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Why Legendary Investor Ray Dalio Thinks America is Headed Towards Civil War
According to Dalio, America is in the “5th Stage.”
Ray Dalio is a billionaire who is the founder of the world’s largest hedge fund, Bridgewater. He is genuinely a brilliant guy and his latest book, Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail, is one of the most fascinating things I’ve listened to in a long time (so much so, that after listening to the audiobook, I bought the book so I could read through it as well).
Dalio has been incredibly effective at his job and part of that job is understanding not just how strong a particular investment looks, but how healthy and economically strong the country that particular business opportunity resides in happens to be. After all, even if you have a dynamite potential investment, you are going to have an extremely difficult time making money if the nation it’s in is falling to pieces.
So, Dalio, who can get world leaders to take his calls and who has contacts and resources most of us couldn’t dream of, actually started looking for repeating patterns through history that explained why nations struggled, thrived, succeeded, and failed. Obviously, that’s a big job and Dalio had an appropriate level of humbleness about the magnitude of the undertaking he was taking on. Yet and still, after looking back through hundreds of years of history for a wide variety of nations, he did come up with an extensive theory about how nations rise and fall. Here is the simplified version of it from a piece Dalio wrote for Linkedin:
…Stage 1, when the new order begins and the new leadership consolidates power, which leads to . . .
…Stage 2, when the resource-allocation systems and government bureaucracies are built and refined, which if done well leads to . . .
…Stage 3, when there is peace and prosperity, which leads to . . .
… Stage 4, when there are great excesses in spending and debt and the widening of wealth and political gaps, which leads to . . . I also call this the “bubble prosperity phase.”
There is the rapidly increasing debt-financed purchases of goods, services, and investment assets, so debt growth outpaces the capacity of future cash flows to service the debts. So, bubbles are created.
There is a shift in the spending of money and time to more on consumption and luxury goods and less on profitable investments.
The country’s balance of payments positions deteriorates, reflecting its increased borrowing and reduced competitiveness.
Wealth and opportunity gaps are large and resentments between classes emerge.
…Stage 5, when there are very bad financial conditions and intense conflict, which leads to . . .The classic toxic mix of forces that brings about big internal conflicts consists of 1) the country and the people in the country (or state or city) being in bad financial shape (e.g., having big debt and nondebt obligations), 2) large income, wealth, and values gaps within that entity, and 3) a severe negative economic shock.
A classic marker of being in Stage 5 and a leading indicator of the loss of borrowing and spending power, which is one of the triggers for going into Stage 6, is that the government has large deficits that are creating more debt to be sold than buyers other than the government’s own central bank are willing to buy. That leading indicator is turned on when governments that can’t print money have to raise taxes and cut spending, or when those that can print money print a lot of it and buy a lot of government debt.
Those places (cities, states, and countries) that have the largest wealth gaps, the largest debts, and the worst declines in incomes are most likely to have the greatest conflicts. Interestingly, those states and cities in the US that have the highest per capita income and wealth levels tend to be the states and cities that are the most indebted and have the largest wealth gaps—e.g., cities like New York, San Francisco, and Chicago, and states like Connecticut, Illinois, Massachusetts, New York, and New Jersey.
Facing these conditions, expenditures have to be cut or more money has to be raised in some way. Who will pay to fix them, the “haves” or the “have-nots”? Obviously, it can’t be the have-nots. But when the haves realize that they will be taxed to pay for debt service and to reduce the deficits, they typically leave, causing the hollowing-out process.
History shows that raising taxes and cutting spending when there are large wealth gaps and bad economic conditions, more than anything else, has been a leading indicator of civil wars or revolutions of some type.
…Stage 6, when there are civil wars/revolutions, which leads to . . .
…Stage 1, which leads to Stage 2, etc., with the whole cycle happening over again.
Dalio considers the United States to be in stage 5 which is, as you can see by reading the description, quite scary – and you can see everything he describes in that section above actually happening. Where did we have riots in 2020? Mostly wealthy liberal cities. What places are the wealthy fleeing for greener pastures? Liberal cities and states. Is the Fed having to buy American debt? Yes, indeed.
So, how did we get here according to Dalio?
Essentially, what I believe he would say is that once America became the world’s Reserve Currency, it made it much easier for us to print more money. Of course, we liked that idea because it created more prosperity in the short term (on a historical scale, which lasts decades). The problem with that is our debts have gotten too high and increasingly, our entire economy has become reliant on debased fiat money. This has led to a terrible dilemma. If let’s say, we did the “responsible thing” and went back to the Gold Standard, it would cause a massive economic contraction that would lead to a deep Depression. Why? Because we have far more money than the government has real assets that could be used to back it. On the other hand, we can keep the party going a little longer by continuing to spend at a reckless rate, but it will devalue our money even further, which will lead to increasing levels of inflation.
When you hear people talk about “income inequality,” that’s a big part of what’s going on. On the one hand, because American labor is comparatively expensive compared to say places like China or India, there are fewer jobs and opportunities for poor and middle-class Americans than there used to be. On the other hand, because ongoing inflation is deeply eating into the buying power of these same workers, they’re becoming increasingly desperate and unhappy about their situation. Meanwhile, when they watch TV, they’re seeing the richest Americans buying mansions and superyachts. Of course, it’s worth noting that the wealthiest Americans didn’t create this problem either. It’s not as if they control the Fed or government spending.
So, you end up with these different forces. The desperate poor. The wealthy trying to safeguard what they’ve earned. Those of us that have long been calling for reduced spending and the people that believe the real solution is to confiscate money from one group to give to another. In good times, everyone is doing well enough that the disagreements and grievances between these groups get papered over. When times get bad, look to be getting worse, and there’s no apparent solution, the population becomes increasingly radical, populism starts to take off on both sides, people start to ignore the “rules” of society, and extreme options that would have seemed ludicrous a decade or two ago start to seem more plausible. Things like revolution, secession, overthrowing the government, radically changing our entire system, and civil war become possible in Dalio’s stage 6.
That’s how Dalio sees the possibilities and it may lead you to ask that classic question from Dickens’ Christmas Carol:
Does every nation that gets to where we are in the cycle end up in some sort of violent civil war? No, but according to Dalio, there's about a "1-in-6 chance of severe internal conflict" in the US and we’re right on the precipice (there are some indicators he uses in the book) of a "1-in-3" chance of a civil war. Of course, we might just have a long-lasting economic downturn that destroys our wealth or some sort of radical restructuring of our economy that lifts up the people at the bottom, helps impoverish the people at the top, and probably leads to hard times for a long while.
Additionally, it is possible we could avert this whole disaster. We’d just need a responsible government willing to do wildly unpopular things to help get the country back on a much sounder financial footing. Since it’s extremely difficult to imagine a candidate getting elected or re-elected by promising to make tough financial decisions that would significantly hurt the economy for years to come in order to get the country back on track, it’s difficult to see how we could thread that needle.
If you buy into all that – and I do – what it means is that the country isn’t just headed towards a cliff, it’s going over the cliff. The only questions left to answer are “when” is it going to happen and whether the country is going to break its leg, die, or end up in several bloody pieces after the fall.