The Changing World Order
Before I begin, I just want to give credit to Ray Dalio and his newest book Principles for Dealing with the Changing World Order. While this isn’t technically a book review or summary, my thoughts are largely inspired by his work and I want to do my best to expand on his ideas and shed light on a crucially important topic that is increasingly becoming more relevant as more major geopolitical events transpire. With that said, let’s get into it.
Throughout modern history and really all of human history, nations, regions, and even just groups of people have fought for power in the world. That’s certainly no secret, but it’s important to understand the cyclical nature of global powers. The specific circumstances of each power’s rise and fall may seem and, in fact, be unique, but they all exhibit the same predicable patterns. Whether it’s a natural progression of economies as they grow or simply a function of human nature, the leaders of the world always seem to succumb to the same temptations that inevitably lead to their downfall. This is extremely relevant today because the United States, the prevailing global leader, is in the later stages of that global power cycle that ends with a new power rising to take its place. Huge macro transitions like this only occur once in a century or so with the last one taking place at the end of World War 2, so viewing present day through the lens of history to identify the stage of that cycle we’re in will help us immensely going forward as we try navigate the changing landscape and predict where the world and financial markets might be headed.
THE CYCLES OF GLOBAL POWERS
As the world as advanced, so, too, have the players fighting for power. What was once accomplished through brute force has evolved into a complex system of financial and geopolitical chess. Historical powers such as the Huns usurped their power through conquest and murder, but more recently global powers have accomplished this through superior trade and technology. Yet, regardless of the means by which power is acquired, it has proven to be fleeting and eventually slips away. No world leader, regardless of how rich, dominant, or successful, remains that way forever. They acquire power through some degree of superiority, they establish a new world order, they enjoy that new world order unchallenged, their competitive advantage thins as internal and external disorder ensue, a new power rises as the current implodes, a war or transfer of power transpires, and the new power takes hold as the cycle repeats.
Now, generally those in power stay in power for some time while there are no formidable rivals, but inevitably complacency and hubris stifle their competitive edge and that nation becomes a victim of its own success through lavish and unsustainable practices. A nation comfortably sitting in the lead is less inclined to innovate and increase productivity and more inclined to pursue materialistic desires or promulgate their hegemony around the world, both of which lead to untenable deficit spending and, ultimately, the downfall of that great power.
Though rising powers indirectly or even directly challenge the prevailing power, it’s the leading power that usually eats itself and opens the door for a new power to ascend and take its place. These cycles don’t happen overnight, but they happen time and time again. Once you understand these cycles and just how common they are, the reality of the United States’ situation becomes very clear and identifying where it is and where it is headed becomes more apparent. To better understand how these cycles actually play out, let’s briefly explain the most recent global leaders starting with the Dutch.
THE DUTCH EMPIRE
While there are countless powers that preceded the Dutch, they are one of the most notable powers in recent history. The Dutch Empire, as a leading innovator of ships, the creators of capitalism, and, consequently, a global trading powerhouse, was the first truly dominant economic global power. Their economic prowess also led them to be the first issuer of a global reserve currency—an exorbitant privilege that is largely responsible for a great power’s eventual demise. This meant they issued the currency everyone used and wanted and, perhaps more importantly, it meant everyone wanted to hold Dutch debt.
The principal reason having the global reserve currency is beneficial is more people and nations want to hold your currency because of all the trade denominated in it, which gives you more opportunity to issue debt. When you issue debt, someone has to buy it and finding someone to buy debt denominated in the global reserve currency is incredibly easy because people all around the world can and do use it for trade. This allowed the Dutch to issue far more debt than they could actually service because there were always willing buyers.
The Netherlands is and was a very small nation and to maintain its hegemony and global presence was very expensive. It required the bank of Amsterdam to issue so much debt that they lacked the hard assets necessary to back those debts, which eventually led to a run on the banks. Their distractions and indebtedness maintaining their power also opened the door for new powers, like Britain, to surpass them in trade and military might through better innovations and a currency with stronger fundamentals and more attractive interest rates, which is a big part of why capital fled the Dutch guilder for the British pound sterling. At a certain point, the Dutch couldn’t sustain its empire and chose to finance it with debt until everyone fled the guilder as the Dutch financial system began to implode. And this brings us to the British Empire.
THE BRITISH EMPIRE
As the Dutch Empire and guilder collapsed, Britain invested more in its education and innovation that led to its eventual domination of world trade and vast expansion of its empire. While most trade was denominated in the guilder during Britain’s rise, their superior ships and expanding economy slowly forced their way into reserves around the world until most trade was eventually denominated in the pound sterling. This afforded the British the same privileges the Dutch had before them by opening the door to massive debt financing. In the beginning when the country is still on their upswing with new technology and a healthy, robust economy, the privilege of the reserve currency is nothing but beneficial. However, the luxuries of ostensibly unfettered deficit spending eventually catch up to a country and Britain was no exception.
Like the Dutch, the British Empire extended all over the world and while Britain was a larger, more populated nation, it was still relatively small and imperialism spread the country thin over time. That said, traditional deficit spending wasn’t necessarily its downfall as a large portion of Britain’s debts were related to the world wars, especially WW2. Not only was the actual war expensive, but the devastation to Britain from all the German bombings added severe insult to injury and literally left the nation in ruins, which paved a clear path for the new rising power largely untouched by the war, the United States, to take its place.
THE UNITED STATES
As WW2 drew to a close and the rest of the world was still reckoning with all the damage, the United States came out relatively unscathed and had also emerged as the world’s largest exporter during that time, once again showing how much of a factor trade is in a nation’s ascent to power. So with Britain effectively destroyed, massively indebted, and the United States a booming economy and military power, it was clear the new financial system would be centered around the US. This was cemented at the Bretton Woods meeting in 1944 and signaled it was now the United States’ turn to hold and abuse the power of the global reserve currency. Much like the currencies of its predecessors, it made complete sense at the time to use the dollar as the global reserve currency given the United States’ outsized role in trade and military supremacy used to support the dollar hegemony. No country even came close to matching the output or strength of the US and thus the beginning stages of the big cycle were set in stone with a new world leader.
As we all know, the economic boom and dominance of the US continued for many decades, but, as is always the case with the global power, that boom fostered an unhealthy affinity for credit and debt. Similar to Britain, the United States got wrapped up in a very expensive war (the Vietnam war) and chose a ‘guns and butter’ policy rather than austerity to support the spending. That unsustainable practice coupled with a growing world economy demanding more and more dollars to facilitate trade was forcing too many dollars outside of the US, which prompted Nixon to cut the dollar’s tie to gold for fear that all the US’s gold reserves would be depleted. Though many suggest otherwise, this was a default on its debts by the United States and a historic shift in the global financial system from gold-backed currencies to fiat.
Yet the fiat dollar Nixon created and that we still have today only worsened the spending habits of the government as they were no longer constrained by gold reserves. The already privileged global reserve currency holder could now print and spend ostensibly as much as it wanted to and the inflation would be mitigated by the massive demand abroad due to the dollar’s reserve status. The initial break form gold in the 70s led to a lot of inflation, but once that was contained by Volcker and the massive spike in interest rates, the world was back to having confidence in the dollar and buying US debt. This may have been beneficial in the short term by allowing the US to purchase more cheap goods through massive trading deficits, but those debts are now forcing real interest rates to be held negative just to avoid another US default. The artificial strength of the dollar also ate away at the US manufacturing base because of other currencies’ relative weakness compared to the dollar. That weakness meant cheaper prices and fewer people buying from the United States. In other words, the US has been burdened by its own success and paved the way for competitors like China to fill their trading void.
Though having the global reserve currency started from trading and financial strength, the luxuries it afforded led to a less competitive US whose biggest export was dollars in the form of treasury debt. This dynamic of less competitive US goods and trading deficits due to artificial dollar strength has predictably led US deficit spending to get so out of hand it’s now endangering the dollar’s credibility as a global reserve asset. This being a notable red flag that the US is nearing the later stages of the big cycle. We are starting to really see this play out with countries like Russia breaking away from the petrodollar system. The US has a lot of leverage with its ability to sanction nations within the dollar system, but that is inspiring a lot of countries to start operating outside it. The more countries flee the dollar to avoid what they view as unfairly wielded power by the US, the less power the US will actually have. Its deficit spending will no longer be propped up by artificial dollar demand and the end stages of the big cycle will truly start to unfold as the US is finally served its deficit bill. So where does this leave us? Well, if history is to be trusted, it leads us to the next global power.
CHINA
For anyone paying attention in the world, China is clearly the next greatest power and quickly surpassing the United States in many very relevant ways. They are now the biggest exporter with an economy inching its way up to the global leader in GDP and they have a military that could soon rival or even beat the United States. And given the United States has long abandoned its trade and manufacturing edge (largely exporting it to China) and built up a daunting $30 trillion in debt through excessive consumerism, credit, war financing, and maintaining dollar hegemony, it seems China only has to wait for this big cycle to play out to watch the US fall out of favor. It has all the characteristics of a rising global power and needs only a push from the rest of the world, whether that’s through a major geopolitical catalyst like a war or country by country acknowledging a deteriorating United States and necessary move away from the dollar. The biggest hindrance right now for this transfer of power to begin is the absence of any serious alternative to the dollar, but that won’t necessarily stop the US from failing and could quickly change.
The Chinese yuan may not be anywhere close to global reserve status, especially considering its small percentage of global reserves at the moment and how closed off it is to capital markets compared to other major currencies, but there is already talk of China implementing a floating exchange rate between the yuan and gold. At a time when fiat is inflating at historic levels all around the world, this would be incredibly enticing and potentially push many nations to lean into the yuan system despite its relative unpopularity as a reserve. If more nations choose to denominate their trade in yuan, which is probably pretty convenient if most of your trade is with China, then China will only further underscore its role as the largest exporter and trading partner for most nations. Couple that with a formidable military power and the de facto global reserve currency and it would effectively solidify itself as the new global power. That said, the US, like most global powers, won’t be so willing to cede its power to any nation, no less China, so this could lead to very intense and dangerous tensions between the rivaling nations—a rivalry that could easily end kinetically as the US relies on its final pillar of strength: its military.
THE FUTURE GLOBAL MONETARY SYSTEM
Now, if you had asked me about the changing world order a few months ago, I would have mostly held the same opinion. The US is overly indebted, China is the new leader in trade and a rapidly growing economy, and eventually the big cycle would lead to the inevitable passing of the torch. However, given the Russian invasion of Ukraine, the Saudi’s unwillingness to cooperate with the US and their simultaneous move to price oil in yuan, and all the other quickly shifting pieces in geopolitics right now, I think this big cycle and changing world order could play out sooner than anticipated. At the moment, the only thing the United States has going for it other than its military might is its reserve currency and countries in the east are starting to abandon that system for one centered around the yuan so that power is slowly slipping away. China, Russia, Saudi Arabia, and India have all implicitly accepted this shift by agreeing to trade outside of the dollar system so it seems like it’s only a matter of time before the writing on the wall is visible to all.
Considering all the problems with the US characteristic of the end stages of a world power and the incremental abandonment of the dollar as the global reserve currency, which is usually the last thing to go for a global power, I think we could be witnessing the beginning stages of the transition period to China as the new world leader. Such transitions are usually quite volatile and contested, often leading to wars, so it’s not a good stage to be in. The war started by Russia could very well be the beginning of a much larger financial, geopolitical, and military war between the western world and the eastern world aimed at creating a new order and financial system. It’s anybody’s guess how this will all pan out, but the United States hegemony is clearly on its way out. The real question is will they go out fighting?