The Algorithm of Decline

George Santayana famously stated, “Those who do not remember the past are condemned to repeat it,” but according to Ray Dalio, hedge fund billionaire and author, we are all condemned anyway. In his most recent book, The Changing World Order, Mr. Dalio states that he has studied history and observed the rise and fall of many world orders dominated by great empires. It is hard to pick just one name to describe these empires or civilizations because the nature of governance has changed over the millennia. Nation states did not exist until recently. In ancient times there was no world order but only regional orders that had limited interaction with other great powers.

But Mr. Dalio asserts all these dissimilar forms of government, nevertheless, were subject to very similar factors that affected their rise and fall. He has used computers and artificial intelligence to analyze big data to identify not only the causal factors that propel certain civilizations to greatness but also the factors that lead to their ultimate decline. He calls this rise and fall of nations, empires and civilizations the Big Cycle. The Big Cycle is similar to what is taught in business schools as the business cycle where economies go through stages of expansion, crisis, recession and recovery as identified by Joseph Schumpeter, except that these cycles are 7 to 12 years in duration while Big Cycles can last several hundreds of years. Also, business cycles are sequential while Big Cycles of the various great powers can overlap so one power can be rising while another power is in decline.

The Big Cycle has three main components: 1) the big debt/money/capital markets/economic cycle, 2) the internal order and disorder cycle, and 3) the external order and disorder cycle. There are eight key determinants that identify the place and direction of a society on the Big Cycle. They are: 1) education, 2) innovation and technology, 3) cost competitiveness, 4) military strength, 5) trade, 6) economic output, 7) markets and financial centers, and 8) reserve currency status. As you can see, these determinants are not the ones normally found in most historical analyses. There is apparently no role for religion or culture in these analyses because these big cycles affect all societies similarly.

In his discussion of the historical basis for his Big Cycle theory, Mr. Dalio analyzes the Big Cycles of three Western empires or world orders since 1500 CE and he also looks at several Chinese dynasties that have gone through a series of Big Cycles since 600 CE. Because he uses different determinants than is found in most history books, his choice of world orders may seem odd and his analyses unique. But he has been very successful at business and has put a lot of resources and study into developing this theory, so it is worthwhile to consider what he says.

The first Western world order that Mr. Dalio investigates is the rise and fall of the Dutch Colonial Empire. Back when I was studying European history it was all about the Habsburg dynasties, the Holy Roman Empire and the great religious wars of the protestant Reformation. The Dutch struggles for independence seemed to be a subchapter of a larger story, but Mr. Dalio thinks otherwise. Because he focuses more on economics and trade than on religion or powerful dynasties, the innovative trade and banking practices of the Dutch gave the Dutch outsized financial power compared to their small population.

Mr. Dalio points out the determinants that led to the rise of the Dutch empire such as the emphasis on education, innovation in transportation and financial technology and the importance of the Dutch guilder in international trade. However, the costs of maintaining a vast colonial empire motivated the Bank of Amsterdam to issue more guilders than there were gold and silver in their vaults which led to a fall in the value of the guilder which forced the bank to create even more guilders to cover its debt service. Yet, despite the debasement of the guilder, the Dutch were able to maintain the guilder as the principal reserve currency for international trade until they lost the Fourth Anglo-Dutch War in 1784.

The British Empire was the rising global order that replaced the declining Dutch order. Again, it was education and innovation that led the way. England led the way on many educational indicators with a literacy rate in the seventeenth century almost double that of France. The Industrial Revolution was driven by well-educated merchants and mechanics and not academic elites or the nobility. England also led in innovation in government and, even though still a monarchy like all the other nation states developing after the Peace of Westphalia, was a much more open society with a growing middle class. The British pound sterling became the reserve currency of international trade, replacing the Dutch guilder.

Toward the end of the eighteenth century the British world order began to show its senescence. Other countries copied the determinants of British success such as industrialization, education and innovation reducing its competitive advantage. Meanwhile the United States was a rising power that was able to avoid the entanglements of the European great powers. After two devastating world wars, the former great powers were enfeebled by the wartime destruction, leaving only the United States to set order back into the world, which it did by creating the United Nations and a host of international organizations. The British pound sterling was replaced by the US dollar as the world reserve currency.

For 75 years after the end of those devastating wars, the world order has prospered under the Pax Americana. But as predicted by Mr. Dalio’s Big Cycle, the United States has become overstretched, over indebted, under invested, and tired of bearing the burdens of global leadership. His eight determinants of power are mostly trending downward. Especially troubling are lagging excellence in education and a weary military with obsolete equipment. Internal conflict, partisanship and perceived inequality are tilting us toward violence and possibly even revolution or civil war. As the American era begins to decline, the rise of China as the next world order seems almost inevitable.

With the help of computers and artificial intelligence, Mr. Dalio has created an algorithm that explains the historical Big Cycles and can also be used to project the future prospects of the world’s great (and some lesser) powers. He and his team have created a website (www.economicprinciples.org) that expands on his analysis and includes the background material on which his book is based. I do have a few quibbles about his theory: he places much more emphasis on economics and especially money and finance than do most other historical analyses and he ignores religion, philosophy and ideology. He also focuses on the last five hundred years (except in the case of China). But the last five hundred years have been exceptional and are unlike the history of the empires, civilizations and world orders that preceded it. The Enlightenment era of Western Civilization has unleashed the power of the individual and created a system of governance and free markets that has created the modern world we live in. Rapid economic growth and scientific advances are the hallmark of our enlightened modern society, compared to agonizingly slow growth and development of autocratic collective societies that dominated prior eras.

But if America declines and is replaced by an autocratic collective power, is that the end of the modern era as we know it.

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Although I may be a bit skeptical about Mr. Dalio’s algorithmic approach to his analysis of the current state of world order, I must reluctantly agree to his evaluations of the key determinants as they relate to the United States. The parlous state of education in America, the hollowed-out economy, the mountain of public debt and the dilapidated infrastructure all point to the decline of a great power. Combine those determinants with a military sacrificed to the welfare state, a debased reserve currency, the perception of growing inequality and the promotion of victimhood as a political tool and you have a scenario that can only lead to an inevitable decline and the chaos that accompanies such declines.

But what I don’t agree with Mr. Dalio about is the purpose and utility of a study such as the one he did. His discussion of the rise and fall of world orders is devoid of values and principles. In his analysis good governance is only of value to the extent it enhances productivity, not how it treats its citizens. Education is only of value to the extent it generates technological innovation, not how it prepares people to be good citizens. Mr. Dalio is a very smart and talented person and he strikes me as someone who would thrive in almost any world order. If he had been born in Communist China, he would probably have risen to the Politburo or some other senior position. He uses many of the techniques of the Communist Party of China in the management of his company, Bridgewater Associates (as I noted in my commentary, On the Limits of Thought Meritocracy January 19, 2018). He makes no comment about what life would be like under a world order designed and maintained by Communist China. I am sure he would do fine.

But I would not be happy in such a world. And perhaps, you wouldn’t either. The value of his study lies not in the exposure of America’s decline and ultimate fate, but in using the study to alter our fate. Mr. Dalio’s algorithm shows us what needs to be changed to avoid decline and irrelevance. We just have to figure out how to accomplish that change. I can tell you that neither Build Back Better nor Make America Great Again addresses these issues.

Luckily, Mr. Dalio’s algorithm that highlights the factors pointing to America’s decline, also gives us a roadmap of how to avoid that decline. The downward pointing indicators in his formula include the debt burden, income inequality, divisiveness, failing education, depleted military strength, unstable prices and doubts about the future of the dollar. These are basically the same factors I wrote about in my recent commentary, Urgent Priorities (December 30, 2021), which I urge you to review again.

Mr. Dalio’s conclusion from the analysis of his algorithmic calculations is that China will surpass the United States as the dominant world power in about ten years. Already China has infiltrated American inspired international organizations such as the World Health Organization and placed their operations under the command of the Communist Party of China. He makes no judgment as to whether this is a good thing or a bad thing. It is just an inevitable outcome of the Big Cycle he sees controlling history.

But I do believe that this would be a bad thing and perhaps you do, too. And we all need to work hard to make our political leaders aware of these urgent priorities and how their political bickering will be the end of the American democratic experiment.