The Changing World Order – How superpowers and their world’s reserve currency rise and fall

by admin on April 18, 2020

Recently, Ray Dalio published a research study called the changing world order. In a nutshell, Ray Dalio believes that declining empires or superpowers decline for the same reasons. He summarized his findings and came up with a typical scenario of raise a fall that he called an archetype. Although the rise and fall of empires may be slightly different from case to case, they have more things in common than differences.

Ray Dalio identified three phases of an empire:

  • The ascent phase, characterized by the gaining of competitive advantages.
  • The top phase, characterized by sustaining the strength but eventually sowing the seeds for loosing the competitive advantages that were behind the ascent.
  • The decline phase, characterized by the self-reinforcing declines in all these strengths.

Ray Dalio identified 17 leading economic/social indicators (he called them measures of strength) that show when a superpower is rising or declining. From those 17 indicators, 8 seems to be the most relevant. The chart below shows how these 8 factors play out in any given rise and fall of a superpower, with most of the weight on the most recent three currency reserve countries (i.e., the US, the UK, and the Dutch).

When a superpower is at the top, its currency becomes the world’s reserve currency. Today is the Dollar of the United States, but before was the British Pound, and before that, the Dutch Guilder. Having one’s currency be a reserve gives that country greater borrowing and purchasing power.

In all cases, this power is abused as superpowers get comfortable, work less hard, engage in more leisurely and less productive activities, and especially spend more than they should. This behavior increases the debt of the superpower exponentially and makes it weak. This decline often coincides with the rise of a challenging superpower, following the conceptual diagram below. In these transitions, there is a big risk of revolutions, wars, and currency breakdown.

All this takes us to the graph below. When all the measures of strength are combined is easy to understand the decline of the Netherlands in the 1800s, and the UK in the 1900s. The United States is in sharp decline today, while China is rising at an unprecedented rate. At some point, this image suggests, a new world order may be unavoidable.

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