5 Highlights From Ray Dalio’s Chapter 4 — The Big Cycle of The U.S. & The $
On July 16th, Ray Dalio published part one of a two part chapter on the economic trajectory of the U.S.. Part one goes through WW II. Part two will bring the U.S. trajectory current. Chapter 5 will focus on the economic trajectory of China.
Dalio’s last piece looked at the rise and fall of the leading reserve currency empires over the last 500 years, ending with the British Empire’s decline in the first half of the 20th century. In this chapter he examined the rise of the U.S. as it progressed along the path taken by all previous dominant reserve currencies including the long-term debt/monetary cycle, the wealth and political gap cycle, and the global geopolitical cycle.
When these seismic shifts in how wealth and power are distributed occur within countries (i.e., via revolutions) or between countries (typically through wars, though sometimes peacefully), the old world order breaks down and a new world order begins, and the process starts all over again.
1. We Are In A Period Of Transition From U.S. Dominance To Shared Dominance Between U.S. & China
Dalio uses a Power indices (see below) that aggregates eight different types of power (education, competitiveness, innovation/technology, trade, economic output, military, financial center status, and reserve currency status) to show the rise and fall of empires over time. This indices highlights an increasingly shared dominance between China and the U.S.:
2. While The Majority Of The Shrinkage In The “Standing” Gap Between The U.S. and China Is Due To China’s Rise, 20%+ Is Due To The U.S.’s Decline
Of the eight types of power Dalio tracks, the U.S. has seen dramatic decreases in relative status in four (education, trade, output, and competitiveness).
The U.S. has largely retained its relative strength in innovation, reserve currency status, financial center power, and military. But China has gained on the U.S. in all eight areas tracked (to be detailed in Chapter 5), and it’s trajectory (as seen in the first graph) should be a concern to all Americans.
3. Dalio Sees Parallels To Today’s Growing Number Of Fascist Leaders & Economic Sanctions & The Depression Era That Lead To WW II
In 1929 the Roaring ’20s bubble burst and the global depression followed, leading all countries to turn to more populist, autocratic, nationalistic, and militaristic leaders and policies. Germany, Japan, Italy, and Spain, with less well-established democracies turned to fascists (the right). The Soviet Union and China turned to communists (the left). The US and the UK became more populist and autocratic, but not nearly as extreme as other nations.
In addition to the internal conflicts and resulting political shifts, every country faced external economic conflicts as they fought for greater shares of a shrinking economic pie. Those conflicts lead to a sequence of intensifying tests of power that led to WW II and the new world order in 1945. Comparisons between the 1930s leading to World War II and today, with regards to fascism and economic sanctions, are especially interesting to Dalio.
In the Roaring ’20s a lot of debt was created to buy speculative assets (stocks). When the Fed tightened in 1929 to curtail speculation, the bubble burst and the global Great Depression began. The U.S. turned protectionist to safeguard jobs, enacting the Smoot-Hawley Tariff Act in 1930, which further depressed economic conditions globally.
We’re once again seeing the rise of fascist leaders around the world who are making the same protectionist mistakes that were made in the 30s.
4. Germany Was Initially Able To Grow Out Of The Depression Internally While Japan’s Needs Could Only Be Met Via Imperialism, Leading To A Showdown With The U.S.
To deal with the depression, Hitler privatized state-owned businesses and encouraged corporate investment paid for by borrowing. He acted to raise the standard of living and financed the increased government spending by forcing banks to buy government bonds. These policies lead to higher stock markets and per capita income:
Japan was more vulnerable to the depression because, as an island nation without adequate natural resources, it relied on exports for income to import necessities. Exports fell by around 50% between 1929 and 1931, leading to economic devastation and a massive surge in right-wing nationalism and militarism to restore order and bring back economic stability by taking resources from other countries via force. Japan invaded Manchuria in 1931 and later expanded through China and Asia to obtain natural resources (e.g., oil, iron, coal, and rubber).
In 1940, the U.S. initiated aggressive economic sanctions against Japan, culminating in the Export Control Act of 1940, restricting “all iron and steel to destinations other than Britain and nations of the Western Hemisphere”. By cutting off the resources needed by Japan, the U.S. hoped to force Japan to retreat from areas they had taken over. But Japan was undeterred, and invaded colonies in Southeast Asia, starting with French Indochina. In 1941, Japan extended its reach by seizing oil reserves in the Dutch East Indies.
Roosevelt then froze all Japanese assets in the U.S., closed Japan’s ability to ship through the Panama Canal, and embargoing all oil and gas exports to Japan. This cut off three-fourths of Japan’s trade and 80% of its oil. With only two years of oil in hand, Japan had to choose between backing down or attacking the U.S.. On December 7, 1941, Japan attacked U.S. military forces in the Philippines and Pearl Harbor, starting World War II.
5. The German Market Outperformed, & The U.S. Market Underperformed Until The Battle Of Midway In June 1942
Knowing Germany needed additional resources to continue it’s growth, Hitler started building up it’s military in 1935. In 1940, Germany captured Belgium, the Netherlands, Luxembourg, and France, quickly gaining needed resources like oil. Germany invaded Russia in June 1941.
When the US entered the European and Pacific wars after the attack on Pearl Harbor, classic wartime economic policies were put in place in most countries by autocratic leaders whose autocratic approaches were broadly supported by their populations. The tables below shows the economic and market controls put in place during the war years in each of the major countries.
German equities outperformed at the beginning of WWII as Germany captured territory and established military dominance. Allied equities rallied almost continuously after the Battle of Midway until the end of the war and beyond. Both the German and Japanese stock markets were closed for the end of the war, and didn’t reopen for around five years:
In Part 2 of this chapter, to be published July 21, Dalio explores the new world order starting with the U.S. as the dominant power and brings us right up to today. The next chapter will focus on China.
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