Besides increasing resentments, decadent spending (as distinct from saving and investing) reduces productivity.
What a society spends money on matters. When it spends on investment items that yield productivity and income gains, it makes for a better future than when it spends on consumption items that don’t raise productivity and income.
Bureaucracy
While early in the internal order cycle bureaucracy is low, it is high late in the cycle, which makes sensible and necessary decision making more difficult.
That is because things tend to get more complex as they develop until they reach the point where even obviously good things can’t be done—necessitating revolutionary changes. In a legal and contract-based system (which has many benefits), this can become a problem because the law can stand in the way of doing obviously good things. I will give you an example that I’m close to because my wife and I care about it.
Because the US Constitution doesn’t make education a federal government responsibility, it has predominantly been a state and local responsibility with school funding coming from revenue raised by local taxes in cities and towns. Though it varies from state to state, typically those children in richer towns in richer states receive a much better education than those in poorer towns in poorer states. This is obviously unfair and unproductive even though most people agree that children should have equal opportunities in education. But because this structure is so ingrained in our political system, it is nearly impossible to fix without a revolutionary reinvention of how we approach it. There are more examples of the bureaucracy standing in the way of doing sensible, productive things than I have time and space to convey here. It is now a big problem in America.
Populism and Extremism
Out of disorder and discontent come leaders who have strong personalities, are anti-elitist, and claim to fight for the common man. They are called populists. Populism is a political and social phenomenon that appeals to ordinary people who feel that their concerns are not being addressed by the elites. It typically develops when there are wealth and opportunity gaps, perceived cultural threats from those with different values both inside and outside the country, and “establishment elites” in positions of power who are not working effectively for most people. Populists come into power when these conditions create anger among ordinary people who want those with political power to be fighters for them. Populists can be of the right or of the left, are much more extreme than moderates, and tend to appeal to the emotions of ordinary people. They are typically confrontational rather than collaborative and exclusive rather than inclusive. This leads to a lot of fighting between populists of the left and populists of the right over irreconcilable differences. The extremity of the revolution that occurs under them varies. For example, in the 1930s, populism of the left took the form of communism and that of the right took the form of fascism while nonviolent revolutionary changes took place in the US and the UK. More recently, in the United States, the election of Donald Trump in 2016 was a move to populism of the right while the popularity of Bernie Sanders, Elizabeth Warren, and Alexandria Ocasio-Cortez reflects the popularity of populism of the left. There are increased political movements toward populism in a number of countries. It could be said that the election of Joe Biden reflects a desire for less extremism and more moderation, though time will tell.
Watch populism and polarization as markers. The more that populism and polarization exist, the further along a nation is in Stage 5, and the closer it is to civil war and revolution. In Stage 5, moderates become the minority. In Stage 6, they cease to exist.
Class Warfare
In Stage 5, class warfare intensifies. That is because, as a rule, l during times of increased hardship and conflict there is an increased inclination to look at people in stereotypical ways as members of one or more classes and to look at these classes as either being enemies or allies. In Stage 5, this begins to become much more apparent. In Stage 6, it becomes dangerous.
A classic marker in Stage 5 that increases in Stage 6 is the demonization of those in other classes, which typically produces one or more scapegoat classes who are commonly believed to be the source of the problems. This leads to a drive to exclude, imprison, or destroy them, which happens in Stage 6. Ethnic, racial, and socioeconomic groups are often demonized. The most classic, horrific example of this comes from the Nazi’s treatment of Jews, who were blamed and persecuted for virtually all of Germany’s problems. Chinese minorities living in non-Chinese countries have been demonized and scapegoated during periods of economic and social stress. In the UK, Catholics were demonized and scapegoated in numerous stressful periods, such as the Glorious Revolution and the English Civil War. Rich capitalists are commonly demonized, especially those who are viewed to be making their money at the expense of the poor. Demonizing and scapegoating are a classic symptom and problem that we must keep an eye on.
The Loss of Truth in the Public Domain
Not knowing what is true because of distortions in the media and propaganda increases as people become more polarized, emotional, and politically motivated.
In Stage 5, those who are fighting typically work with those in the media to manipulate people’s emotions to gain support and to destroy the opposition. In other words, media folks of the left join with others of the left and media folks of the right join with others of the right in the dirty fight. The media goes wild like vigilantes: people are commonly attacked and essentially tried and found guilty in the media, and they have their lives ruined without a judge and jury. A common move among 1930s populists of the left (communists) and of the right (fascists) was to take control of the media and establish “ministers of propaganda” to guide them. The media they produced was explicitly aimed at turning the population against the groups that the governments considered “enemies of the state.” The government of the democratically run United Kingdom created a “Ministry of Information” during World War I and World War II to spread government propaganda, and leading newspaper publishers were elevated by the government if they did what the government wanted them to do to win the propaganda war or were vilified and suffered if they didn’t cooperate. Revolutionaries did the same distorting of the truth in all sorts of publications. During the French Revolution, newspapers run by revolutionaries pushed anti-monarchist and anti-religious sentiment, but when those revolutionaries attained power, they shut down dissenting newspapers during the Reign of Terror. During times of great wealth gaps and populist thinking, stories that bring down elites are popular and lucrative, especially those that bring down left-leaning elites in right-leaning media outlets and those that bring downright-leaning elites in left-leaning media outlets. History shows that significant increases in these activities are a problem that is typical of Stage 5, and that when combined with the ability to inflict other punishments, the media becomes a powerful weapon.
It is well-recognized this is happening at the time of this writing. The perceived truth in media, both traditional and social, is lower than at any other time in our lifetimes. For example, a 2019 Gallup poll found that only 13 percent of Americans surveyed have “a great deal” of trust in the media and only 41 percent of those surveyed have either a “fair” or “great deal” of trust in the media. That compares with 72 percent who trusted the media in 1976. This is not just a fringe media problem; it is a mainstream media problem and a problem for our whole society. The dramatically decreased trustworthiness has even plagued former icons of journalistic trust such as The Wall Street Journal and The New York Times, which have seen their trust ratings plunge. In addition to being politically motivated, sensationalistic stories have become commercially rewarding at a time when the media business is in financial trouble. Most of the media folks I speak with share my concerns, though they typically won’t share them openly. Still, in reflecting on the problem, Martin Baron, then executive editor of The Washington Post, said, “If you have a society where people can’t agree on the basic facts, how do you have a functioning democracy?” This dynamic is impeding free speech since people are afraid to speak up because of how they will be attacked in both traditional and social media by distortions that are meant to bring them down.
Even very capable and powerful people are now too afraid of the media to speak up about important matters or run for public office. Since most high-profile people are torn down, most everyone I speak with agrees that it is dangerous to be a high-profile, vocal person who fights for truth and justice, especially if one offends people who are inclined to use the media to fight. Though not discussed in public because of fears of media reprisals, this issue is continuously discussed in private. For example, during a lunch I had not long ago with a general who had held a very high political position and had just left government service, we explored what he would do next. I asked him what he was most passionate about. He said, “Of course helping my country.” I asked him whether he would consider running for elected office, and he explained that while he was willing to die for his country he couldn’t bring himself to run for public office because of how enemies would use the media and social media to make up lies to harm him and his family. This general and almost everyone I know who we should listen to are afraid to speak openly because they fear that attacks by extremists who oppose them will be enabled and amplified by the sensationalistic media. Many of my friends tell me that I’m crazy to speak so openly about controversial things such as those covered in this book because it is inevitable that some people or groups will try to take me down via the media. I think they are probably right, but I won’t let the risks dissuade me.
Rule-Following Fades and Raw Fighting Begins
When the causes that people are passionately behind are more important to them than the system for making decisions, the system is in jeopardy. Rules and laws work only when they are crystal clear and most people value working within them enough that they are willing to compromise in order to make them work well.
If both of these are less than excellent, the legal system is in jeopardy. If the competing parties are unwilling to try to be reasonable with each other and to make decisions civilly in pursuit of the well-being of the whole, which will require them to give up things that they want and might win in a fight, there will be a sort of civil war that will test the relative powers of the relevant parties. In this stage, winning at all costs is the game and playing dirty is the norm. Late in Stage 5 is when reason is abandoned in favor of passion.
When winning becomes the only thing that matters, unethical fighting becomes progressively more forceful in self-reinforcing ways. When everyone has causes that they are fighting for and no one can agree on anything, the system is on the brink of civil war/revolution.
This typically happens in a couple of ways:
Late in Stage 5 it is common for the legal and police systems to be used as political weapons by those who can control them. Also, private police systems form—e.g., thugs who beat people up and take their assets, and bodyguards to protect people from these things happening to them. For instance, the Nazi party formed a paramilitary wing before it came to power that then became an official force when the Nazis were in power. The short-lived British Union of Fascists in the 1930s and the Ku Klux Klan in the US were effectively paramilitary groups as well. Such cases are quite normal, so view their development as a marker of moving to the next stage.
Late in Stage 5 there are increasing numbers of protests that become increasingly violent. Because there is not always a clear line between a healthy protest and the beginnings of a revolution, leaders in power often struggle over how to allow protests without giving the perceived freedom to revolt against the system. Leaders must manage these situations well. A classic dilemma arises when demonstrations start to cross over into revolution. Both giving the freedom to protest and suppressing protests are risky paths for leaders, as either path could lead the revolution to get strong enough to topple the system. No system allows people to bring down the system—in most, an attempt to do so is treason, typically punishable by death. Nonetheless, it is the job of revolutionaries to bring down systems, so governments and revolutionaries test each other to see what the limits are. When broad-based discontent bubbles up and those in power allow it to grow, it can boil over to the point that when they try to put a lid on it, it explodes. The conflicts in the late part of Stage 5 typically build up to a crescendo that triggers the violent fighting that signifies the transition into what historians stamp as official civil war periods, which I am identifying as Stage 6 in the Big Cycle.
People dying in the fighting is the marker that almost certainly signifies the progression to the next and more violent civil war stage, which will continue until the winners and losers are clearly determined.
That brings me to my next principle:
When in doubt, get out—if you don’t want to be in a civil war or a war, you should get out while the getting is good.
This is typically late in Stage 5. History has shown that when things get bad, the doors typically close for people who want to leave. The same is true for investments and money as countries introduce capital controls and other measures during such times.
Crossing the line from Stage 5 (when there are very bad financial conditions and intense internal and external conflict exist) to Stage 6 (when there is civil war) occurs when the system for resolving disagreements goes from working to not working. In other words, it happens when the system is broken beyond repair, people are violent with each other, and the leadership has lost control.
As you might imagine, it is a much bigger deal to break a system/order and build a new one than it is to make revolutionary changes within an existing system/order. Though breaking a system/order is more traumatic, it isn’t necessarily a worse path than operating within a system.
Deciding whether to keep and renovate something old that is not working well or to dispose of it and replace it with something new is never easy, especially when the something new is not clearly known and what is being replaced is as important as the domestic order. Nonetheless, it happens, though typically it is not decided on intellectually; it is more often emotionally driven.
When one is in Stage 5 (like the US is now), the biggest question is how much the system will bend before it breaks.
The democratic system, which allows the population to do pretty much whatever it decides to do, produces more bending because the people can make leadership changes and only have themselves to blame. In this system regime changes can more easily happen in a peaceful way. However, the “one person, one vote” democratic process has the drawback of having leaders selected via popularity contests by people who are largely not doing the sort of thoughtful review of capabilities that most organizations would do when trying to find the right person for an important job. Democracy has also been shown to break down in times of great conflict.
Democracy requires consensus decision making and compromise, which requires a lot of people who have opposing views to work well with each other within the system. That ensures that parties that have significant constituencies can be represented, but like all big committees of people who have widely different views (and might even dislike each other), the decision-making system is not efficient.
The biggest risk to democracies is that they produce such fragmented and antagonistic decision making that they can be ineffective, which leads to bad results, which leads to revolutions led by populist autocrats who represent large segments of the population who want to have a strong, capable leader get control of the chaos and make the country work well for them.
Also noteworthy: history has shown that during times of great conflict federalist democracies (like the US) typically have conflicts between the states and the central government over their relative powers. That would be a marker to look out for that hasn’t yet arisen much in the US; it’s happening would signify the continued progression toward Stage Six.
There are far too many breakdowns of democracies to explore, let alone describe. While I looked into a number of them to see the patterns, I haven’t fully mined them, and I’m not going to dive into them here. I will say that the factors described in the explanations of Stage 5 when taken to the extreme—most importantly, terrible finances, decadence, internal strife and disorder, and/or major external conflict—lead to a dysfunctional set of conditions and a fight for power led by a strong leader. Archetypical examples include Athens from the late 400s to the 300s BCE, the end of the Roman Republic in the century or so preceding 27 BCE, Germany’s Weimar Republic in the 1920s, and the weak democracies of Italy, Japan, and Spain in the 1920s and 1930s that turned to autocracies of the right (fascism) to bring order to the chaos.
Different stages require different types of leaders to get the best results. Stage 5 is a juncture in which one path could lead to civil war/revolution and the other could lead to peaceful and, ideally, prosperous coexistence. Obviously the peaceful and prosperous path is the ideal path, but it is the much more difficult path to pull off.
That path requires a “strong peacemaker” who goes out of their way to bring the country together, including reaching out to the other side to involve them in the decision making and reshaping the order in a way that most people agree is fair and works well (i.e., is highly productive in a way that benefits most people). There are few such cases in history. We pray for them. The second type is a “strong fighter” who is capable of taking the country through the hell of civil war/revolution.
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