Principles for Dealing with the Changing World Order
Peaceful and prosperous periods tend to last much longer than periods of depression, chaos, and war at about a 5:1 ratio and both consist of the same big cycle patterns.
The big cycle swings from booms to busts come as a surprise because they generally only occur once in a lifetime. This is why studying history is so important.
As debt continues to pile up, eventually there are far too many debt assets relative to the amount of money or hard assets.
Debt and credit growth lead to asset inflation and a corresponding growth in the wealth gap that tends to inspire populism and overall social divide and upheaval.
The 8 factors relating to a global world power’s standing are:
- Education
- Competitiveness
- Innovation & technology
- Economic output
- Share of world trade
- Military strength
- Financial center strength
- Reserve currency status
The 8 factors contributing to a nation’s world power status tend to follow from one another. Good education leads to competitiveness, which leads to better innovation and technology, which translates to higher economic output and share of world trade, which eventually leads to a strong financial center and a more widely held currency for reserves.
When a country’s debts begin to affect the quality and value of their currency, the rich begin to flee that currency for safer assets, which reduces that country’s tax revenue and worsens the problem. Eventually, the country will ban flight from the currency through capital controls, which sparks greater fears among its currency holders.
When the world’s leading power has indebtedness, civil revolution at home, and a loss of faith in the currency all align, a change in the world order is typically at hand.
Major determinants contributing to a country’s success or failure:
- Geography (size and relation to other nations and their border)
- Geology (natural resources)
- Acts of natural (plagues, floods, famines)
- Genealogy (variations and tendencies related to their genetics)
Human capital is arguably a nation’s most important and sustainable asset. It’s what leads to new ideas and an ability to excel beyond purely geographical or ostensibly random advantages.
There are four levers policy makers can pull to bring debt and debt devices down relative to the income and cash levels required to service those debts:
- Austerity
- Debt default and restructurings
- Taxes and redistribution of wealth
- Printing money and devaluing it
When a nation sufficiently devalues its currency, it frequently moves to back that currency with a hard asset like gold to restore faith in it.
The goal of printing money is to reduce debt burdens so the most important thing for currencies to devalue against is debt.
Nations facing financial difficulties initially respond by letting short term rates rise, but eventually that becomes too painful and they increase the supply of money.
The international order follows the law of the jungle more than the rule of law and there are five major types of fights:
- Trade and economic wars (conflicts over imports, exports, and tariffs)
- Technology wars (which technologies are shared and which are held as special aspects of national security)
- Capital wars (conflicts imposed by sanctions and limiting access to foreign markets)
- Geopolitical wars (conflicts over territories and political alliances
- Military wars (conflicts that involve actual shooting and military forces)
The first global reserve currency was the Dutch guilder and resulted from Dutch dominance in world trade because of their superior ships and capital markets. Eventually maintaining their power and military presence around the world led to their over-indebtedness and a collapse of their currency.
As the Dutch East India company struggled and needed more loans from the bank of Amsterdam, the bank printed more claims on hard assets than they had as reserves, which led to a classic run on the banks.
The second global reserve currency was the British pound sterling. As the Dutch empire began to eat itself, Britain invested more in its education and innovation that led to its eventual domination of world trade and vast expansion of its empire.
After large wars tear world powers down, nations come together to create a new world order, such as those established at Westphalia, the congress of Vienna, and Brenton woods.
There are three types of monetary policy:
- Interest rate-driven monetary policy, which is the first to be used and the most preferable policy.
- Printing money and buying financial assets such as government bonds (quantitative easing)
- Coordination between fiscal policy and monetary policy in which the government does a lot of debt financed spending. This is the next step after the first two methods aren’t satisfactory.
The internal order cycle of nations:
- New order begins and new leadership consolidated power.
- Resource allocation systems and government bureaucracies are built and refined
- Peace and prosperity
- Great excesses in spending and debt that lead to a widening of the wealth and political gaps
- Very bad financial conditions that lead to conflict
- Civil wars and revolutions
China has a significantly longer history than most of the world and thus views the present in the context of a much larger story. Recent history for Americans is a decade ago, but recent history in China is centuries ago.
Americans hold the individual above all else whereas the Chinese hold family above all else. Americans generally prefer bottom-up approaches and Chinese top-down.
Countries who do the most trade generally get to price goods in their currency as more people want to hold that currency for future trading with that country. The increase in trade often creates an incentive driving their currency more and more towards a deeper reserve status. With more people wanting the currency, there is also more lending of that currency with interest rates lower than alternatives (because of demand and liquidity). This further incentivizes buyers/borrowers. This trend will continue until borrowers begin to dry up, which then sounds alarms for lenders to ditch the currency.
Having the reserve currency allows a nation to borrow more money because so many people want to hold reserve currency debt. This creates short-term spending surpluses, but leads to long-term currency instability.
Borrowing and spending can cast the illusion of a strong nation when, in reality, their financials are in ruin and the borrowing is the only reason they have been able to extend beyond their fundamentals.
Inflation is not necessarily bad if productivity grows at commensurate or greater rate as being more productive is a deflationary force—making goods and services better and cheaper over time.
Gold is the currency of war. With nations printing so much to finance wars, currencies and debt lose value and people become less willing to accept credit. This turns them to hard assets.
When there is a great increase in money or credit, it drives down the value of money and credit, which drives up the value of assets.
Beyond the trade disputes, there are three main economic criticisms the US has about how China handles its economy:
- The Chinese pursue interventionist policies that protect their domestic industries by creating unfair practices.
- The Chinese government offers significant guidance, resources, and regulatory support for domestic industries designed to extract advanced technology from foreign companies
- The Chinese steal intellectual property with some of that stealing believed to be state sponsored.
When there is no desirable replacement for the global reserve currency, capital tends to flow to things like commodities, gold, property, or other assets, so the devaluation process is not limited in the absence of an alternative reserve currency.