An online series by RAY DALIO

The Changing
World Order

Where we are and where we're going

A new study on the rises and declines of past leading empires that puts today’s economic, political, and policy situation into perspective of the big picture.

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Published 03/29/20

I believe that the times ahead will be radically different from the times we have experienced so far in our lifetimes, though similar to many other times in history.

I believe this because about 18 months ago I undertook a study of the rises and declines of empires, their reserve currencies, and their markets, prompted by my seeing a number of unusual developments that hadn’t happened before in my lifetime but that I knew had occurred numerous times in history. Most importantly, I was seeing the confluence of 1) high levels of indebtedness and extremely low interest rates, which limits central banks’ powers to stimulate the economy, 2) large wealth gaps and political divisions within countries, which leads to increased social and political conflicts, and 3) a rising world power (China) challenging the overextended existing world power (the US), which causes external conflict. The most recent analogous time was the period from 1930 to 1945. This was very concerning to me.

As I studied history, I saw that this confluence of events was typical of periods that existed as roughly 10- to 20-year transition phases between big economic and political cycles that occurred over many years (e.g., 50-100 years). These big cycles were comprised of swings between 1) happy and prosperous periods in which wealth is pursued and created productively and those with power work harmoniously to facilitate this and 2) miserable, depressing periods in which there are fights over wealth and power that disrupt harmony and productivity and sometimes lead to revolutions/wars. These bad periods were like cleansing storms that got rid of weaknesses and excesses, such as too much debt, and returned the fundamentals to a sounder footing, albeit painfully. They eventually caused adaptations that made the whole stronger, though they typically changed who was on top and the prevailing world order.

The answers to this question can only be found by studying the mechanics behind similar cases in history—the 1930-45 period but also the rise and fall of the British and Dutch empires, the rise and fall of Chinese dynasties, and others—to unlock an understanding of what is happening and what is likely to happen.[1] That was the purpose of this study. Then the pandemic came along, which was another one of those big events that never happened to me but happened many times before my lifetime that I needed to understand better.

My Approach

While it might seem odd that an investment manager who is required to make investment decisions on short time frames would pay so much attention to long-term history, through my experiences I have learned that I need this perspective to do my job well. My biggest mistakes in my career came from missing big market moves that hadn’t happened in my lifetime but had happened many times before. These mistakes taught me that I needed to understand how economies and markets have worked throughout history and in faraway places so that I could learn the timeless and universal mechanics underlying them and develop timeless and universal principles for dealing with them well.

The first of these big surprises for me came in 1971 when I was 22 years old and clerking on the floor of the New York Stock Exchange as a summer job. On a Sunday night, August 15, 1971, President Nixon announced that the US would renege on its promise to allow paper dollars to be turned in for gold. This led the dollar to plummet. As I listened to Nixon speak, I realized that the US government had defaulted on a promise and that money as we knew it had ceased to exist. That couldn’t be good, I thought. So on Monday morning I walked onto the floor of the exchange expecting pandemonium as stocks took a dive. There was pandemonium all right, but not the sort I expected. Instead of falling, the stock market jumped about 4 percent. I was shocked. That is because I hadn’t experienced a currency devaluation before. In the days that followed, I dug into history and saw that there were many cases of currency devaluations that had similar effects on stock markets. By studying further, I figured out why, and I learned something valuable that would help me many times in my future. It took a few more of those painful surprises to beat into my head the realization that I needed to understand all the big economic and market moves that had happened in the last 100+ years and in all major countries.

In other words, if some big and important event had happened in the past (like the Great Depression of the 1930s), I couldn’t say for sure that it wouldn’t happen to me, so I had to figure out how it worked and be prepared to deal with it well. Through my research I saw that there were many cases of the same type of thing happening (e.g., depressions) and that by studying them just like a doctor studies many cases of a particular type of disease, I could gain a deeper understanding of how they work. The way I work is to study as many of the important cases of a particular thing I can find and then to form a picture of a typical one, which I call an archetype. The archetype helps me see the cause-effect relationships that drive how these cases typically progress. Then I compare how the specific cases transpire relative to the archetypical one to understand what causes the differences between each case and the archetype. This process helps me refine my understanding of the cause-effect relationships to the point where I can create decision-making rules in the form of “if/then” statements—i.e., if X happens, then make Y bet. Then I watch actual events transpire relative to that template and what we are expecting. I do these things in a very systematic way with my partners at Bridgewater Associates.[1a] If events are on track we continue to bet on what typically comes next, and if events start to deviate we try to understand why and course correct.

My approach is not an academic one created for scholarly purposes; it is a very practical one that I follow in order to do my job well. You see, as a global macro investor, the game I play requires me to understand what is likely to happen to economies better than the competition does. From my years of wrestling with the markets and trying to come up with principles for doing it well, I’ve learned that 1) one’s ability to anticipate and deal well with the future depends on one’s understanding of the cause-effect relationships that make things change and 2) one’s ability to understand these cause-effect relationships comes from studying how they have played out in the past. How practical this approach has been can be measured in Bridgewater’s performance track record over several decades.

This Approach Affects How I See Everything

Having done many such studies in pursuit of timeless and universal principles, I’ve learned that most things—e.g., prosperous periods, depressions, wars, revolutions, bull markets, bear markets, etc.—happen repeatedly through time. They come about for basically the same reasons, typically in cycles, and often in cycles that are as long or longer than our lifetimes. This has helped me come to see most everything as “another one of those,” just like a biologist, upon encountering a creature in the wild, would identify what species (or “one of those”) the creature belongs to, think about how that species of thing works, and try to have and use timeless and universal principles for dealing with it effectively.

Seeing events in this way helped shift my perspective from being caught in the blizzard of things coming at me to stepping above them to see their patterns through time.[2] The more related things I could understand in this way, the more I could see how they influence each other—e.g., how the economic cycle works with the political one—and how they interact over longer periods of time. I also learned that when I paid attention to the details I couldn’t see the big picture and when I paid attention to the big picture I couldn’t see the details. Yet in order to understand the patterns and the cause-effect relationships behind them, I needed to see with a higher-level, bigger-picture perspective and a lower-level, detailed perspective simultaneously, looking at the interrelationships between the most important forces over long periods of time. To me it appears that most things evolve upward (improve over time) with cycles around them, like an upward-pointing corkscrew:

For example, over time our living standards rise because we learn more, which leads to higher productivity, but we have ups and downs in the economy because we have debt cycles that drive actual economic activity up and down around that uptrend.

I believe that the reason people typically miss the big moments of evolution coming at them in life is that we each experience only tiny pieces of what’s happening. We are like ants preoccupied with our jobs of carrying crumbs in our minuscule lifetimes instead of having a broader perspective of the big-picture patterns and cycles, the important interrelated things driving them, and where we are within the cycles and what’s likely to transpire. From gaining this perspective, I’ve come to believe that there are only a limited number of personality types going down a limited number of paths that lead them to encounter a limited number of situations to produce only a limited number of stories that repeat over time.[3]

The only things that change are the clothes the characters are wearing and the technologies they’re using.

This Study & How I Came to Do It

One study lead to another that led me to do this study. More specifically:

  • Studying money and credit cycles throughout history made me aware of the long-term debt cycle (which typically lasts about 50-100 years), which led me to view what is happening now in a very different way than if I hadn’t gained that perspective. For example, before interest rates hit 0% and central banks printed money and bought financial assets in response to the 2008-09 financial crisis, I had studied that happening in the 1930s, which helped us navigate that crisis well. From that research, I also saw how and why these central bank actions pushed financial asset prices and the economy up, which widened the wealth gap and led to an era of populism and conflict. We are now seeing the same forces at play in the post-2009 period.
  • In 2014, I wanted to forecast economic growth rates in a number of countries because they were relevant to our investment decisions. I used the same approach of studying many cases to find the drivers of growth and come up with timeless and universal indicators for anticipating countries’ growth rates over 10-year periods. Through this process, I developed a deeper understanding of why some countries did well and others did poorly. I combined these indicators into gauges and equations that we use to produce 10-year growth estimates across the 20 largest economies. Besides being helpful to us, I saw that this study could help economic policy makers because, by seeing these timeless and universal cause-effect relationships, they could know that if they changed X, it would have Y effect in the future. I also saw how these 10-year leading economic indicators (such as the quality of education and the level of indebtedness) were worsening for the US relative to big emerging countries such as China and India. This study is called “Productivity and Structural Reform: Why Countries Succeed and Fail, and What Should Be Done So Failing Countries Succeed.”
  • Soon after the Trump election in 2016 and with increases in populism in developed countries becoming more apparent, I began a study of populism. That highlighted for me how gaps in wealth and values led to deep social and political conflicts in the 1930s that are similar to those that exist now. It also showed me how and why populists of the left and populists of the right were more nationalistic, militaristic, protectionist, and confrontational—and what such approaches led to. I saw how strong the conflict between the economic/political left and right could become and the strong impact this conflict has on economies, markets, wealth, and power, which gave me a better understanding of events that were and still are transpiring.
  • From doing these studies, and from observing numerous things that were happening around me, I saw that America was experiencing very large gaps in people’s economic conditions that were obscured by looking only at economic averages. So I divided the economy into quintiles—i.e., looking at the top 20% of income earners, the next 20%, and so on down to the bottom 20%—and examined the conditions of these populations individually. This resulted in two studies. In “Our Biggest Economic, Social, and Political Issue: The Two Economies—The Top 40% and the Bottom 60%,” I saw the dramatic differences in conditions between the “haves” and the “have-nots,” which helped me understand the greater polarity and populism I saw emerging. Those findings, as well as the intimate contact my wife and I were having through her philanthropic work with the reality of wealth and opportunity gaps in Connecticut communities and their schools, led to the research that became my “Why and How Capitalism Needs to Be Reformed” study.
  • At the same time, through my many years of international dealings in and research of other countries, I saw huge global economic and geopolitical shifts taking place, especially in China. I have been going to China a lot over the last 35 years and am lucky enough to have become well-acquainted with its top policy makers. This has helped me see up close how remarkable the advances in China have been and how excellent the capabilities and historical perspectives that were behind them are. These excellent capabilities and perspectives have led China to become an effective competitor with the US in production, trade, technology, geopolitics, and world capital markets.

By the way you can read these studies for free at

So, what you are now reading came about because of my need to understand important things that are now happening that hadn’t happened in my lifetime but have happened many times before that. These things are the result of three big forces and the questions they prompt.


At no point in our lifetimes have interest rates been so low or negative on so much debt as they are today. At the start of 2020, more than $10 trillion of debt was at negative interest rates and an unusually large amount of additional new debt will soon need to be sold to finance deficits. This is happening at the same time as huge pension and healthcare obligations are coming due. These circumstances raised some interesting questions for me. Naturally I wondered why anyone would want to hold debt yielding a negative interest rate and how much lower interest rates can be pushed. I also wondered what will happen to economies and markets when they can’t be pushed lower and how central banks could be stimulative when the next downturn inevitably came. Would central banks print a lot more currency, causing its value to go down? What would happen if the currency that the debt is denominated in goes down while interest rates are so low? These questions led me to ask what central banks will do if investors flee debt denominated in the world’s reserve currencies (i.e., the dollar, the euro, and the yen), which would be expected if the money that they are being paid back in is both depreciating in value and paying interest rates that are so low.

In case you don’t know, a reserve currency is a currency that is accepted around the world for transactions and savings. The country that gets to print the world’s primary currency (now the US) is in a very privileged and powerful position, and debt that is denominated in the world’s reserve currency (i.e., US dollar-denominated debt) is the most fundamental building block for the world’s capital markets and the world’s economies. It is also the case that all reserve currencies in the past have ceased to be reserve currencies, often coming to traumatic ends for the countries that enjoyed this special privilege. So I also began to wonder whether, when, and why the dollar will decline as the world’s leading reserve currency—and how that would change the world as we know it.


Wealth, values, and political gaps are now larger than at any other time during my lifetime. By studying the 1930s and other prior eras when polarity was also high, I’ve learned that which side wins out (i.e., left or right) will have very big impacts on economies and markets. So naturally I wondered what these gaps will lead to in our time. My examinations of history have taught me that, as a principle, when wealth and values gaps are large and there is an economic downturn, it is likely that there will be lot of conflict about how to divide the pie. How will people and policy makers be with each other when the next economic downturn arrives? I am especially concerned because of the previously mentioned limitations on central banks’ abilities to cut interest adequately to stimulate the economy. In addition to these traditional tools being ineffective, printing money and buying financial assets (now called “quantitative easing”) also widen the wealth gap because buying financial assets pushes up their prices, which benefits the wealthy who hold more financial assets than the poor.


For the first time in my lifetime, the United States is encountering a rival power. China has become a competitive power to the United States in a number of ways and is growing at a faster rate than the US. If trends continue, it will be stronger than the United States in most of the most important ways that an empire becomes dominant. (Or at the very least, it will become a worthy competitor.) I have seen both countries up close for most of my life, and I now see how conflict is increasing fast, especially in the areas of trade, technology, geopolitics, capital, and economic/political/social ideologies. I can’t help but wonder how these conflicts, and the changes in the world order that will result from them, will transpire in the years ahead and what effects that will have on us all.

The confluence of these three factors piques my curiosity and most draws my attention to similar periods such as the 1930-45 period and numerous others before that. More specifically, in 2008-09 like in 1929-32, there were serious debt and economic crises. In both cases, interest rates hit 0% which limited central banks’ ability to use interest rate cuts to stimulate the economy, so, in both cases, central banks printed a lot of money to buy financial assets which, in both cases, caused financial asset prices to rise and widened the wealth gap. In both periods, wide wealth and income gaps led to a high level of political polarization that took the form of greater populism and battles between ardent socialist-led populists of the left and ardent capitalist-led populists of the right. These domestic conflicts stewed while emerging powers (Germany and Japan in the 1930s) increasingly challenged the existing world power. And finally, just like today, the confluence of these factors meant that it was impossible to understand any one of them without also understanding the overlapping influences among them.

As I studied these factors, I knew that the short-term debt cycle was getting late and I knew that a downturn would eventually come. I did not expect the global pandemic to be what brought it about, though I did know that past pandemics and other acts of nature (like droughts and floods) have sometimes been important contributors to these seismic shifts.

To gain the perspective I needed about these factors and what their confluence might mean, I looked at the rises and declines of all the major empires and their currencies over the last 500 years, focusing most closely on the three biggest ones: the US empire and the US dollar which are most important now, the British Empire and the British pound which were most important before that, and the Dutch Empire and the Dutch guilder before that. I also focused less closely on the other six other significant, though less dominant, empires of Germany, France, Russia, Japan, China, and India. Of those six, I gave China the most attention and looked at its history back to the year 600 because 1) China was so important throughout history, it’s so important now, and it will likely be even more important in the future and 2) it provides many cases of dynasties rising and declining to look at to help me better understand the patterns and the forces behind them. In these cases, a clearer picture emerged of how other influences, most importantly technology and acts of nature, played significant roles. From examining all these cases across empires and across time, I saw that important empires typically lasted roughly 250 years, give or take 150 years, with big economic, debt, and political cycles within them lasting about 50-100 years. By studying how these rises and declines worked individually, I could see how they worked on average in an archetypical way, and then I could examine how they worked differently and why. Doing that taught me a lot. My challenge is in trying to convey it well.

Remember That What I Don’t Know Is Much Greater Than What I Know

In asking these questions, from the outset I felt like an ant trying to understand the universe. I had many more questions than answers, and I knew that I was delving into numerous areas that others have devoted their lives to studying. So I aggressively and humbly drew on knowledge of some remarkable scholars and practitioners, who each had in-depth perspectives on some piece of the puzzle, though none had the holistic understanding that I needed in order to adequately answer all my questions. In order to understand all the cause-effect relationships behind these cycles, I combined my triangulation with historians (who specialized in different parts of this big, complicated history) and policy makers (who had both practical experiences and historical perspectives) with an examination of statistics drawn out of ancient and contemporary archives by my excellent research team and by reading a number of superb books on history.

While I have learned an enormous amount that I will put to good use, I recognize that what I know is still only a tiny portion of what I’d like to know in order to be confident about my outlook for the future. Still, I also know from experience that if I waited to learn enough to be satisfied with my knowledge, I’d never be able to use or convey what I have learned. So please understand that while this study will provide you with my very top-down, big-picture perspective on what I’ve learned and my very low-confidence outlook for the future, you should approach my conclusions as theories rather than facts. But please keep in mind that even with all of this, I have been wrong more times than I can remember, which is why I value diversification of my bets above all else. So, whenever I provide you with what I think, as I’m doing in this study, please realize that I’m just doing the best I can to openly convey to you my thinking.

It’s up to you to assess for yourself what I’ve learned and do what you like with it.

How This Study Is Organized

As with all my studies, I will attempt to convey what I learned in both a very short, simple way and in a much longer, more comprehensive way. To do so, I wrote this book in two parts.

Part 1 summarizes all that I learned in one very simplified archetype of the rises and declines of empires, drawing from all my research of specific cases. In order to make the most important concepts easy to understand, I will write in the vernacular, favoring clarity over precision. As a result, some of my wording will be by and large accurate but not always precisely so. (I will also highlight key sentences in bold so that you can just read these and skip the rest to quickly get the big picture.) I will first distill my findings into an index of total power of empires, which provides an overview of the ebbs and flows of different powers, that is constituted from eight indexes of different types of power. Then I go into an explanation of these different types of power so you can understand how they work, and finally I discuss what I believe it all means for the future.

Part 2 shows all the individual cases in greater depth, sharing the same indices for all the major empires over the last 500 years. Providing the information this way allows you to get the gist of how I believe these rises and declines work by reading Part 1 and then to choose whether or not to go into Part 2 to see these interesting cases individually, in relation to each other, and in relation to the template explained in Part 1. I suggest that you read both parts because I expect that you will find the grand story of the evolutions of these countries over the last 500 years in Part 2 fascinating. That story presents a sequential picture of the world’s evolution via the events that led the Dutch empire to rise and decline into the British empire, the British empire to rise and decline into the US empire, and the US empire to rise and enter its early decline into the rise of the Chinese empire. It also compares these three empires with those of Germany, France, Russia, Japan, China, and India. As you will see in the examinations of each of them, they all broadly followed the script, though not exactly. Additionally, I expect that you will find fascinating and invaluable the stories of the rises and declines of the Chinese dynasties since the year 600 just like I did. Studying the dynasties showed me what in China has been similar to the other rises and declines (which is most everything), helped me to see what was different (which is what makes China different from the West), and gave me an understanding of the perspectives of the Chinese leaders who all study these dynasties carefully for the lessons they provide.

Frankly, I don’t know how I’d be able to navigate what is happening now and what will be coming at us without having studied all this history. But before we get into these fascinating individual cases, let’s delve into the archetypical case.


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[1] To be clear, while I am describing these cycles of the past, I’m not one of those people who believe that what happened in the past will necessarily continue into the future without understanding the cause-effect mechanics that drive changes. My objective above all else is to have you join with me in looking at the cause-effect relationships and then to use that understanding to explore what might be coming at us and agree on principles to handle it in the best possible way.

[1a] For example, I have followed this approach for debt cycles because I’ve had to navigate many of them over the last 50 years and they are the most important force driving big shifts in economies and markets. If you are interested in understanding my template for understanding big debt crises and seeing all the cases that made it up, you can get Principles for Navigating Big Debt Crisesin free digital form at or in print form for sale in bookstores or online. It was that perspective that allowed Bridgewater to navigate the 2008 financial crisis well when others struggled. I’ve studied many big, important things (e.g., depressions, hyperinflation, wars, balance of payments crises, etc.) by following this approach, usually because I was compelled to understand unusual things that appeared to be germinating around me.

[2] I approach seeing just about everything this way. For example, in building and running my business, I had to understand the realities of how people think and learn principles for dealing with these realities well, which I did using this same approach. If you are interested in what I learned about such non-economic and non-market things, I conveyed it in my book Principles: Life and Work, which is free in an app called “Principles in Action” available on the Apple App Store or is for sale in the usual bookstores.

[3] In my book Principles: Life and Work, I shared my thinking about these different ways of thinking. I won’t describe them here but will direct you there should you be interested.

Chapter 1

The Big Picture in a Tiny Nutshell

Published 03/29/20

As explained in the Introduction, the world order is now rapidly shifting in important ways that have never happened in our lifetimes but have happened many times before in history. My objective is to show you those cases and the mechanics that drove them and, with that perspective, attempt to imagine the future.

What follows here is an ultra-distilled description of the dynamics that I saw in studying the rises and declines of the last three reserve currency empires (the Dutch, the British, and the American) and the six other significant empires (Germany, France, Russia, India, Japan, and China) over the last 500 years, as well as all of the major Chinese dynasties back to the Tang Dynasty around the year 600. The purpose of this chapter is simply to provide an archetype to use when looking at all the cycles, most importantly the one that we are now in. In studying these past cases, I saw clear patterns that occurred for logical reasons that I briefly summarize here and cover more completely in subsequent chapters of Part 1. While the focus of this chapter and this book are on those forces that affected the big cyclical swings in wealth and power, I also saw ripple-effect patterns in all dimensions of life including culture and the arts, social mores, and more, which I will touch on in Part 2. By going back and forth between this simple archetype and the cases shown in Part 2, we will see how the individual cases fit the archetype (which is essentially just the average of those cases) and how well the archetype describes the individual cases. Doing this, I hope, will help us better understand what is happening now.

I’m on a mission to figure out how the world works and to gain timeless and universal principles for dealing with it well. It’s both a passion and a necessity for me. While the curiosities and concerns that I described earlier pulled me into doing this study, the process of conducting it gave me a much greater understanding of the really big picture on how the world works than I expected to get, and I want to share it with you. It made much clearer to me how peoples and countries succeed and fail over long swaths of time, it revealed giant cycles behind these ups and downs that I never knew existed, and, most importantly, it helped me put into perspective where we now are.

Though the big-picture synthesis that I’m sharing in this chapter is my own, you should know that the theories I express in this book have been well-triangulated with other experts. About two years ago, when I felt that I needed to answer the questions I described in the Introduction, I decided to immerse myself in research with my research team, digging through archives, speaking with the world’s best scholars and practitioners who each had in-depth understandings of bits and pieces of the puzzle, reading relevant great books by insightful authors, and reflecting on the prior research I’ve done and the experiences that I have from investing globally for nearly 50 years.

Because I view this as an audacious, humbling, necessary, and fascinating undertaking, I am worried about missing important things and being wrong, so my process is iterative. I do my research, write it up, show it to the world’s best scholars and practitioners to stress test it, explore potential improvements, write it up again, stress test it again, and so on, until I get to the point of diminishing returns. This study is the product of that exercise. While I can’t be sure that I have the formula for what makes the world’s greatest empires and their markets rise and fall exactly right, I’m confident that I got it by-and-large right. I also know that what I learned is essential for me putting what is happening now in perspective and for imagining how to deal with important events that have never happened in my lifetime but have happened repeatedly throughout history.

I’m passing it along to you to take or leave as you like.

The Countries Shown in This Study Had the Most Wealth and Power

This is a study of how wealth and power have come and gone in the leading powers of the world. To be clear, while the leading powers covered in this study were the richest and most powerful, they weren’t necessarily the best-off countries for two reasons. First, while wealth and power are what most people want and will fight over most, some people and their countries don’t think that these things are the most important and wouldn’t think of fighting over them. For example, some believe that having peace and savoring life are more important than having a lot of wealth and power and wouldn’t think of fighting hard enough to gain enough of the wealth and power to make it into the group included in this study. (By the way, I think there is a lot to be said for putting peace and savoring life ahead of gaining wealth and power.) Second, this group of countries excludes what I will call the “boutique countries” (like Switzerland and Singapore) that score very high in wealth and living standards but aren’t large enough to become one of the biggest empires.

Throughout History Wealth Was Gained by Either Making It, Taking It from Others, or Finding It in the Ground

Let’s start with the big-picture basics. Throughout recorded history various forms of groups of people (e.g., tribes, kingdoms, countries) have gained wealth and power by building it themselves, taking it from others, or finding it in the ground. When they gathered more wealth and power than any other group, they became the world’s leading power, which allowed them to determine the world order. When they lost that wealth and power, which they all did, the world order changed in very big ways. That changed all aspects of life in profound ways. In this chapter we will describe how throughout time the same basic forces have ebbed and flowed in basically the same sorts of ways to cause these ups and downs in empires.

Human productivity is the most important force in causing the world’s total wealth, power, and living standards to rise over time. Productivity—i.e., the output per person, driven by learning, building, and inventiveness—has steadily improved over time because learning is gained more than lost. However, it has risen at different rates for different people, though always for the same reasons—because of the quality of people’s education, inventiveness, work ethic, and economic systems to turn ideas into output. These reasons are important for policy makers to understand in order to achieve the best possible outcomes for their countries, and for investors and companies to understand in order to determine where the best long-term investments are.

But while significant, these learnings and productivity improvements are evolutionary, so they are not what cause big shifts in who has what wealth and power. They are caused by a number of forces, most importantly money and credit cycles. I have identified 17 important forces in total that have explained almost all of these movements throughout time, which we will delve into in a moment. These big forces generally transpire in classic cycles that are mutually reinforcing in ways that tend to create a single very big cycle of ups and downs. This big archetypical cycle governs the rising and declining of empires and influences everything about them, including their currencies and markets (which I’m especially interested in). As with the archetypical debt cycle, which I outlined in Principles for Navigating Big Debt Crises, this big cycle represents the archetypical one that we can compare others to, including the one that we are now in. I believe that we need to understand this archetypical cycle in order to put where we are in perspective and attempt to squint into the future.

Of the 17 forces, the debt cycle, the money and credit cycle, the wealth gap cycle, and the global geopolitical cycle are most important to understand in order to put where we are in perspective. For reasons explained in this book, I believe that we are now seeing an archetypical big shift in relative wealth and power and the world order that will affect everyone in all countries in profound ways. This big wealth and power shift is not obvious because most people don’t have the patterns of history in their minds to see this one as “another one of those.” So in this first chapter, I will describe in a very brief way how I see the archetypical mechanics behind rises and declines of empires and their markets working. Then we will delve into the various factors happening in the various past cases.

To See the Big Picture, You Can’t Focus on the Details

While I will attempt to paint this big sweeping picture accurately, I can’t paint it in a precise way, and, in order for you to see it and understand it, you can’t try to do so in a precise way. That is because we are looking at evolution over long time frames. To see it, you will have to let go of the details. Of course, when the details are important, which they often are, I will go from the very big, imprecise picture to a more detailed one.

Looking at what happened in the past from this very big-picture perspective will radically alter how you see things. For example, because the span of time covered is so large, many of the most fundamental things that we take for granted and many of the terms we use to describe them did not exist over the full period of time. As a result, I will be imprecise in my wording so that I can convey the big picture without getting tripped up on what might seem to be big things but, in the scope of what we are looking at, are relative details.

For example, I wrestled with how much I should worry about the differences between countries, kingdoms, nations, states, tribes, empires, and dynasties. Nowadays we think mostly in terms of countries. However, countries as we know them didn’t come into existence until the 17th century, after Europe’s Thirty Years’ War. In other words, before then there were no countries—generally speaking, though not always, there were kingdoms instead. In some places, kingdoms still exist and can be confused with being countries, and some places are both. Generally speaking, though not always, kingdoms are small, countries are bigger, and empires are biggest (spreading beyond the kingdom or the country). The relationships between them are often not all that clear. The British Empire was mostly a kingdom that gradually evolved into a country and then an empire that extended way beyond England’s borders, so that its leaders controlled broad areas and many non-English peoples. It’s also the case that each of these types of singularly controlled entities—countries, kingdoms, tribes, empires, etc.—controls its population in different ways, which further confuses things for those who seek precision. For example, in some cases empires are areas that are occupied by a dominant power while in other cases empires are areas influenced by a dominant power that controls other areas through threats and rewards. The British Empire generally occupied the countries in its empire while the American Empire has controlled more via rewards and threats—though that is not entirely true, as at the time of this writing the US has military bases in 70 countries. So, though it is clear that there is an American Empire, it is less clear exactly what is in it. Anyway, you get my point—that trying to be precise can stand in the way of conveying the biggest, most important things. So in this chapter you are going to have to bear with my sweeping imprecisions. You will also understand why I will henceforth imprecisely call these entities countries, even though not all of them were countries, technically speaking.

Along these lines, some will argue that my comparing different countries with different systems in different times is impossible. While I can understand that perspective, I want to assure you that I will seek to explain whatever major differences exist, that the timeless and universal similarities are much greater than the differences, and that to let the differences stand in the way of seeing those similarities which provide us with the lessons of history we need, would be tragic.

Most Everything Evolves in an Uptrend with Cycles Around It

As mentioned earlier, over long periods of time we evolve because we learn to do things better, which raises our productivity. Over the long run, that is the most important force, though over the short run, the swings around this upward trend are most important. This is conveyed in the chart below, which shows the estimated output (i.e., estimated real GDP) per person over the last 500 years. As shown from this top-down, big-picture perspective, output per person appears to be steadily improving, though very slowly in the early years and faster after around 1800, when the slope up becomes much steeper, reflecting the faster productivity gains. This shift from slower productivity gains to faster productivity gains was primarily due to the improvements in broad learning and the conversion of that learning into productivity. That was brought about by a number of factors going as far back as the invention of the printing press in Europe in the mid-15th century (it had been used in China substantially earlier), which increased the knowledge and education available to many more people, contributing to the European Renaissance, the Scientific Revolution, the Enlightenment, and the first Industrial Revolution in Britain.

That broader-based learning also shifted wealth and power away from 1) an agriculture-based economy in which land ownership was the principal source of power, and the monarchies, nobles, and church worked together to maintain their grip on it, toward 2) an industrial-based economy in which inventive capitalists created and owned the means of production of industrial goods and worked together with those in government to maintain the system that allowed them to have the wealth and power. In other words, since the Industrial Revolution, which brought about that change, we have been operating in a system in which wealth and power have primarily come more from the combination of education, inventiveness, and capitalism, with those who run governments working with those who control most of the wealth and education. While in the first half of the 20th century there were deviations away from capitalism toward communism (which in the years between 1950 and 1990 showed that it didn’t work in the forms that have been tried) and socialism (which is essentially a hybrid wealth and opportunity distribution system that people can debate the merit of), the formula for success has been a system in which educated people come up with innovations, receive funding through capital markets, and own the means by which their innovations are turned into the production and allocation of resources, allowing them to be rewarded by profit-making. This happens best in capitalism and the government systems that work symbiotically with it. At the same time, how this is happening continues to evolve. For example, while ages ago agricultural land and agricultural production were worth the most and that evolved into machines and what they produced being worth the most, digital things that have no apparent physical existence (data and information processing) are evolving to become worth the most. That will create a fight over who obtains the data and how they use it to have wealth and power. (We will delve into that in the chapter that deals with learning and improving to raise productivity.) The main point I’m trying to get across is that the greatest power that produces these uptrends in living standards is humanity’s ability to adapt and improve—so much so that movements around that uptrend caused by everything else don’t even show up when one looks at what’s happening from the higher level in order to gain a bigger-picture perspective.

At the same time, like all such systems, capitalism has failed to do that job well enough to achieve the goals of producing equal opportunity and maximum productivity through broad-based human capital development (for more on that see “Why and How Capitalism Needs to Be Reformed”). But, to reiterate the main point: from the top-down, big-picture level shown in the below chart, things pretty much keep getting better because people keep getting smarter and keep conveying that smartness into more and better output.

Underneath this relatively smooth upward trajectory of learning and productivity are turbulent historical periods, including booms, busts, revolutions, and wars. History shows us that almost all of these turbulent times are due to money and credit collapses, big wealth gaps, fighting over wealth and power (i.e., revolutions and wars), and severe acts of nature (like droughts, floods, and epidemics). It also shows that how bad these periods get depends almost exclusively on how strong the countries are to endure them. For example, those with large savings, low debts, and a strong reserve currency can withstand economic and credit collapses better than those that don’t have much savings, have a lot of debt, and don’t have a strong reserve currency. Likewise those with strong and capable leadership and civil populations can be managed better than those that don’t have these, and those that are more inventive will adapt better than those that are less inventive. As you will read in the cases in Part 2, these factors are measurable timeless and universal truths.

Because these turbulent times are small in relation to the evolutionary uptrend of humanity’s capacity to adapt and invent, they barely show up in the previous chart, appearing only as relatively minor wiggles. Yet these wiggles seem very big to us because we are so small and short-lived. Take the 1930-45 depression and war period, for example. The levels of the US stock market and global economic activity are shown in the chart below. As you can see, the economy fell by about 10%, and the stock market fell by about 85% and then began to recover.

This is part of the classic money and credit cycle that has happened for as long as there has been recorded history and that I will explain in the money and credit cycles chapter. More specifically, a credit collapse that happened because there was too much debt so the central government had to spend a lot of money it didn’t have and make it easier for debtors to pay their debt. To do that, the central bank had to print money and liberally provide credit—like they are doing now. When credit collapsed, spending collapsed with it so they had to print money. In that case the debt bust was the natural extension of the Roaring ‘20s boom that became a debt-financed bubble that popped in 1929. Almost all debt busts, including the one we are now in, come about for basically the same reason of extrapolating the uptrend forward and over-borrowing to bet heavily on things going up and being hurt when they go down.

Back then, the popping of the bubble and the resulting economic bust were the biggest influences on the 1930-45 period’s internal and external fight for wealth and power. Then, like now and like in most other cases, there were large wealth gaps, which when heightened by debt/economic collapses led to revolutionary changes in social and economic programs and big wealth transfers that were manifest in different systems in different places. Clashes and wars developed over which of these systems was best and as different people and countries fought to get their share. The popular systems that were fought over included communism (which supported dividing most wealth pretty much equally), fascism (which was autocratic state-controlled capitalism), and socialized democracy (which redistributed a lot of wealth while maintaining democracy and a more free-market capitalism—though often in a more autocratic form during the war years). There are always arguments or fights between those who want to make big redistributions of wealth and those who don’t. In the US in the 1930s, Mother Nature also gave us a painful drought.

Looking over the whole of the cases I examined, I’d say that past economic and market declines each lasted about three years until they were reversed through a big restructuring process that included restructuring of the debt and the monetary and credit system, fiscal policies of taxation and spending, and changes in political power. The quicker the printing of money to fill the debt holes, the quicker the closing of the deflationary depression and the sooner the worrying about the value of money begins. In the 1930s US case, the stock market and the economy bottomed the day that newly elected President Roosevelt announced that he would default on the government’s promise to let people turn in their money for gold, and that the government would create enough money and credit so that people could get their money out of banks and others could get money and credit to buy things and invest. As shown in the previous chart, that created a big improvement but not a full recovery. Then came the war, which resulted from fighting over wealth and power as the emerging powers of Germany and Japan challenged the existing leading world powers of Great Britain, France, and eventually the US (which was dragged into the war). The war period raised economic output of things that were used in war, but it would be a misnomer to call the war years a “productive period”—even though when measured in output per person, it was—because there was so much destruction. At the end of the war, global GDP per capita had fallen by about 12%, much of which was driven by declines in the economies of countries that lost the war. The stress test that these years represented wiped out a lot, made clear who the winners and losers were, and led to a new beginning and a new world order in 1945. Classically that was followed by a lengthy period of peace and prosperity that became overextended so that all countries are now, 75 years later, being stress tested again.

Most cycles in history happened for basically the same reasons. For example, the 1907-19 period began with the Panic of 1907, which, like the 1929-32 money and credit crisis following the Roaring ‘20s, was the result of boom periods (the Gilded Age in the US, the Belle Époque in continental Europe, and the Victorian era in Great Britain) becoming debt-financed bubbles that led to economic and market declines. These declines also happened when there were large wealth gaps that led to big wealth redistributions and a world war. The wealth redistributions, like those in the 1930-45 period, came about through large increases in taxes and government spending, big deficits, and big changes in monetary policies that monetized the deficits. Then Mother Nature brought about a pandemic (the Spanish flu) that intensified the stress test and the resulting restructuring process. This stress test and global economic and geopolitical restructuring led to a new world order in 1919, which was expressed in the Treaty of Versailles. That ushered in the 1920s debt-financed boom, which led to the 1930-45 period and the same things happening again.

Basically these periods of destruction/reconstruction cleaned out the weak, made clear who the powerful were, and established revolutionary new approaches to doing things that set the stage for periods of reconstruction and prosperity that became overextended as debt bubbles with large wealth gaps and led to debt busts that produced new stress tests and destruction/reconstruction periods, which eventually again led to the strong gaining relative to the weak, and so on.

What are these destruction/reconstruction periods like for the people who experience them? Since you haven’t been through one of these and the stories about them are very scary, the prospect of being in one is very scary to most people. It is true that these destruction/reconstruction periods have produced tremendous human suffering both financially and, more importantly, in lost or damaged human lives. Like the coronavirus experience, what each of these destruction/reconstruction periods has meant and will mean for each person depends on each person’s own experiences, with the broader deep destruction periods damaging the most people. While the consequences are worse for some people, virtually no one escapes the damage. Still, history has shown us that typically the majority of people stay employed in the depressions, are unharmed in the shooting wars, and survive the natural disasters.

Some people who struggled through them have even described these very difficult times as bringing about important, good things like drawing people closer together, building strength of character, learning to appreciate the basics, etc. For example, Tom Brokaw called the people who went through these times “the Greatest Generation” because of the strength of character it gave them. My parents and aunts and uncles who went through the Great Depression and World War II, as well as others of their era whom I’ve spoken to in other countries who went through their own versions of this destruction period, saw it that way too. Keep in mind that economic destruction periods and war periods typically don’t last very long—they tend to last roughly two or three years. And the lengths and severities of natural disasters (like droughts, floods, and epidemics) vary, though they typically lessen in painfulness as adaptations are made. One rarely gets all three of these types of big crises—i.e., 1) economic, 2) revolution and/or war, and 3) natural disaster—at the same time.

My point is that while these periods can be depressing and lead to a lot of human suffering, we should never, especially in the worst of times, lose sight of the fact that humanity’s power to adapt and quickly get to new, higher levels of well-being is much greater than all the bad stuff that can be thrown at us. For that reason, I believe that it is smart to believe and invest in humanity’s adaptability and inventiveness. So, while I am pretty sure that in the coming years both you and the world order will experience big challenges and changes, I believe that humanity will become smarter and stronger in very practical ways that will lead us to overcome these challenging times and go on to new and higher levels of prosperity.

Now let’s look at the cycles of rises and declines in the wealth and power of the major countries over the last 500 years.

The Shifts in Wealth and Power That Occurred Between Countries

While the first chart of rising productivity shared previously was for the whole world (to the best of our ability to measure it), it doesn’t show the shifts in wealth and power that occurred between countries. The chart below shows you the relative wealth and power of the 11 leading empires over the last 500 years.1 Each one of these indices of wealth and power is a composite of eight different measures that I will explain shortly. Though these indices aren’t perfect because all data through time isn’t perfect, they do an excellent job of painting the big picture. As you can see, nearly all of these empires saw periods of ascendancy followed by periods of decline. The thicker lines represent the four most important empires: the Dutch, British, American, and Chinese. These empires held the last three reserve currencies—the US now, the British before it, and the Dutch before that. China is included because it has risen to be the second-most powerful empire/country and because it was so consistently powerful in most years prior to around 1850. To very briefly summarize what the chart shows:

  • China was dominant for centuries (consistently outcompeting Europe in goods trade), though it entered a steep decline starting in the 1800s.
  • The Netherlands, a relatively small country, became one of the world’s great empires in the 1600s.
  • The UK followed a very similar path, peaking in the 1800s.
  • Finally, the US rose to become the world’s superpower over the last 150 years, though particularly during and after WWII, and is now in relative decline while China is catching up once again.

Now let’s look at the same chart that extends the data all the way back to the year 600. I focused on the one above (which covers just the last 500 years) rather than the one below (which covers the last 1,400 years) because it includes the empires I focused on most intently on and is simpler, though with 11 countries, 12 major wars, and over 500 years, it can hardly be called simple. Still, the one below is more extensive and worth glancing at. I left out the shading of the war periods to lessen the confusion. As shown, in the pre-1500 period, China was almost always the most powerful, though the Middle Eastern caliphates, the French, the Mongols, the Spanish, and the Ottomans were also in the picture.

Our Measures of Wealth and Power

The single measure of wealth and power that I showed you for each country in the prior charts is made up as a roughly equal average of eight measures of strength. They are: 1) education, 2) competitiveness, 3) technology, 4) economic output, 5) share of world trade, 6) military strength, 7) financial center strength, and 8) reserve currency. While there are more measures of and influences on power that we will explore later, let’s begin by focusing on these key eight.

The chart below shows the average of each of these measures of strength, with most of the weight on the most recent three reserve countries (i.e., the US, the UK, and the Dutch).2

The lines on the chart do a pretty good job of telling the story of why and how the rises and declines took place. Using these and referring to some additional factors that we will delve deeper into later, I will describe that cycle in a nutshell. But before I start, it’s worth noting that all of these measures of strength rose and declined over the arc of the empire. That’s because these strengths and weaknesses are mutually reinforcing—i.e., strengths and weaknesses in education, competitiveness, economic output, share of world trade, etc., contribute to the others being strong or weak, for logical reasons. For example, it makes sense that better-educated people would produce societies that are more innovative, competitive, and productive. I call this cyclical interrelated move up and down “the Big Cycle.” Take note of the order that these items move up and down in the chart because it is broadly indicative of the processes that lead to the rising and declining of empires. For example, quality of education has been the long-leading strength of rises and declines in these measures of power, and the long-lagging strength has been the reserve currency. That is because strong education leads to strengths in most areas, including the creation of the world’s most common currency. That common currency, just like the world’s common language, tends to stay around because the habit of usage lasts longer than the strengths that made it so commonly used.

The Big Cycle

Broadly speaking, we can look at these rises and declines as happening in three phases: 1) the ascent phase, which is characterized by the gaining of competitive advantages; 2) the top phase, which is characterized by sustaining the strength but eventually sowing the seeds for the loss of the competitive advantages that were behind the ascent; and 3) the decline phase, which is characterized by self-reinforcing declines in all of these strengths.

In a nutshell, the ascent phase comes about when there is…

  • strong enough and capable enough leadership to provide the essential ingredients for success, which include…
  • strong education. By strong education I don’t just mean teaching knowledge and skills; I also mean teaching…
  • strong character, civility, and a strong work ethic, which are typically taught in the family as well as in school. These lead to improved civility that is reflected in factors such as…
  • low corruption and high respect for rules, such as rule of law.
  • People being able to work well together, united behind a common view of how they should be together and a common purpose, is also important. When people have knowledge, skills, good character, and the civility to behave and work well together, and there is…
  • a good system for allocating resources, which is significantly improved by…
  • being open to the best global thinking, the country has the most important ingredients in order to succeed. That lead to them gaining…
  • greater competitiveness in the global market, which brings in revenues that are greater than expenses, which leads them to have…
  • strong income growth, which allows them to make…
  • increased investments to improve their infrastructures, education systems, and research and development, which leads them to have…
  • higher productivity (more valuable output per hour worked). Increasing productivity is what increases wealth and productive capabilities. When they achieve higher productivity levels, they can become productive inventors of…
  • new technologies. These new technologies are valuable for both commerce and the military. As these countries become more competitive in these ways, naturally they gain…
  • a significant share of world trade, which requires them to have…
  • a strong military to protect their trade routes and to influence those who are important to it outside its borders. In becoming economically pre-eminent they develop the world’s leading…
  • financial centers for attracting and distributing capital. (For example, Amsterdam was the world’s financial center when the Dutch empire was pre-eminent, London was it when the British empire was on top, and New York is now it because the US is on top, but China is beginning to develop its own financial center in Shanghai.) In expanding their trade globally, these growing empires bring their…
  • strong equity, currency, and credit markets. Naturally those dominant in trade and capital flows have their currency used much more as the preferred global medium of exchange and the preferred storehold of wealth, which leads to their currency becoming a reserve currency. That is how the Dutch guilder became the world’s reserve currency when the Dutch Empire was pre-eminent, the British pound became the world’s reserve currency when the British Empire was pre-eminent, and the US dollar became the world’s reserve currency in 1944 when the US was about to win World War II and was clearly pre-eminent economically, financially, and militarily. Having one’s currency be a reserve currency naturally gives that country greater borrowing and purchasing power. As shown in the most recent chart, gaining and losing of reserve currency status happens with a significant lag to the other fundamentals.

It is through the mutually reinforcing and unwavering improvements in these things that countries rise and sustain their powers. Those who build empires allocate resources well by coordinating their economic, political, and military forces into a profitable economic/political/military system. For example, the Dutch created the Dutch East India Company, the British created the British East India Company, the US created the military-industrial complex, and China has Chinese state capitalism. Such economic, political, and military coordination has proved essential for all empires to profitably expand.

In a nutshell, the top phase typically occurs because within the successes behind the ascent lie the seeds of decline. More specifically, as a rule:

  • Prosperous periods lead to people earning more, which naturally leads them to become more expensive, which naturally makes them less competitive relative to those in countries where people are willing to work for less.
  • Those who are most successful typically have their ways of being more successful copied by emerging competitors, which also contributes to the leading power becoming less competitive. For example, British shipbuilders, who had less expensive workers than Dutch shipbuilders, hired Dutch shipbuilding architects to design ships that were built more cost-effectively than the Dutch ships. Because it takes less time and money to copy than invent, all else being equal, emerging empires tend to gain on mature empires through copying.
  • Those who become richer naturally tend to work less hard, engage in more leisurely and less productive activities, and at the extreme, become decadent and unproductive. That is especially true as generations change from those who had to be strong and work hard to achieve success to those who inherited wealth—these younger generations tend to be less strong/battle-hardened, which makes them more vulnerable to challenges. Over time people in the prosperous society tend to want and need more luxuries and more leisure and tend to get weaker and more overextended in order to get them, which makes them more vulnerable.
  • The currencies of countries that are richest and most powerful become the world’s reserve currencies, which gives them the “exorbitant privilege” of being able to borrow more money, which gets them deeper into debt. This boosts the leading empire’s spending power over the short term and weakens it over the longer run. In other words, when borrowing and spending are strong, the leading empire appears strong while its finances are in fact being weakened. That borrowing typically sustains its power beyond its fundamentals by financing both domestic over-consumption and the military and wars that are required to maintain its empire. This over-borrowing can go on for quite a while and even be self-reinforcing, because it strengthens the reserve currency, which raises the returns of foreign lenders who lend in it. When the richest get into debt by borrowing from the poorest, it is a very early sign of a relative wealth shift. For example, in the 1980s, when the US had a per capita income that was 40 times that of China’s, it started borrowing from Chinese who wanted to save in US dollars because the dollar was the world’s reserve currency. This was an early sign of that dynamic beginning. Similarly, the British borrowed a lot of money from its much poorer colonies, particularly during WWII, and the Dutch did the same before their top, which contributed to the reversals in their currencies and economies when the willingness to hold their currency and debt suddenly fell. The United States has certainly done a lot of borrowing and monetization of its debt, though this hasn’t yet caused a reduced demand for the US currency and debt.
  • The leading country extends the empire to the point that the empire has become uneconomical to support and defend. As the costs of maintaining it become greater than the revenue it brings in, the unprofitability of the empire further weakens the leading country financially. That is certainly the case for the US.
  • Economic success naturally leads to larger wealth gaps because those who produce a lot of wealth disproportionately benefit. Those with wealth and power (e.g., those who benefit commercially and those who run the government) naturally work in mutually supportive ways to maintain the existing system that benefits them while other segments of the population lag, until the split becomes so large that it is perceived as intolerably unfair. This is an issue in the US.

The decline phase typically happens as the excesses of the top phase are reversed in a mutually reinforcing set of declines, and because a competitive power gains relative strength in the previously described areas.

  • When debts become very large, when the central banks lose their ability to stimulate debt and economic growth, and when there is an economic downturn, that leads to debt and economic problems and to more printing of money, which eventually devalues it.
  • When wealth and values gaps get large and there is a lot of economic stress (wherever that stress comes from), there are high probabilities of greater conflict between the rich and the poor, at first gradually and then increasingly intensely. That combination of circumstances typically leads to increased political extremism—i.e., populism of both the left (i.e., those who seek to redistribute the wealth, such as socialists and communists) and the right (i.e., those who seek to maintain the wealth in the hands of the rich, such as the capitalists). That happens in both democratically and autocratically run countries. For example, in the 1930s, increasingly extreme populists of the left became communist and those from the right became fascist. Populists tend to be more autocratic, more inclined to fight, and more inclined to respect power than law.
  • When the rich fear that their money will be taken away and/or that they will be treated with hostility, that leads them to move their money and themselves to places, assets, and/or currencies that they feel are safer. If allowed to continue, these movements reduce the tax and spending revenue in the locations experiencing these conflicts, which leads in turn to a classic self-reinforcing hollowing-out process in the places that money is leaving. That’s because less tax money worsens conditions, which raises tensions and taxes, causing still more emigration of the rich and even worse conditions, and so on. For example, we are now seeing some of that happening via the rich leaving higher-tax states where there is financial stress and large wealth gaps. When it gets bad enough, governments no longer allow that to happen—i.e., they outlaw the flows of money out of the places that are losing them and to the places, assets, and/or currencies that are getting them, which causes further panic by those seeking to protect themselves.
  • When these sorts of disruptive conditions exist, they undermine productivity; that shrinks the economic pie and causes more conflict about how to divide the shrinking resources well, which leads to even more internal conflict that increasingly leads to fighting between the populist leaders from both sides who want to take control to bring about order. That is when democracy is most challenged by autocracy. This is why in the 1920s and 1930s Germany, Japan, Italy, and Spain (and a number of smaller countries) all turned away from democracy to autocratic leadership, and the major democracies (the US, the UK, and France) became more autocratic. It is widely believed that, during periods of chaos, more centralized and autocratic decision making is preferable to less centralized and more democratic, debate-based decision making, so this movement is not without merit when there is unruly, violent crowd fighting.
  • When a country gains enough economic, geopolitical, and military power that it can challenge the existing dominant power, there are many areas of potential conflict between these rival world powers. Since there is no system for peacefully adjudicating such disputes, these conflicts are typically resolved through tests of power.
  • When a leading country’s costs of maintaining its empire abroad become greater than the revenue that the empire brings in, that economically weakens the country. When that happens at the same time that other countries are emerging as rival powers, the leading power feels compelled to defend its interests. This is especially threatening to the leading country both economically and militarily, because greater military spending is required to maintain the empire, which comes when worsening domestic economic conditions are making it more difficult for leaders to tax and more necessary for them to spend on domestic supports. Seeing this dilemma, enemy countries are more inclined to mount a challenge. Then the leading power is faced with the difficult economic and military choice of fighting or retreating.
  • When other exogenous shocks, such as acts of nature (e.g., plagues, droughts, or floods), occur during times of vulnerabilities such as those mentioned above, they increase the risk of a self-reinforcing downward spiral.
  • When the leadership of the country is too weak to provide what the country needs to be successful at its stage in the cycle, that is also a problem. Of course, because each leader is responsible for leading during only a tiny portion of the cycle, they have to deal with, and can’t change, the condition of the country that they inherit. This means that destiny, more than the leader, is in control.

I threw a lot at you fast in the last few paragraphs in which I tried to briefly describe the major cause-effect relationship, so you might want to read them again slowly so you can see if that sequence makes sense to you. In Part 2, we will get into a number of specific cases in greater depth and you will see the patterns of these cycles emerge, albeit not in a precise way. The fact that they occur and the reasons for them occurring are less disputable than the exact timing of their occurrences.

To summarize, around the upward trend of productivity gains that produce rising wealth and better living standards, there are cycles that produce 1) prosperous periods of building, in which the country is fundamentally strong because there are a) relatively low levels of indebtedness, b) relatively small wealth, values, and political gaps, c) people working effectively together to produce prosperity, d) good education and infrastructure, e) strong and capable leadership, and f) a peaceful world order that is guided by one or more dominant world powers. These are the prosperous and enjoyable periods. When they are taken to excess, which they always are, the excesses lead to 2) depressing periods of destruction and restructuring, in which the country’s fundamental weaknesses of a) high levels of indebtedness, b) large wealth, values, and political gaps, c) different factions of people unable to work well together, d) poor education and poor infrastructure, and e) the struggle to maintain an overextended empire under the challenge of emerging powerful rivals lead to a painful period of fighting, destruction, and then a restructuring that establishes a new order, setting the stage for a new period of building.

Looked at even more simply, the items shown below are the main forces that drive the rises and declines of countries. For any country, the more items it has on the left, the more it is likely to ascend; the more items it has on the right, the more it is likely to decline. Those that make it to the top acquire the characteristics on the left (which causes them to ascend), but with time they move to the right, which makes them more prone to decline, while new competitive countries acquire the characteristics to the left until they are stronger, at which time the shift occurs.

That, in a nutshell, is what my research has shown makes the cycles of rising and declining empires occur. Now, for the fun of it you might want to go through a little exercise of ticking off where each of those measures is for each country you’re interested in. Rank each country on a 1-10 scale for each attribute, beginning with 10 on the far left and 1 on the far right. If you add these all these rankings up, the higher the number, the greater the probability of the country rising on a relative basis. The lower the number, the more likely it will fall. Take a moment to calculate where the United States is, where China is, where Italy is, where Brazil is, and so on. Later in this report we will do exactly this in a systematic way for each of the largest 20 countries using key performance indicators that I will show you.

Because all of these factors, both ascending and descending, tend to be mutually reinforcing, it is not a coincidence that large wealth gaps, debt crises, revolutions, wars, and changes in the world order have tended to come as a perfect storm. The big cycles of an empire’s rise and decline look like those in the chart below. The bad periods of destruction and restructuring via depression, revolution, and war, which largely tear down the old system and set the stage for the emergence of a new system, typically take about 10 to 20 years, though variations in the range can be much larger. They are depicted by the shaded areas in the chart. They are followed by more extended periods of peace and prosperity in which smart people work harmoniously together and no country wants to fight the world power because it’s too strong. These peaceful periods last for about 40 to 80 years, though variations in the range can be much larger. Within these cycles are smaller cycles like the short-term debt/business cycle that last about 7 to 10 years.

Where We Are Now

As previously explained, the last major period of destroying and restructuring happened in 1930-45, which led to the new period of building and the new world order that began in 1945 with the creation a new global monetary system (built in 1944 in Bretton Woods, New Hampshire) and a new American-dominated system of world governance (located the United Nations in New York and the World Bank and the International Monetary Fund in Washington, DC). The new American world order was the natural consequence of the US being the richest country (it then had 80% of the world’s gold stock and gold was then money), the dominant economic power (it then accounted for about half of world production), and the strongest military power (it then had a monopoly on nuclear weapons and the strongest conventional forces).

It is now 75 years later, and we are classically near the end of a long-term debt cycle when there are large debts and classic monetary policies don’t work well for the world’s reserve currency central banks. This is happening as we are simultaneously in a deep economic and debt contraction that is producing income and balance sheet holes for people, companies, nonprofit organizations, and governments, while politically fragmented central governments are trying to fill in these holes by giving out a lot of money that they are borrowing. Central banks are helping them do that by monetizing government debt. All this is happening at the same time that there are big wealth and values gaps and there is a rising world power that is competing with the leading world power in trade, technology development, capital markets, and geopolitics. And on top of all this, we have a pandemic to contend with.

At the same time, we have great human capital and thinking technologies that can help us see how to best deal with these challenges and do the inevitable restructurings well. If we can all deal with each other well, we will certainly get past this difficult time and move on to a new prosperous period that will be quite different.

In the next chapters of Part 1, I will more closely look into the histories and mechanics of the most important of the 17 drivers and will conclude by attempting to squint into the future.

I will try to pass along pieces of this study to you about once a week until we reach the point of diminishing returns.

[1] These indices were made up of a number of different statistics, some of which were directly comparable and some of which were broadly analogous or broadly indicative. In some cases, a data series that stopped at a certain point had to be spliced with a series that continued back in time. Additionally, the lines shown on the chart are 30-year moving averages of these indices, shifted so that there is no lag. I chose to use the smoothed series because the volatility of the unsmoothed series was too great to allow one to see the big movements. Going forward, I will use these very smoothed versions when looking at the very long term and much less smoothed or unsmoothed versions when looking at these developments up close, because the most important developments were best captured this way.

[2] We show where key indicators were relative to their history by averaging them across the cases. The chart is shown such that a value of “1” represents the peak in that indicator relative to history and “0” represents the trough. The timeline is shown in years with “0” representing roughly when the country was at its peak (i.e., when the average across gauges was at its peak). In the rest of this section, we walk through each of the stages of the archetype in more detail. While the charts show the countries that produced global reserve currencies, we’ll also heavily reference China, which was a dominant empire for centuries, though it never established a reserve currency.

Chapter 2

Money, Credit, and Debt

Published 04/23/20

Note: To make this an easier and shorter document to read, I tried to convey the most important points in simple language and bolded them, so you can get the gist of the whole thing in just a few minutes by focusing on what’s in bold. Additionally, if you want a simple and entertaining 30-minute explanation of how what a lot of what I’m talking about here works, see “How the Economic Machine Works,” which is available on YouTube.

This article, along with others in this series, are an early preview of a book I’m working on called The Changing World Order. I will publish the book this fall but felt that, as I was writing it, the learning I was getting from my research was very helpful in understanding what is happening right now, so I wanted to pass it along to you as a work-in-progress. If you’d like to sign up to receive updates on this series, go to You can also pre-order the book at Amazon or Barnes and Noble.

Chapter 2: The Big Cycle of Money, Credit, Debt, and Economic Activity

Because what most people and their countries want the most is wealth and power, and because money and credit are the biggest single influence on how wealth and power rise and decline, if you don’t understand how money and credit work, you can’t understand the biggest driver of politics within and between countries so you can’t understand how the world order works. And if you don’t understand how the world order works, you can’t understand what’s coming at you.

For example, if you don’t understand how the Roaring ’20s led to a debt bubble and a big wealth gap, and how the bursting of that debt bubble led to the 1930-33 depression, and how the depression and wealth gap led to conflicts over wealth all around the world, you can’t understand the forces that led to Franklin D. Roosevelt being elected president. You also wouldn’t understand why, soon after his inauguration in 1933, he announced a new plan in which the central government and the Federal Reserve would together provide a lot of money and credit, a change that was similar to things happening in other countries at the same time and similar to what is happening now. Without understanding money and credit, you wouldn’t understand why these things changed the world order nor would you understand what happened next (i.e., the war, how it was won and lost, and why the new world order was created as it was in 1945), and you won’t be able to understand what is happening now or imagine the future. However, by seeing many of these cases and understanding the mechanics behind them, you will be able to better understand what is happening now and what is likely to happen in the future.

In doing this study, I spoke with several of the world’s most renowned historians and political practitioners, including current and former heads of state, foreign ministers, finance ministers, and central bankers. In our explorations of how the world really works, it was clear that we each brought different pieces of the puzzle that made the picture much clearer when we put them together. We agreed that the two most essential understandings to have are of 1) how money, credit, and economics work and 2) how domestic and international politics work. Several told me that the understanding conveyed in this chapter has been the biggest missing piece in their quest to understand the lessons of history and I explained to them how their perspectives helped me better understand the political dynamic that affects economic policy choices. This chapter is focused on the money, credit, and economic piece.

Let’s start with the timeless and universal fundamentals of money and credit.

The Timeless and Universal Fundamentals of Money and Credit

All entities—people, companies, nonprofit organizations, and governments—deal with the same basic financial realities, and always have. They have money that comes in (i.e., revenue) and money that goes out (i.e., expenses) which, when netted, makes up their net income. These flows are measured in numbers that can be shown in their income statements. If one brings in more than one spends, one has a profit that causes one’s savings to go up. If one’s spending is more than one’s earnings, one’s savings goes down or one has to make up the difference by borrowing it or taking it from someone else. The assets and liabilities (i.e., debts) that one has can be shown in one’s balance sheet. Whether one writes these numbers out or not, every country, company, nonprofit organization, and person has them. The relationships between each entity’s income, expenses, and savings when combined to be the relationships between all entities’ incomes, expenses, and savings transpire in a dynamic way to be the biggest driver of changes in the world order. So, if you can take your understanding of your own income, expenses, and savings, imagine how that applies to others, and put them together, you will see how the whole thing works.

In brief, if one spends more than one takes in one has to get the money from somewhere, and if one takes in more than one spends one has to put the money one gains somewhere. If one is short of money one can get the money by either drawing down one’s saving, borrowing the money, or taking it from someone else. If one has more money than one uses it will either be added to one’s savings as an investment or given to someone else. What one’s savings looks like—i.e., the assets and the liabilities—shows up in one’s balance sheet. If one has many more assets than liabilities (i.e., a large net worth), one can spend above one’s income by selling assets until the money runs out, at which point one has to slash one’s expenses. If one doesn’t have much more in assets than one has in liabilities and one’s income falls beneath the amount one needs to pay out to cover the total of one’s operating expenses and one’s debt-service expenses, one will have to cut one’s expenses or will default/restructure one’s debts. Since one person’s spending is another person’s income, that cutting of expenses will hurt not just the entity that is having to cut those expenses but it will hurt the ones who depend on that spending to earn income. Similarly, since one’s debts are another’s assets, that defaulting on debts reduces other entities’ assets, which requires them to cut their spending. This dynamic produces a self-reinforcing downward debt and economic contraction that becomes a political issue as people argue over how to divide the shrunken pie. As a principle, debt eats equity. What I mean by that is that for most systems, when the rules of the game are followed, debts have to be paid above all else so that when one has “equity” ownership—e.g., in one’s investment portfolio or in one’s house—and one can’t service the debt, the asset will be sold or taken away. In other words, the creditor will get paid ahead of the owner of the asset. As a result, when one’s income is less than one’s expenses and one’s assets are less than one’s liabilities (i.e., debts), one is on the way to having one’s assets sold and going broke.

However, unlike what most people intuitively think, there isn’t a fixed amount of money and credit in existence. Money and credit can easily be created by governments. Their creating it is liked because it gives people, companies, nonprofit organizations, and governments more spending power. Their taking the credit and spending it on goods, services, and investment assets makes most everything go up in price which most people like. The problem is that it creates a lot of debt and paying it back is difficult and painful. That is why money, credit, debt, and economic activity are inherently cyclical. In the credit creation phase, demand for goods, services, and investment assets and the production of them is strong, and in the debt paying back phase it is weak.

But what if the debts never had to be paid back? Then there would be no debt squeeze and no painful paying back period. But that would be terrible for those that lent to them because they’d lose their money, right? Let’s think about that for a moment to see if we can find a way around that problem. Since government (i.e., the central government and the central bank combined) has the abilities to both make and borrow money, why couldn’t the central bank lend money at an interest rate of about 0% to the central government (to distribute as it likes) and also lend to others at low rates and allow those debtors to never pay it back. Normally debtors have to pay the original amount borrowed (principal) plus interest in installments over a period of time. But what if the interest rate was 0% and the central bank that lent the money kept rolling over the debt so that the debtor never had to pay it back? That would be the equivalent of giving the debtors the money but it wouldn’t look that way because the debt would still be accounted for as an asset that the central bank owns so the central bank can still say it is performing its normal lending functions. Central banks could do that. In fact that is what is now happening.

To understand what is now happening and will happen financially to you, to other individuals, to companies, to nonprofit organizations, to governments, and to whole economies, it is important to watch how their income statements and balance sheets are doing and to imagine what will likely happen. Take a moment to think about how this is happening to you and your own financial situation. How much income do you have and will you have in the future relative to your expenses? How much savings do you have, and what’s that savings in? Now play things out. If your income fell or disappeared, how long would your savings last? How much risk do you have in the value of the investments in your savings? If your savings fell in value by half how would you be financially? Can you easily sell your assets to get cash to pay your expenses or service your debts? What are your other sources of money, from the government or from elsewhere? These are the most important calculations you can make to assure your economic well-being. Now look at others—other people, businesses, nonprofit organizations, and governments—realizing that the same is true for them. Now see how we are interconnected and what changes in conditions might mean for you and others who might affect you. Since the economy is nothing more than all these entities operating in this way, if you can visualize this well it will help you understand what is happening and what is likely to happen.

As for what is happening now, the biggest problem that we collectively now have is that for many people, companies, nonprofit organizations, and governments the incomes are low in relation to the expenses, and the debts and other liabilities (such as those for pension, healthcare, and insurance) are very large relative to the value of their assets. It may not seem that way—in fact it often seems the opposite—because there are many people, companies, nonprofit organizations, and governments that look rich even while they are in the process of going broke. They look rich because they spend a lot, have plenty of assets, and even have plenty of cash. However, if you look carefully you will be able to identify those who look rich but are in financial trouble because they have incomes that are below their expenses and/or liabilities that are greater than their assets so, if you project out what will likely happen to their finances, you will see that they will have to cut their expenses and sell their assets in painful ways that will leave them broke. We each need to do those projections of what the future will look like for our own finances, for others who are relevant to us, and for the world economy.

If anything I said is confusing to you, I urge you to think about it until you get it. So, pencil out what your financial safety margin looks like (how long will you be financially OK if the worst scenario happens—like you lose your job and your investment assets fall to be only half as much to account for possible price falls, taxes, and inflation). Then do that calculation for others, add them up, and then you will have a good picture of the state of the world. I’ve done that with the help of my partners at Bridgewater and find it invaluable in imagining what is likely to happen. You can read more of my perspective on this in "The Big Picture.” In a nutshell, the liabilities are enormous relative to the net incomes and the asset values that are required to meet those obligations.

In summary, those basic financial realities work for all people, companies, nonprofit organizations, and governments in the same way they work for you and me, with one big, important exception. All countries can create money and credit out of thin air to give to people to spend or to lend it out. By producing money and giving it to debtors in need, central banks can prevent the debt crisis dynamic that I just explained. For that reason I will modify the prior principle to say debt eats equity, money feeds the hunger of debt, and central banks can produce money. So, it should not be surprising that governments print money when there are debt crises that are causing debt to eat more equity and causing more economic pain that is politically acceptable.

However, not all money that governments print is of equal value.

The monies (i.e., currencies) that are widely accepted around the world are called reserve currencies. At this time the world’s dominant reserve currency is the US dollar, which is created by the US central bank, which is the Federal Reserve; it accounts for about 55% of all international transactions. A much less important currency is the euro, which is produced by the Eurozone countries’ central bank, the European Central Bank; it accounts for about 25% of all international transactions. The Japanese yen, the Chinese renminbi, and the British pound all are relatively small reserve currencies now, though the renminbi is growing quickly in importance.

Having a reserve currency is great while it lasts because it gives the country exceptional borrowing and spending power but also sows the seeds of it ceasing to be a reserve currency, which is a terrible loss. That is because having a reserve currency allows the country to borrow a lot more than it could otherwise borrow which leads it to have too much debt that can’t be paid back which requires its central bank to create a lot of money and credit which devalues the currency so nobody wants to hold the reserve currency as a storehold of wealth. Countries that have reserve currencies can produce a lot of money and credit/debt denominated in them, especially when there is a shortage of them such as now. That is what the Fed is now doing. In contrast countries that don’t have reserve currencies are especially prone to finding themselves in need of these reserve currencies (e.g., dollars) when a) they have a lot of debt that is owed in the reserve currencies that they can’t print (e.g., dollars), b) they don’t have much savings in those reserve currencies, and c) their ability to earn the currencies they need falls off. When countries that don’t have reserve currencies desperately need reserve currencies to pay their debts that are denominated in reserve currencies and to buy things from sellers who want them to pay in reserve currencies, their inability to get enough reserve currencies to meet those needs can bankrupt them. That is where things now stand for a number of countries. It is also where things stand for local governments and states and for many of us. For example a number of states, local governments, companies, nonprofit organizations, and people have suffered income losses and don’t have much savings relative to their losses. They will have to cut their expenses or get money and credit some other way. Others will get money or very cheap credit that may never have to be paid back from the government. The government, and not the free market, will determine who gets what.

At the time of this writing the income levels of a number of people, companies, nonprofit organizations, and governments have plunged to be below their expense levels by amounts that are large in relation to their net worths so they will be forced either to slash their expenses, which is painful to do now, or to risk running out of their savings and having to default on their debts. Governments that have the power to do so are creating money and credit to give to many but not all of them to help ease the debt burdens and help finance the expenses that are denominated in their own currencies. This configuration of circumstances has happened throughout history and has been handled in the same way so it’s easy to see how this machine works. That is what I want to make sure that I convey in this chapter.

Let’s start with the real basics and build from there.

What is money?

Money is a medium of exchange that can also be used as a storehold of wealth.

By medium of exchange, I mean that it can be given to someone to buy things. Basically people produce things in order to exchange them with people who have other things that they want. Because carrying around non-money objects in the hope of exchanging them for what one wants (i.e., barter) is inefficient, virtually every society that has ever existed has invented money (also known as currency) to be something portable that everyone agrees is of value so it can be exchanged for what we want.

By a storehold of wealth, I mean a vehicle for storing buying power between acquiring it and spending it. While people can store their wealth in assets that they expect will retain their value or appreciate (such as gold, gems, paintings, real estate, stocks, and bonds), one of the most logical things to store it in has been the money that one will use later. But they actually don’t hold the currency because they believe that they can hold something a bit better and always exchange the thing they’re holding to get the currency to buy the things they want to buy. That is where credit and debt come into the picture.

When lenders lend, they assume that the money they will receive back will buy more goods and services than if they just held onto the money. If done well, the borrowers used the money productively and earned a profit so that they can pay the lenders back and keep some extra money. When the loan is outstanding it is an asset for the lender (e.g., a bond) and a liability (debt) for the borrower. When the money is paid back, the assets and liabilities disappear, and the exchange is good for both the borrowers and lenders. They essentially split the profits that come from doing this productive lending. It is also good for the whole society, which benefits from the productivity gains that result from this.1

So, it’s important to realize that 1) most money and credit (especially the fiat money that now exists) has no intrinsic value, 2) it is just journal entries in an accounting system that can easily be changed, 3) the purpose of that system is to help to allocate resources efficiently so that productivity can grow, rewarding both lenders and borrowers, and 4) that system periodically breaks down. As a result, since the beginning of time, all currencies have either been destroyed or devalued. When currencies are destroyed or devalued that shifts wealth in a big way that sends big reverberations through the economy and markets.

More specifically, rather than working perfectly the money and credit system swings the supplies, demands, and values of money in cycles that in the upswings produce joyful abundance and in the downswings produce painful restructurings. Let’s now get into how these cycles work building from the fundamentals up to where we now are.

The Fundamentals

While money and credit are associated with wealth, they aren’t wealth. Because money and credit can buy wealth (i.e., goods and services) the amount of money and credit one has and the amount of wealth one has look pretty much the same. But one cannot create more wealth simply by creating more money and credit. To create more wealth, one has to be more productive. The relationship between the creation of money and credit and the creation of wealth (actual goods and services) is often confused yet it is the biggest driver of economic cycles, so let’s look at this relationship more closely.

There is typically a mutually reinforcing relationship between a) the creation of money and credit and b) the amount of goods, services, and investment assets that are produced so it’s easy to get them confused. Think of it this way. There is both a real economy and a financial economy. Though they are related, they are different. Each has their own supply and demand factors that drive them. For example, in the real economy, when the level of goods and services demanded is strong and rising and the capacity to produce those things demanded is limited, the real economy’s capacity to grow is limited and, if demand keeps rising faster than the capacity to produce, inflation rises. In that example inflation rises because of what is happening in the real economy. Knowing that, central banks normally tighten money and credit at such times to slow the demand. That is an example of something that is happening in the financial economy affecting what’s happening in the real economy. During normal times, which is through most of the long-term debt cycle, central banks turn on and turn off credit, which raises and lowers demand and production. Because they do that imperfectly we have the short-term debt cycles, which we also call overheated economies and recessions. In the financial economy, normally money and credit are created by central banks and flow into financial assets, which produces lending that finances people’s borrowing and spending with the private credit system allocating that money and credit. How financial assets are produced by the government through fiscal and monetary policy has a huge effect on who gets the money and credit and the buying power that goes along with it, which also determines what it’s spent on. For example you now see governments atypically giving money, credit, and buying power to those they want to get it to rather than it being allocated by the marketplace, so you are see capitalism as we know it being suspended.

Then of course there is the value of money and credit to consider. It is based on its own supply and demand. For example, when a lot of it is created relative to the demand for it, declines in its value will occur. Where it flows to is important in determining what happens. For example, when the money and credit that central banks are creating no longer go into lending that fuels increases in economic demand and instead go into other currencies and inflation-hedge assets, it fails to stimulate economic activity and instead causes the value of the currency to decline and the value of inflation-hedge assets to rise. At such times high inflation can occur because the supply of money and credit has increased relative to the demand for it, which we call monetary inflation. That can happen at the same time as there is weak demand for goods and services and the selling of assets so that the real economy is experiencing deflation. That is how inflationary depressions come about. For these reasons to understand what is likely to happen financially and economically one has to watch movements in the supplies and demands of both the real economy and the financial economy.

Similarly confused is the relationship between the prices of things and the value of things. Because they tend to go together they can be confused as being the same thing. They tend to go together because when people have more money and credit they are more inclined to spend more and can spend more. In other words, if you give people more money and credit they will feel richer and spend more on goods and services. To the extent that spending increases economic production and raises the prices of goods, services, and financial assets, it can be said to increase wealth, because the people who own those assets become “richer” when measured by the way we account for wealth. However, that increase in wealth is more an illusion than a reality for two reasons: 1) the increased credit that pushes prices and production up has to be paid back, which, all things being equal, will have the opposite effect when it has to be paid back and 2) the intrinsic value of things doesn’t increase just because their prices go up. Think about it this way: if you own a house and the government creates a lot of money and credit and the price of your house goes up you will still own the same house—i.e., your actual wealth hasn’t increased; just your calculated wealth has increased. Similarly, if the government creates a lot of money and credit that is used to buy goods, services, and investment assets (e.g., stocks, bonds, and real estate) which go up in price, the amount of calculated wealth goes up but the amount of actual wealth hasn’t gone up because you own the exact same thing as you did before it was considered worth more. In other words, using market values of what one owns to measure one’s wealth gives an illusion of changes in wealth that doesn’t really exist. As far as how the economic machine works, the big thing is that money and credit is stimulative when it’s given out and depressing when it has to be paid back. That’s what normally makes money, credit, and economic growth so cyclical.

The people who control money and credit (i.e., central banks) vary the costs and availability of money and credit to control markets and the economy as a whole. When the economy is growing too quickly and they want to slow it down, they make less money and credit available, causing both to become more expensive. This encourages people to lend rather than to borrow and spend. When there is too little growth and central bankers want to stimulate the economy, they make money and credit cheap and plentiful, which encourages people to borrow and invest and/or spend. These variations in the cost and availability of money and credit also cause the prices and quantities of goods, services, and investment assets to rise and fall. But banks can only control the economy within their capacities to produce money and credit growth, and their capacities to do that are limited.

Think of the central bank as having a bottle of stimulant that they can inject into the economy as needed with the amount of stimulant in the bottle being limited. When the markets and the economy sag they give them shots of the money and credit stimulant to pick them up, and when they’re too hot they give them less stimulant. These moves lead to cyclical rises and declines in the amounts and prices of money and credit, and of goods, services, and financial assets. These moves typically come in the form of short-term debt cycles and long-term debt cycles. The short-term cycles of ups and downs typically last about eight years, give or take a few. The timing is determined by the amount of time it takes the stimulant to raise demand to the point that it reaches the limits of the real economy’s capacity to produce. Most people have seen enough of these short-term debt cycles to know what they are like—so much so that they mistakenly think that they will go on working this way forever. They’re most popularly called “the business cycle,” though I call them “the short-term debt cycle” to distinguish them from “the long-term debt cycle.” Over long periods of time these short-term debt cycles add up to long-term debt cycles that typically last about 50 to 75 years.2 Because they come along about once in a lifetime most people aren’t aware of them; as a result they typically take people by surprise, which hurts a lot of people. The last big long-term debt cycle, which is the one that we are now in, was designed in 1944 in Bretton Woods, New Hampshire, and was put in place in 1945 when World War II ended and we began the dollar/US-dominated world order.

These long-term debt cycles start when debts are low after previously existing excess debts have been restructured in a way so that central banks have a lot of stimulant in the bottle, and they end when debts are high and central banks don’t have much stimulant left in the bottle. More specifically, the ability of central banks to be stimulative ends when the central bank loses its ability to produce money and credit growth that pass through the economic system to produce real economic growth. That lost ability of central bankers typically takes place when debt levels are high, interest rates can’t be adequately lowered, and the creation of money and credit increases financial asset prices more than it increases actual economic activity. At such times those who are holding the debt (which is someone else’s promise to give them currency) typically want to exchange the currency debt they are holding for other storeholds of wealth. When it is widely perceived that the money and the debt assets that are promises to receive money are not good storeholds of wealth, the long-term debt cycle is at its end, and a restructuring of the monetary system has to occur. In other words the long-term debt cycle runs from 1) low debt and debt burdens (which gives those who control money and credit growth plenty of capacity to create debt and with it to create buying power for borrowers and a high likelihood that the lender who is holding debt assets will get repaid with good real returns) to 2) high debt and debt burdens with little capacity to create buying power for borrowers and a low likelihood that the lender will be repaid with good returns. At the end of the long-term debt cycle there is essentially no more stimulant in the bottle (i.e., no more ability of central bankers to extend the debt cycle) so there needs to be a debt restructuring or debt devaluation to reduce the debt burdens and start this cycle over again. Throughout history central governments and central banks have created money and credit which weakened their own currencies and raised their levels of monetary inflation to offset the deflation that comes from the deflationary credit and economic contractions.

Since these cycles are big deals and have happened virtually everywhere for as long as there has been recorded history, we need to understand them and have timeless and universal principles for dealing with them well. However, these long-term debt cycles take about a lifetime to transpire, unlike the short-term debt cycles that we all experience a number of times in our lifetimes so most people understand better. When it comes to the long-term debt cycle most people, including most economists, don’t recognize or acknowledge its existence because, to see a number of them in order to understand the mechanics of how they work, one has to look at them operating in a number of countries over many hundreds of years in order to get a good sample size. In Part 2 of this study we will look at all of the most important cycles with reference to the timeless and universal mechanics of why money and credit have worked and failed to work as mediums of exchange and storeholds of wealth. In this chapter, we will look at how they archetypically work.

I will start with the basics of the long-term debt cycle from way back when and bring you up to the present, giving you a classic template. To repeat, while I’m saying that this is a classic template I’m not saying that all cases transpire exactly like this, though I am saying that almost all follow this pattern closely.

The Long-Term Debt Cycle

Let’s start with the basics.

1) It Begins with No or Low Debt and “Hard Money”

When societies first invented money they used all sorts of things, like grain and beads. But mostly they used things that had intrinsic value, like gold, silver, and copper. Let’s call that “hard money.”

Gold and silver (and sometimes copper and other metals like nickel) were the preferred forms of money because 1) they had intrinsic value and 2) they could easily be shaped and sized to be to portable so they could easily be exchanged. Having intrinsic value (i.e., being useful in and of themselves) was important because no trust—or credit—was required to carry out an exchange with them. Any transaction could be settled on the spot, even if the buyer and seller were strangers or enemies. There is an old saying that “gold is the only financial asset that isn’t someone else’s liability.” That is because it has widely accepted intrinsic value, unlike debt assets or other assets that require an enforceable contract or a law to ensure the other side will deliver on its promise to deliver whatever it promised to deliver (which when it’s just “paper” currency that can easily be printed isn’t much of a promise). On the other hand, if during such a period of lack of trust and enforceability one receives gold coins from a buyer, that doesn’t have a credit component to it—i.e., you could melt them down and still receive almost the same amount of value because of its intrinsic value—so the transaction can happen without the same sort of risks and lingering promises that need to be kept. When countries were at war and there was not trust in the intentions or abilities to pay, they could still pay in gold. So gold (and to a lesser extent silver) could be used as both a safe medium of exchange and a safe storehold of wealth.

2) Then Come Claims on “Hard Money” (aka, “Notes” or “Paper Money”)

Because carrying a lot of metal money around was risky and inconvenient, credible parties (which came to be known as banks, though they initially included all sorts of institutions that people trusted, such as temples in China) arose that would put the money in a safe place and issue paper claims on it. Soon people treated these paper “claims on money” as if they were money themselves. After all, they were as good as money because they could be redeemed for tangible money. This type of currency system is called a linked currency system because the value of the currency is linked to the value of something, typically a “hard money” such as gold.

3) Then Comes Increased Debt

At first there is the same number of claims on the “hard money” as there is hard money in the bank. However, the holders of the paper claims and the banks discover the wonders of credit and debt. They can lend these paper claims to the bank in exchange for an interest payment so they get interest. The banks that borrow it from them like it because they lend the money to others who pay a higher interest rate so the banks make a profit. And those who borrow the money from the bank like it because it gives them buying power that they didn’t have. And the whole society likes it because it leads asset prices and production to rise. Since everyone is happy with how things are going they do a lot of it. More lending and borrowing happens over and over again many times, there is a boom, and the quantity of the claims on the money (i.e., debt assets) rises relative to the amount of actual goods and services there are to buy. Trouble approaches either when there isn’t enough income to survive one’s debts or when the amount of the claims (i.e., debt assets) that people are holding in the expectation that they can sell them to get money to buy goods and services increases faster than the amount of goods and services by an amount that makes the conversion from that debt asset (e.g., that bond) implausible. These two problems tend to come together.

Concerning the first of these problems, think of debt as negative earnings and a negative asset that eats up earnings (because earnings have to go to pay it) and eats up other assets (because other assets have to be sold to get the money to pay the debt). It is senior—meaning it gets paid before any other type of asset—so when incomes and the values of one’s assets fall, there is a need to cut expenditures and sell off assets to raise the needed cash. When that’s not enough, there needs to be a) debt restructurings in which debts and debt burdens are reduced, which is problematic for both the debtor and the creditor because one person’s debts are another’s assets and/or the b) central bank printing money and the central government handing out money and credit to fill in the holes in incomes and balance sheets (which is what is happening now).

Concerning the second of these problems, it occurs when holders of debt don’t believe that they are going to get adequate returns from it. Debt assets (e.g., bonds) are held by investors who believe that they are storeholds of wealth that can be sold to get money, which can be used to buy things. When the holders of debt assets try to make the conversion to real money and real goods and services and find out that they can’t, this problem surfaces. Then a “run” occurs, by which I mean that lots of holders of that debt want to make that conversion to money, goods, services, and other financial assets. The bank, regardless of whether it is a private bank or a central bank, is then faced with the choice to allow that flow of money out of the debt asset, which will raise interest rates and cause the debt and economic problems to worsen, or to “print money” and buy enough of those bonds that others are selling to prevent interest rates from rising and hopefully reverse the run out of them. Sometimes their doing that buying works temporarily, but if the ratio of a) claims on money (debt assets) to b) the amount of money there is and the quantity of goods and services there are to buy is too high, the bank is in a bind that it can’t get out of because it simply doesn’t have enough money to meet the claims so it will have to default on its claims. When that happens to a central bank it has the choice either to default or to print the money and devalue it. They inevitably devalue. When these debt restructurings and currency devaluations are big they lead to breakdowns and possibly destructions of the monetary system. Whatever the bank or the central bank does, the more debt (i.e., claims on money and claims on goods and services) there is, the more the likelihood that it will be necessary to devalue the money.

Remember that there is always a limited amount of goods and services because the amount is constrained by the ability to produce. Also remember that in our example of paper money being claims on “hard money,” there is a limited amount of that “hard money” (e.g., the gold on deposit), while the amount of paper money (e.g., the claims on that hard money) and debt (the claims on that paper money) is constantly growing. And, as that amount of paper money claims grows relative to the amount of hard money in the bank and goods and services in the economy, the risk increases that the holders of those debt assets may not be able to redeem them for the amounts of hard money or goods and services that they expect to be able to exchange them for.

It is important to understand the difference between money and debt. Money is what settles claims—i.e., one pays one’s bills and one is done. Debt is a promise to deliver money. In watching how the machine is working it is important to watch a) the amounts of both debt and money that exist relative to the amount of hard money (e.g., gold) in the bank and b) the amounts of goods and services that exist, which can vary, remembering that debt cycles happen because most people love to expand their buying power (generally through debt) while central banks tend to want to expand the amount of money in existence because people are happier when they do that. But this can’t go on forever. And it is important to remember that the “leveraging up” phase of the money and debt cycle ends when bankers—whether private bankers or central bankers—create a lot more certificates (paper money and debt) than there is hard money in the bank to give and the inevitable day comes when more certificates are turned in than there is money to give. Let’s look at how that happens.

4) Then Come Debt Crises, Defaults, and Devaluations

History has shown that when the bank’s claims on money grow faster than the amount of money in the bank—whether the bank is a private bank or government-controlled (i.e., central bank)—eventually the demands for the money will become greater than the money the bank can provide and the bank will default on its obligations. That is what is called a bank run. One can quite literally tell when a bank run is happening and a banking crisis is imminent by watching the amounts of money in banks (whether “hard” or paper) decline and approach the point of running out due to withdrawals.

A bank that can’t deliver enough hard money to meet the claims that are being made on it is in trouble whether it is a private or a central bank, though central banks have more options than private banks do. That’s because a private bank can’t simply print the money or change the laws to make it easier to pay their debts, while a central bank can. Private bankers must either default or get bailed out by the government when they get into trouble, while central bankers can devalue their claims (e.g., pay back 50-70%) if their debts are denominated in their national currency. If the debt is denominated in a currency that they can’t print, then they too must ultimately default.

5) Then Comes Fiat Money

Central banks want to stretch the money and credit cycle to make it last for as long as they can because that is so much better than the alternative, so, when “hard money” and “claims on hard money” become too painfully constrictive, governments typically abandon them in favor of what is called “fiat” money. No hard money is involved in fiat systems; there is just “paper money” that the central bank can “print” without restriction. As a result, there is no risk that the central bank will have its stash of “hard money” drawn down and have to default on its promises to deliver it. Rather the risk is that, freed from the constraints on the supply of tangible gold or some other “hard” asset, the people who control the printing presses (i.e., the central bankers working with the commercial bankers) will create ever more money and debt assets and liabilities in relation to the amount of goods and services being produced until a time when those who are holding the enormous amount of debt will try to turn them in for goods and services which will have the same effect as a run on a bank and result in either debt defaults or the devaluation of money. That shift from a) a system in which the debt notes are convertible to a tangible asset (e.g., gold) at a fixed rate to b) a fiat monetary system in which there is no such convertibility last happened in 1971. When that happened—on the evening of August 15, when President Nixon spoke to the nation and told the world that the dollar would no longer be tied to gold—I watched that on TV and thought, “Oh my God, the monetary system as we know it is ending,” and it was. I was clerking on the floor of the New York Stock Exchange at the time, and that Monday morning I went on the floor expecting pandemonium with stocks falling and found pandemonium with stocks rising. Because I had never seen a devaluation before I didn’t understand how they worked. Then I looked into history and found that on Sunday evening March 5, 1933, President Franklin Roosevelt gave essentially the same speech doing essentially the same thing which yielded essentially the same result over the following months (a devaluation, a big stock market rally, and big gains in the gold price), and I saw that that happened many times before in many countries, including essentially the same proclamations by the heads of state.

In the years leading up to 1971 the US government spent a lot of money on military and social programs then referred to as “guns and butter” policy, which it paid for by borrowing money that created debt. The debt was a claim on money that could be turned in for gold. The investors bought this debt as assets because they got paid interest on this government debt and because the US government promised that it would allow the holders of these notes to exchange them for the gold that was held in the gold vaults in the US. As the spending and budget deficits in the US grew the US had to issue much more debt—i.e., create many more claims on gold—even though the amount of gold in the bank didn’t go up. Naturally more investors turned in their promises to get the gold for the claims on the gold. People who were astute enough to pay attention could see that the US was running out of gold and the amount of outstanding claims on gold was much larger than the amount of gold in the bank, so they realized that if this continued the US would default. Of course the idea that the United States government, the richest and most powerful government in the world, would default on its promise to give those who had claims on gold the gold it promised to give them seemed implausible at the time. So, while most people were surprised at the announcement and the effects on the markets, those who understood the mechanics of how money and credit work were not.

When credit cycles reach their limit it is both the logical and the classic response for central governments and their central banks to create a lot of debt and print money that will be spent on goods, services, and investment assets to keep the economy moving. That is what was done during the 2008 debt crisis, when interest rates could no longer be lowered because they had already hit 0%. As explained that was also done in response to the 1929-32 debt crisis, when interest rates had been driven to 0%. This creating of the debt and money is now happening in amounts that are greater than at any time since World War II.

To be clear, central banks’ “printing money” and giving it out for spending rather than supporting spending with debt growth is not without its benefits—e.g., money spends like credit, but in practice (rather than in theory) it doesn’t have to be paid back. In other words, there is nothing wrong with having an increase in money growth instead of an increase in credit/debt growth, provided that the money is put to productive use. The main risks of printing money rather than facilitating credit growth are a) market participants will fail to carefully analyze whether the money is being put to productive use and b) it eliminates the need to have the money paid back. Both increase the chances that money will be printed too aggressively and not used productively so people will stop using it as a storehold of wealth and will shift their wealth into other things. Throughout history, when the outstanding claims on hard money (debt and money certificates) are far greater than there is hard money and goods and services, a lot of defaults or a lot of printing of money and devaluing have always happened.

History has shown us that we shouldn’t rely on governments to protect us financially. On the contrary, we should expect most governments to abuse their privileged positions as the creators and users of money and credit for the same reasons that you might do these abuses if you were in their shoes. That is because no one policy maker owns the whole cycle. Each one comes in at one or another part of it and does what is in their interest to do at that time given their circumstances at the time.

Because early in the debt cycle governments are considered trustworthy and they need and want money as much or more than anyone else, they are typically the biggest borrowers. Later in the cycle, when successive leaders come in to run the more indebted governments the new government leaders and the new central bankers have to face the greater challenge of paying back debts when they have less stimulant in the bottle. To make matters worse, governments also have to bail out debtors whose failures would hurt the system. As a result, they tend to get themselves into big cash flow jams that are much larger than those of individuals, companies, and most other entities.

In other words, in virtually all cases the government contributes to the accumulation of debt in its actions and by becoming a large debtor and, when the debt bubble bursts, bails itself and others out by printing money and devaluing it. The larger the debt crisis, the more that is true. While undesirable, it is understandable why this happens. When you can manufacture money and credit and pass it out to everyone to make them happy, it is very hard to resist the temptation to do so.3 It is a classic financial move. Throughout history, rulers have run up debts that won’t come due until long after their reign is over, leaving it to their successors to pick up the pieces.

How do governments react when they have debt problems? They do what any practical, heavily indebted entity with promises to give money that they can print would do. Without exception, they print money and devalue it if the debt is in their own currency. When central banks print money and buy up debt that puts money into the financial system and bids up the prices of financial assets (which also widens the wealth gap because it helps those with the financial assets that are bid up relative to those who don’t have financial assets). It also puts a lot of debt in the hands of the central bank, which allows the central bank to handle the debts however they see fit. Also their printing of the money and buying the financial assets (mostly bonds) holds interest rates down, which stimulates borrowing and buying and encourages those holding these bonds to sell them and encourages the borrowing of money at low interest rates to invest it in higher-returning assets, which leads to central banks printing more money and buying more bonds and sometimes other financial assets. That typically does a good job of pushing up financial asset prices but is relatively inefficient in getting money and credit and buying power into the hands of those who need it most. That is what happened in 2008 and has happened for most of the time since until just recently. Then, when the printing of money and the central bank’s buying up of financial assets fails to get money and credit to where it needs to go, the central government—which can decide what to spend money on—borrows money from the central bank (which prints it) so it can spend it on what it needs to be spent on. In the US the Fed announced this plan on April 9, 2020. This approach of printing money to buy debt (called debt monetization) is vastly more politically palatable as a way of getting money and shifting wealth from those who have it to those who need it than imposing taxes, which leads taxed people to get angry. That is why in the end central banks always print money and devalue.

When governments print a lot of money and buy a lot of debt so the amounts of both money and debt increase, they cheapen money and debt, which essentially taxes those who own it to make it easier for debtors and borrowers. When this happens enough that the holders of this money and debt assets realize what is happening, they seek to sell their debt assets and/or borrow money to get into debt that they can pay back with cheap money. They also often move their wealth to other storeholds of wealth like gold, certain types of stocks, and/or somewhere else (like another country that is not having these problems). At such times central banks have typically continued to print money and buy debt directly or indirectly (e.g., by having banks do the buying for them) and have outlawed the flow of money into inflation-hedge assets and alternative currencies and alternative places.

Such periods of reflation either stimulate another money and credit expansion that finances another economic expansion (which is good for stocks) or devalue money so that it produces monetary inflation (which is good for inflation-hedge assets such as gold). Earlier in the long-term debt cycle when the amounts of outstanding debts aren’t large and when there is lots of room to stimulate by lowering interest rates (and failing that, printing money and buying financial assets), the greater the likelihood that credit growth and economic growth will be good, while later in the long-term debt cycle when the amounts of debt are large and when there isn’t much room to stimulate by lowering interest rates (or printing money and buying financial assets) the greater the likelihood that there will be a monetary inflation accompanied by economic weakness.

6) Then Comes the Flight Back into Hard Money

When taken too far, the over-printing of fiat currency leads to the selling of debt assets and the earlier-described bank “run” dynamic, which ultimately reduces the value of money and credit, which prompts people to flee out of both the currency and the debt (e.g., bonds). They need to decide what alternative storehold of wealth they will use. History teaches us that they typically turn to gold, other currencies, assets in other countries not having these problems, and stocks that retain their real value. Some people think that there needs to be an alternative reserve currency to go to, but that’s not true as the same dynamic of the breakdown of the monetary system and the running to other assets happened in cases in which there was no alternative currency to go to (e.g., in China and in the Roman Empire). The debasement of the currency leads it to devalue and have people run from it and debt denominated in it into something else. There is a whole litany of things people run to when money is devalued, including rocks (used for construction) in Germany’s Weimar Republic.

Typically at this stage in the debt cycle there is also economic stress caused by large wealth and values gaps, which lead to higher taxes and fighting between the rich and the poor, which also makes those with wealth want to move to hard assets and other currencies and other countries. Naturally those who are governing the countries that are suffering from this flight from their debt, their currency, and their country want to stop it. So, at such times, governments make it harder to invest in assets like gold (e.g., via outlawing gold transactions and ownership), foreign currencies (via eliminating the ability to transact in them), and foreign countries (via establishing foreign exchange controls to prevent the money from leaving the country). Eventually the debt is largely wiped out, usually by making the money to pay it back plentiful and cheap, which devalues both the money and the debt.

When this becomes extreme so that the money and credit system breaks down and debts have been devalued and/or defaulted on, necessity generally compels governments to go back to some form of hard currency to rebuild people’s faith in the value of money as a storehold of wealth so that credit growth can resume. Quite often, though not always, the government links its money to some hard money (e.g., gold or a hard reserve currency) with promises to allow holders of the new money to make that conversion to the hard money. Sometimes that hard money is another country’s. For example, over the past decades many weak-currency countries have linked their money to the US dollar or simply dollarized their economy (i.e., used the dollar as their own medium of exchange and storehold of wealth).

To review, in the long-term debt cycle, holding debt as an asset that provides interest is typically rewarding early in the cycle when there isn’t a lot of debt outstanding, but holding debt late in the cycle when there is a lot of it outstanding and it is closer to being defaulted on or devalued is risky relative to the interest rate being given. So, holding debt (e.g., bonds) is a bit like holding a ticking time bomb that rewards you while it’s still ticking and blows you up when it goes off. And as we’ve seen, that big blowup (i.e., big default or big devaluation) happens something like once every 50 to 75 years.

These cycles of debt and writing off debts have existed for thousands of years and in some cases have been institutionalized. For example, the Old Testament provided for a year of Jubilee every 50 years, in which debts were forgiven (Leviticus 25:8-13). Knowing that the debt cycle would happen on that schedule allowed everyone to act in a rational way in preparation for it. Helping you understand this dynamic so that you are prepared for it rather than are surprised by it is the main objective behind my writing this.

Because most people don’t pay attention to this cycle much in relation to what they are experiencing, ironically the closer people are to the blowup the safer they tend to feel. That is because they have held the debt and enjoyed the rewards of doing that and the longer it has been from the time since the last one blew up, the more comfortable they have become as the memories of the last blowup fade—even as the risks of holding this debt rise and the rewards of holding it decline. By keeping an eye on the amount of debt that needs to be paid relative to the amount of hard money that there is to pay it, the amount of debt payments that have to be made relative to the amount of cash flow the debtors have to service the debt, and the interest rewards that one is getting for lending one’s money, one can assess the risk/reward of holding the time bomb.

The Long-Term Debt Cycle in Summary

For thousands of years there have always been three types of monetary system:

  • Hard Money (e.g., metal coins)
  • “Paper Money” claims on hard money
  • Fiat Money (e.g., the US dollar today)

Hard money is the most restrictive system because money can’t be created unless the supply of the metal or other intrinsically valuable commodity that is the money is increased. Money and credit are more easily created in the second type of system, so the ratio of the claims on hard money to the actual hard money held rises, which eventually leads to a “run” on the banks. The result is a) defaults, when the bank closes its doors and the depositors lose their hard assets and/or b) devaluations of the claims on money, which means that the depositors get back less. In the third type of system, governments can create money and credit freely, which works for as long as people continue to have confidence in the currency and fails when they don’t.

Throughout history, countries have transitioned across these different types of systems for logical reasons. As a country needs more money and credit than it currently has, whether to deal with debts, wars, or other problems, it naturally moves from Type 1 to Type 2, or Type 2 to Type 3, so that it has more flexibility to print money. Then creating too much money and debt depreciates its value, causing people to get out of holding the debt and money as a storehold of wealth, and moving back into hard assets (like gold) and other currencies. Since this typically takes place when there is wealth conflict and sometimes a war, there is typically also a desire to get out of the country. Such countries need to re-establish confidence in the currency as a storehold of wealth before they can restore their credit markets.

The below diagram conveys these different transitions. There are many historical examples, from the Song Dynasty to Weimar Germany, of countries making the full transition from constrained types (Type 1 and Type 2) to fiat money, then back to a constrained currency as the old fiat currency hyperinflates.

As noted earlier this big debt cycle plays out over the long term—something like 50 to 75 years—and, at its end, is characterized by a restructuring of debts and of the monetary system. The abrupt parts of these restructurings—i.e., the debt and currency crisis periods—typically happen quickly, lasting only months to up to three years, depending on how long it takes the governments to exercise these moves. However, the ripple effects of them can be long-lasting. For example, these circumstances can lead to reserve currencies stopping being reserve currencies. Within each of these currency regimes there are typically two to four big debt crises—i.e., big enough to cause banking crises and debt write-downs or devaluations of 30% or more—but not big enough to break the currency system. Because I have invested in many countries for about 50 years I have experienced dozens of them. They all run the same way, which is explained in greater depth in my book Principles for Navigating Big Debt Crises.

The Monetary System That We Are in, from Its Beginning until Now

The dollar became the world’s leading reserve currency when the United States became the world’s strongest economic and military power at the end of World War II. Since then having the world’s leading reserve currency has been critical to the United States sustaining and extending its power. That is because a great power comes from being able to create money and credit in the currency that is widely accepted around the world as a medium of exchange and a storehold of wealth. As a result of having the ability to print the world’s currency the United States’ relative financial economic power is multiple times the size of its real economic power.

At the risk of boring you by repeating some of the things I already told you, I will now review the US case and the circumstances that led to the US and the dollar putting the world in the position that we are now in.

In brief, the new world order began after the end of World War II in 1945, with the Bretton Woods agreement having put the dollar in the position of being the world’s leading reserve currency in 1944. The US and the dollar naturally fit into that role because at the end of the war, the US had around two-thirds of the world’s gold held by governments (which was the world’s money at the time), accounted for 50% of the world’s economic production, and was the dominant military power. The new monetary system was a Type 2 (i.e., claims on hard money) monetary system, in which “paper dollar” claims on gold could be exchanged by other countries’ central banks for an ounce of gold at a price of $35/ounce. It was then illegal for individuals to own gold because government leaders didn’t want gold to compete with money and credit as a storehold of wealth. So, at the time, gold was the money in the bank and the paper dollars were like checks in a checkbook that could be turned in for the real money. At the time of the establishment of this new monetary system there was $50 of paper money in existence for each ounce of gold the US government owned, so there was nearly 100% gold backing. Other major countries that were US allies (e.g., the UK, France, and the Commonwealth countries) or under US control (Germany, Japan, and Italy) had US-controlled currencies that were linked to the dollar. In the years that followed, to finance its activities, the US government spent more than it took in in tax revenue so it had to borrow money, which created more dollar-denominated debt. The US Federal Reserve allowed the creation of a lot more claims on gold (i.e., dollar-denominated money and credit) than could actually be converted into gold at that $35 price. As the paper money was turned in for the hard money (gold), the quantity of gold in the US bank went down at the same time as the claims on it continued to rise. As a result, the Bretton Woods monetary system broke down on August 15, 1971 when President Nixon, like President Roosevelt on March 5, 1933, defaulted on the US’s promise to allow holders of paper dollars to turn them in for gold. Thus the dollar devalued against gold and other currencies. That is when the US and all countries went to a Type 3 fiat monetary system. If you want to read a great description of this process of figuring out how to go from the old monetary system to the new fiat one, I recommend Changing Fortunes by Paul Volcker, who was the leading American negotiator of how the new monetary system would work.

This move to a fiat monetary system freed the Federal Reserve and other central banks to create a lot of dollar-denominated money and credit, which led to the inflationary 1970s, which was characterized by a flight from dollars and dollar-denominated debt to goods, services, and inflation-hedge assets such as gold. That panic out of dollar debt also led interest rates to rise and drove the gold price from the $35 that it was fixed at in 1944 and officially stayed at until 1971 to a then-peak of $670 in 1980.

With the money and credit managed this way in the 1970s it was profitable to borrow dollars and convert them into goods and services, so many entities in many countries borrowed dollars largely through US banks to do that. As a result, dollar-denominated debt grew rapidly around the world, and US banks made a lot of money lending it to these borrowers. This lending led to the classic debt bubble part of the debt cycle. The panic out of dollars and dollar-debt assets and into inflation-hedge assets, as well as the rapid borrowing of dollars and the getting into debt, accelerated. That created the money and credit crisis of 1979-82, during which time the US dollar and dollar-denominated debt were at risk of ceasing to be an accepted storehold of wealth. Of course, the average citizen didn’t understand how this money and credit dynamic worked, but they felt it in the form of high inflation and high interest rates, so it was a huge political issue. President Carter, who like most political leaders didn’t understand the monetary mechanics very well, knew that something had to be done to stop it and appointed a strong monetary policy maker, Paul Volcker. Just about everyone who followed such things, including me, hung on his every word. He was strong enough to do the painful but right things needed to break the back of inflation. He became a hero of mine and eventually a good personal friend because of his great character and great capabilities, and I loved his wry humor too.

To deal with that monetary inflation crisis and to break the back of inflation, Volcker tightened the supply of money, which drove interest rates to the highest level “since Jesus Christ,” according to German Chancellor Helmut Schmidt. Because the interest rate was far above the inflation rate debtors had to pay much more in debt service at the same time as their incomes and assets fell in value. That squeezed the debtors and required them to sell assets. Because of the great need for dollars, the dollar was strong. For these reasons, inflation rates fell, which allowed the Federal Reserve to lower interest rates and to ease money and credit for Americans. Of course many debtors and holders of these assets that were falling in value went broke. So in the 1980s these debtors, especially foreign debtors and more especially those in emerging countries, went through a decade-long depression and debt-restructuring period. The Federal Reserve protected the American banks by providing them with the money they needed, and the American accounting system protected them from going broke by not requiring them to account for these bad debts as losses or value these debt assets at realistic prices. This debt management and restructuring process lasted until 1991, when it was completed through the Brady Bond agreement, named after Nicholas Brady who was the US Secretary of Treasury at the time. This whole 1971-91 cycle, which affected just about everyone in the world, was the result of the US going off the gold standard. It led to the soaring of inflation and inflation-hedge assets in the 1970s, which led to the 1979-81 tightening and a lot of deflationary debt restructuring by non-American debtors, falling inflation rates, and excellent performance of bonds and other deflationary assets in the 1980s. The entire period was a forceful demonstration of the power of the US having the world’s reserve currency—and the implications for everyone around the world of how that currency was managed.

From that 1979-81 peak in dollar-denominated inflation and dollar-denominated interest rates until now, both the inflation rates and interest rates have fallen to nearly 0%. You can clearly see that whole big cycle up and down in interest rates and inflation rates since the new dollar-denominated monetary system.

After the 1980s debt restructurings were completed the 1990s saw a new global increase in money, credit, and debt begin again, which again produced a prosperity that led to debt-financed purchases of speculative investments that became the dot-com bubble, which burst in 2000. That led to an economic downturn in 2000-01 that spurred the Federal Reserve to ease money and credit, which pushed debt levels to new highs and created another prosperity that turned into another and bigger debt bubble in 2007, which burst in 2008, which led the Fed and other reserve currency countries’ central banks to ease again, leading to the next bubble that just recently burst. So, between the 1980s debt restructuring and 2008 there were two fairly typical debt/economic cycles. However, the credit/economic contraction of 2008 needed to be handled differently.

Because short-term interest rates hit 0% in 2008 and that amount of interest rate decline wasn’t enough to create the money and credit expansion that was needed, central banks needed to print money and buy financial assets. Stimulating money and credit growth by lowering interest rates is the first-choice monetary policy of central banks. I call it “Monetary Policy 1.” With this approach no longer available to central banks, they turned to the second-choice monetary policy (which I call “Monetary Policy 2”), which is the printing of money and the buying of financial assets, mostly government bonds and some high-quality debt. The last time they had needed to do that because interest rates had hit 0% began in 1933 and continued through the war years. This approach is called “quantitative easing” rather than “debt monetization” because it sounds less threatening. All the world’s major reserve currency central banks did this. The paradigm that began in 2008 worked as follows.

By printing money and buying debt, as had been done beginning in 1933, central banks kept the money and debt expansion cycle going. They did that by making those purchases, which pushed bond prices up, and providing the sellers of these bonds with cash, which led them to buy other assets. This pushed those asset prices up and, as they rose in price, drove future expected returns down. With interest rates below the expected returns of other investments and bond yields and other future expected returns falling to very low levels relative to the returns needed by investors to fund their various spending obligations, investors increasingly borrowed money to buy assets that they expected to have greater returns than their borrowing costs. In other words they followed the classic bubble process of buying financial assets with borrowed money betting that the assets they bought would have higher returns than their costs of funds. Those leveraged purchases pushed these asset prices up, drove their expected future returns down, and created a new debt bubble vulnerability that would come home to roost if the incomes produced by the assets they bought had returns that were less than their borrowing costs. With both long-term and short-term interest rates around 0% and central banks’ purchases of bonds not as effectively flowing through to stimulate economic growth and help those who needed it most, it became apparent to me that the second type of monetary policy wouldn’t work well and the third type of monetary policy—“Monetary Policy 3,” or MP3—would be needed. MP3 works by the reserve currency central governments increasing their borrowing and targeting their spending and lending to where they want it to go with the reserve currency central banks creating money and credit and buying debt (and possibly other assets, like stocks) to fund these purchases.

Throughout all this time, inclusive of all of these swings, the amount of dollar-denominated money, credit, and debt in the world and the amounts of other non-debt liabilities (such as pensions and healthcare) continued to rise in relation to incomes, especially in the US because of the Federal Reserve’s unique ability to support this debt growth. Though I won’t explain the various ways of doing that here, they were explained in my book Principles for Navigating Big Debt Crises, which you can get online for free here.

So, before we had the pandemic-induced downturn, the circumstances were set up for this path being the necessary one in the event of a downturn. If you want to look at relevant research pieces that look at these issues in greater depth that I did at the time, you can find them at

In any case, throughout this period debt and non-debt obligations (e.g., pensions and healthcare) continued to rise relative to incomes while central banks managed to keep debt service costs down (see my report “The Big Picture” for a more complete explanation of the coming “squeeze” this will cause). This pushed interest rates toward nil and made the debt long-term so that principal payments would be low. These conditions—i.e., central banks owning a lot of debt, interest rates around 0% so no interest payment would be required, and structuring debt to be paid back over the very long term so principal payments could be spread out or even possibly not paid back—meant that there was little or no limit to the capacities of central banks to create money and credit. That set of conditions set the stage for what came next.

The coronavirus trigged economic and market downturns around the world, which created holes in incomes and balance sheets, especially for indebted entities that had incomes that suffered from the downturn. Classically, central governments and central banks had to create money and credit to get it to those entities they wanted to save that financially wouldn’t have survived without that money and credit. So, on April 9, 2020 the US central bank (the Fed) announced a massive money and credit creation program, alongside massive programs from the US central government (the president and Congress). They included all the classic MP3 techniques, including helicopter money (direct payments from the government to citizens). It was essentially the same announcement that Roosevelt made on March 5, 1933. While the virus triggered this particular financial and economic downturn, something else would have eventually triggered it, and regardless of what did, the dynamic would have been basically the same because only MP3 would have worked to reverse the downturn. The European Central Bank, the Bank of Japan, and—to a lesser extent—the People’s Bank of China made similar moves, though what matters most is what the Federal Reserve did because it is the creator of dollars, which are still the world’s dominant money and credit.

The US dollar now accounts for about 55% of the world’s international transactions, savings, and borrowing. The Eurozone’s euro accounts for about 25%. The Japanese yen accounts for less than 10%. The Chinese renminbi accounts for about 2%. Most other currencies are not used internationally as mediums of exchange or storeholds of wealth, though they are used within countries. Those other currencies are ones that even the smart people in those countries, and virtually everyone outside those countries, won’t hold as storeholds of wealth. In contrast, the reserve currencies I mentioned are the currencies that most people around the world like to save, borrow, and transact, roughly in proportion to the percentages I just mentioned.

Countries that have the world’s reserve currencies have amazing power—a reserve currency is probably the most important power to have, even more than military power. That is because when a country has a reserve currency it can print money and borrow money to spend as it sees fit, the way the US is doing now, while those that don’t have reserve currencies have to get the money and credit that they need (which is denominated in the world’s reserve currency) to transact and save in it. For example right now, as of this writing, those who have a lot of debt that they need to service and need more dollars to buy goods and services now that their dollar incomes have fallen are strongly demanding dollars.

As shown in the chart in Chapter 1 that depicts eight measures of a country’s rising and declining power, the reserve currency power (which is measured by the share of transactions and savings in that currency) significantly lags the other measures of the country’s strength. That has been true for the US and the US dollar. For example, in 1944 when the US dollar was anointed as the world’s dominant reserve currency, the US had around two-thirds of the world’s gold held by governments (which was considered money at the time) and accounted for about half of world GDP. Today the US accounts for only around 20% of world GDP but still accounts for about 60% of global reserves and about half of international transactions. So the US dollar and the dollar-based monetary and payments system still reign supreme and are outsized relative to the size of the US economy.

As with all banks that printed reserve currencies, the Federal Reserve is now in the strong but awkward position of running its monetary policy in a way that is good for Americans but that might not be good for others around the world who are dependent on dollars. For example the US central government just recently decided that it would borrow money to give it and dollar credit to Americans and the Federal Reserve decided to buy that US government debt and a lot more other debt of Americans to help them through this financial crisis. Understandably little of that will go to foreigners. The European Central Bank will do something similar for those in the Eurozone. The Bank of Japan, which is still smaller on the world scene, will do the same thing for the Japanese, and the People’s Bank of China will do the same thing for the Chinese. A couple of other relatively small countries (like Switzerland) might be able to do something similar for their people, but most of the world won’t get the money and credit they need to fill their income and balance sheet holes the way Americans will. This dynamic of countries not being able to get the hard currency they need is like what happened in the 1982-91 period, except interest rates can’t be cut significantly this time while they could be cut very significantly in that 1982-91 period.

At the same time, dollar-denominated debt owed by non-Americans (i.e., those in emerging markets, European countries, and China) is about $20 trillion (which is about 50% higher than what it was in 2008), with a bit less than half of that total being short-term. These dollar debtors will have to come up with dollars to service these debts and they will have to come up with more dollars to buy goods and services in world markets. So, by having the US dollar as the world’s reserve currency and having the world’s bank that produces that currency, and by having the power to put these needed dollars in the hands of Americans, the US can help Americans (and others around the world if it so chooses) more effectively than most other countries’ governments can help their own citizens. At the same time the US risks losing this privileged position by creating too much money and debt. In the appendix to this chapter we will look much more closely into how countries that had reserve currencies lost them and how devaluations of currencies work.

In Summary: How the Big Cycle of Money, Credit, Debt & Economic Activity Fits In with the Big Domestic and International Political Cycles to Affect the World Order

Stepping back to look at all of this from the big-picture level, what I’m saying about the relationship between 1) the economic part (i.e., money, credit, debt, economic activity, and wealth) and 2) the political part (both within countries and between countries) of rises and declines looks like the picture shown below. Typically the big cycles start with a new world order—i.e., a new way of operating both domestically and internationally that includes a new monetary system and new political systems. The last one began in 1945. Because at such times, after the conflicts, there are dominant powers that no one wants to fight and people are tired of fighting, there is a peaceful rebuilding and increasing prosperity that is supported by a credit expansion that is sustainable. It is sustainable because income growth exceeds or keeps pace with the debt-service payments that are required to service the growing debt and because of central banks’ capacities to stimulate credit and economic growth is great. Along the way up there are short-term debt and economic cycles that we call recessions and expansions. With time investors extrapolate past gains into the future and borrow money to bet on them continuing to happen, which creates debt bubbles at the same time as the wealth gaps grow because some benefit more than others from this money-making upswing. This continues until central banks run out of their abilities to stimulate credit and economic growth effectively. As money becomes tighter the debt bubble bursts and credit contracts and with it the economy contracts. At the same time, when there is a large wealth gap, big debt problems, and an economic contraction, there is often fighting within countries and between countries over wealth and power. These typically lead to revolutions and wars that can be either peaceful or violent. At such times of debt and economic problems central governments and central banks typically create money and credit to fund their domestic and war-related financial needs. These money and credit crises, revolutions, and wars lead to restructurings of a) the debts, b) the monetary system, c) the domestic order, and d) the international order — which together I am simply calling the world order.

Then it starts again. For example in the United States in the 1930-45 period there was a peaceful domestic revolution that produced a significant wealth redistribution that was accompanied by large government borrowings (creating a lot of government debt) that was financed by the central bank creating a lot of money and credit…and this was followed by violent external wars that were due to rising powers challenging existing world powers, with these wars financed by large government borrowings (that created a lot of government debt) that was financed by central banks creating of money and credit.

The cycle that I am describing is conveyed in the chart below. While no cycle goes exactly this way, almost all of them by and large go that way.

This explanation of money and credit will be followed by an appendix that will show why and how all currencies devalue and/or die, with references to the most important cases of the last 500 years.

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[1] While borrowers are typically willing to pay interest, which is what gives lenders the incentive to lend it out, nowadays there are some debt assets that have negative interest rates, which is a weird story that we will explore later.

[2] By the way, please understand that these rough estimates of cycle times are just rough estimates, and to know where we are in these cycles we need to look more at the conditions than the amount of time.

[3] Some central banks have made this harder by separating themselves from the direct control of politicians, but virtually every central bank has to bail out their governments at some point, so devaluations always happen.

Chapter 2 Appendix

The Changing Value of Money

Published 05/07/20

This is an appendix to Chapter 2, “The Big Cycle of Money, Credit, Debt, and Economic Activity.” It is intended to look at the concepts expressed in that chapter in a more granular way and to show you how these concepts are consistent with the actual cases that are behind the concepts. While in this appendix we will get a bit more into the mechanics and specifics than we did in Chapter 2, it is written in a way that should be both palatable to most people and specific enough to satisfy the needs of skilled economists and investors. If you find that the material that you are reading is getting too wonky for your taste just stick to reading that which is in bold and you should be just fine.

Rather than carefully examining the whole cycle (which we will do in the Part 2 examinations) we will focus exclusively on big devaluations and end of reserve currency periods because a) the dollar, euro, and yen are in the late stages of their long-term debt cycles when the debts denominated in them are high, real interest rate compensations for holding these debt assets are low, and large amounts of new debt denominated in them are being created and monetized—which is a higher-risk confluence of circumstances, and b) such big devaluations and/or the loss of reserve currency status by the leading reserve currencies would be the most disruptive economic event we could imagine.

As previously explained, there is a real economy and there is a financial economy, which are intertwined but different. The real economy and the financial economy each has its own supply and demand dynamics. In this section we will focus more on the supply and demand dynamics of the financial economy to explore what determines the value of money.

Printing and Devaluing Money Is the Easiest Way out of a Debt Crisis

While people tend to think that a currency is pretty much a permanent thing and believe that “cash” is the safe asset to hold, that’s not true because all currencies devalue or die and when they do cash and bonds (which are promises to receive currency) are devalued or wiped out. That is because printing a lot of currency and devaluing debt is the most expedient way of reducing or wiping out debt burdens. When the debt burdens are sufficiently reduced or eliminated, the credit/debt expansion cycles can begin all over again, as described in Chapter 2.

As I explained more comprehensively in my book Principles for Navigating Big Debt Crises than I can explain here, there are four levers that policy makers can pull to bring debt and debt-service levels down relative to the income and cash-flow levels that are required to service one’s debts:

  • Austerity (spending less)
  • Debt defaults and restructurings
  • Transfers of money and credit from those who have more than they need to those who have less than they need (e.g., raise taxes)
  • Printing money and devaluing it

Austerity is deflationary and doesn’t last long because it’s too painful. Debt defaults and restructurings are also deflationary and painful because the debts that are wiped out or reduced in value are someone’s assets; as a result defaults and restructurings are painful for both the debtor who goes broke and has their assets taken away and for the creditor who loses the wealth arising from having to write down the debt. Transfers of money and credit from those who have more than they need to those who have less than they need (e.g., raising taxes to redistribute wealth) is politically challenging but more tolerable than the first two ways and is typically part of the resolution. In comparison to the others, printing money is the most expedient, least well-understood, and most common big way of restructuring debts. In fact it seems good rather than bad to most people because it helps to relieve debt squeezes, it’s tough to identify any harmed parties that the wealth was taken away from to provide this financial wealth (though they are the holders of money and debt assets), and in most cases it causes assets to go up in the depreciating currency that people use to measure their wealth in so that it appears that people are getting richer.

You are seeing these things happen now in response to the announcements of the sending out of large amounts of money and credit by central governments and central banks.

Note that you don’t hear anyone complaining about the money and credit creation; in fact you hear cries for a lot more with accusations that the government would be cheap and cruel if it didn’t provide more. There isn’t any acknowledging that the government doesn’t have this money that it is giving out, that the government is just us collectively rather than some rich entity, and that someone has to pay for this. Now imagine what it would have been like if government officials cut expenses to balance their budgets and asked people to do the same, allowing lots of defaults and debt restructurings, and/or they sought to redistribute wealth from those who have more of it to those who have less of it through taxing and redistributing the money. This money and credit producing path is much more acceptable. It’s like playing Monopoly in a way where the banker can make more money and redistribute it to everyone when too many of the players are going broke and getting angry. You can understand why in the Old Testament they called the year that it’s done “the year of Jubilee.”

Most people don’t pay enough attention to their currency risks. Most worry about whether their assets are going up or down in value; they rarely worry about whether their currency is going up or down. Think about it. Right now how worried are you about your currency declining relative to how worried you are about how your stocks or your other assets are doing? If you are like most people, you are not nearly as aware of your currency risk and you need to be.

So let’s explore that currency risk.

All Currencies Have Been Devalued or Died

Think about holding currencies (which is the same as holding cash) in the same way as you would think about holding any other assets. How would you have done in these investments?

Of the roughly 750 currencies that have existed since 1700, only about 20% remain, and of those that remain all have been devalued. In 1850 the world’s major currencies wouldn’t look anything like the ones today. While the dollar, pound, and Swiss franc existed back then, most others were different and have since died. In 1850 in what is now Germany, you would have used the gulden or the thaler. There was no yen, so in Japan you might have used a koban or the ryo instead. In Italy you would have used one or more of the six possible currencies. You would have used different currencies in Spain, China, and most other countries. Some were completely wiped out (in most cases they were in countries that had hyperinflation and/or lost wars and had large war debts) and replaced by entirely new currencies. Some were merged into currencies that replaced them (e.g., the individual European currencies were merged into the euro). And some remain in existence but were devalued, like the British pound and the US dollar.

What Do They Devalue Against?

The most important thing for currencies to devalue against is debt. That is because the goal of printing money is to reduce debt burdens. Debt is a promise to deliver money, so giving more money to those who need it lessens the debt burden. How this newly created money and credit then flow determines what happens next. Increases in the supply of money and credit both reduce the value of money and credit (which hurts holders of it) and relieve debt burdens. In cases in which the debt relief facilitates the flows of this money and credit into productivity and profits for companies, rising real stock prices (i.e., the value of stocks after adjusting for inflation) happens. When it sufficiently hurts the actual and prospective returns of “cash” and debt assets so that it drives flows out of these assets and into inflation-hedge assets and other currencies, that leads to a self-reinforcing decline in the value of money. At times when the central bank is faced with the choice of a) allowing real interest rates (i.e., the rate of interest minus the rate of inflation) to rise to the detriment of the economy or b) preventing real interest rates from rising by printing money and buying those cash and debt assets, they will choose the second path, which reinforces the bad returns of holding “cash” and those debt assets. The later one is in the long-term debt cycle—i.e., a) when the amounts of debt and money are impossibly large for them to be turned into real value for the amounts of goods and services they are claims on, b) when the levels of real interest rates that are low enough to save debtors from bankruptcy are below the levels that are required for creditors to hold the debt as a viable storehold of wealth, and c) when the normal central bank levers of allocating capital via interest rate changes (MP1) and/or printing money and buying high-quality debt (MP2) don’t work so that monetary policy becomes a facilitator of the political system that allocates resources in an uneconomic way—the greater the likelihood that there will be a breakdown in the currency and monetary system. So, there are a) systemically beneficial devaluations (though they are always costly to the holders of money and debt) and b) systemically destructive ones that damage the credit/capital allocation system but are required to wipe out the debt in order to create a new monetary order. It’s important to be able to tell the difference. In this study we will explore both types.

To do that I will show you the value of currencies in relation to both gold and consumer price index weighted baskets of goods and services because gold has been the timeless and universal alternative currency and because money is meant to buy goods and services so its buying power is of paramount importance. I will also touch on their value in relation to other currencies/debt and in relation to stocks because they too can be storeholds of wealth. The pictures that all these measures convey are broadly similar in big currency devaluations because the currency moves are so significant that they change in relation to most things. Because many other things (real estate, art, etc.) are also alternative storeholds of wealth, we could go on and on describing how they perform in big currency devaluations but I chose not to because that would take this past the point of diminishing returns.

In Relation to Gold

The chart below shows spot currency returns of the three major reserve currencies in relation to gold since 1600. While we will examine these in depth in this study, for now I would like to focus your attention on both the spot currency returns and the total returns of holding interest-earning cash in all the major currencies since 1850.

As shown in the next two charts, devaluations typically occur as relatively abrupt declines during debt crises that are separated by periods of currency stability during periods of prosperity. I noted six such ones, which we will soon delve into. Of course there were many more devaluations of more minor currencies that we won’t get into right now.

Here are some notable takeaways:

  • Big devaluations have tended to be more episodic than evolutionary. There were six time frames that there were really big devaluations of major currencies (though plenty more of minor currencies) over the last 170 years.
  • In the 1860s the large financing needs of the Civil War prompted the US to suspend gold convertibility and print money (known as “greenbacks”) to help monetize war debts.
  • After the US returned to its prior gold peg in the mid-1870s a number of other countries joined the gold standard; most currencies remained fixed against gold up until World War I. Major exceptions were Japan (which was on a silver-linked standard until the 1890s, which led its exchange rate to devalue against gold as silver prices fell during this period), and Italy and Spain, which frequently suspended convertibility to support large fiscal deficits.
  • Then came World War I when warring countries ran enormous deficits that were funded by central banks’ printing and lending of money. During the war years gold was international money as international credit was lacking because trust was lacking. Then the war ended, and a new monetary order was created with gold and the winning countries’ currencies, which were tied to it, at the center of that new monetary order.
  • Still, in 1919-22 the printing of money and devaluations of several European currencies were required as an extension of the debt crises of those most indebted, especially those that lost World War I. As shown this led to the total extinction of the German mark and German mark debt in the 1920-23 period and big devaluations in other countries’ currencies including the winners of the war that also had debts that had to be devalued to create a new start.
  • With the debt, domestic political, and international geopolitical restructurings done, the 1920s was a boom period, which became a bubble that burst in 1929.
  • In 1930-45, 1) when the debt bubble burst that required central banks to print money and devalue it, and then 2) when the war debts had to increase to fund the war that required more printing of money and more devaluations.
  • At the end of the war, in 1944-45, the new monetary system that linked the dollar to gold and other currencies to the dollar was created, and the currencies and debts of Germany, Japan, Italy, and China (and a number of other countries) were quickly and totally destroyed while those of most winners of the war were slowly but still substantially depreciated. That monetary system stayed in place until the late 1960s.
  • In 1968-73 (most importantly in 1971), when excessive spending and debt creation especially by the US required the breaking of the link with gold because claims on gold were being turned in for actual gold and the claims were far greater than the amount of gold that was available to redeem the claims, that led to going to a dollar-based fiat monetary system that allowed the big increase in dollar-denominated money and credit that fueled the inflation of the 1970s and led to the debt crisis of the 1980s.
  • Since 2000 the value of money has fallen in relation to the value of gold due to lots of money and credit creation and because of interest rates being low in relation to inflation rates. Because the monetary system has been a free-floating monetary system there have not been the abrupt breaks that there have been in the past; there has been a more gradual and continuous devaluation in which low or in some cases negative interest rates did not provide compensation for the increasing amount of money and credit and the resulting (albeit low) inflation.

Let’s look at these periods more closely.

As shown in the prior charts, the returns of holding currencies (i.e., short-term debt that collects interest) during the period from 1850 to 1913 were generally profitable relative to the returns of holding gold. During that more than 60-year debt/currency cycle period, most currencies were able to remain fixed against gold or silver and one would have collected an attractive interest rate because it was mostly a prosperous period in which both lending and borrowing worked well for those who did it. That prosperous period was what is known as the Second Industrial Revolution, when the borrowers turned the money they borrowed into earnings that allowed the debts to be paid back. While there were debt crises in that period (such as “the Panic of 1873,” “the Panic of 1893,” and “the Panic of 1907” in the US) they were not big enough to necessitate devaluations, though they were turbulent. For example, the prosperity of the Second Industrial Revolution led to a debt-financed speculative boom in stocks that grew overextended, which led to a banking and brokerage crisis. In the US that led to the six-week-long Panic of 1907 at the same time the large wealth gap and other social issues (e.g., women’s suffrage) caused political tensions, capitalism was challenged, and taxes started to rise to fund the wealth redistribution process.

In China, which was still a world away but impacted, there was the same dynamic—a stock market bubble led by rubber production stocks (which was China’s equivalent of America’s railroad stock bubbles that contributed to panics there throughout the 19th century) that burst and led to a crash in 1910, which some have described as a factor in a debt/money/economic downswing that contributed to the end of Imperial China. So, throughout that period the Type 2 monetary systems (i.e., with notes convertible into metal money) remained in place in most countries and holders of notes got paid good interest rates without having their currencies devalued. The big exceptions were the US devaluation to finance the Civil War debts in the 1860s, the frequent devaluations of Spain’s currency due to its continued weakening as a global power, and the sharp devaluations in Japan’s currency due to its remaining on a silver-linked standard until the 1890s (and silver prices falling relative to gold prices in this period).

World War I began in 1914 and countries borrowed a lot to fund it, which led to the late debt cycle breakdowns and devaluations that came when war debts had to be wiped out, effectively destroying the monetary systems of those who lost the war. The Paris Peace Conference that ended the war in 1918 attempted to institute a new international order around the League of Nations, but the efforts at cooperation were unable to avoid debt crises and monetary instability due to huge war indemnities placed on the defeated powers (such as Germany in the Treaty of Versailles), as well as large war debts owed by the victorious Allies to each other (particularly to the US). As shown in the chart below, that led to a complete wipeout of the value of money and credit in Germany, which led to the world’s most iconic hyperinflation in the Weimar Republic. As you will read briefly when we cover Germany’s rise and decline in Part 2 (and as you can read much more completely in my detailed examination of the Weimar Republic in Principles for Navigating Big Debt Crises) this case was the direct result of Germany having these enormous war-related debts and indemnities that had to be disposed of. The Spanish flu also occurred during the period, beginning in 1918 and ending in 1920. Coming out of the war, all currencies except the US dollar, the Japanese currency, and the Chinese currency devalued because they had to monetize some of their war debts and because not to devalue with the countries that devalued would have hurt their competitiveness in world markets. As shown in the chart below, China’s silver-based currency rallied sharply relative to gold (and gold-linked currencies) near the end of the war as prices rose and then mechanically devalued as silver prices fell sharply amid the post-war deflation in the US. That was then followed by an extended and productive period of economic prosperity, particularly in the US, that was known as the Roaring ’20s, which like all such periods, led to big debt and asset bubbles and a large wealth gap that sowed the seeds for the turbulence that lay ahead.

Next, in the 1930s you see different versions of the same thing happening in all countries—i.e., in the 1930-33 period there was a global debt crisis that led to economic contractions that led to the printing of money and competitive devaluations in virtually all countries, which eroded the value of money moving into World War II. The conflicts over wealth within countries and between countries led to greater conflicts within and between countries. All the warring countries built up war debts while the US gained a lot of wealth (gold) in the war. Then, after the war, the value of money and debt was completely wiped out for the losers of the war (i.e., Germany, Japan, and Italy), as well as for China, and was severely devalued for Great Britain and France even though they were the supposed winners of the war. I should note that during war years money and credit are not commonly accepted between countries because there is a justifiable wariness about whether they will get paid back in currency that has value. During wars gold, or in some cases silver or barter, is the coin of the realm. At such times prices and capital flows are typically controlled so it is even difficult to say what the real prices of many things are. After the war was the prosperity period that we won’t examine other than to say that within it was excessive borrowing that sowed the seeds of the next big devaluation, which happened in 1968-73.

By the mid-1950s, before that devaluation, the dollar and the Swiss franc were the only currencies worth even half of their 1850s value. As shown below, the downward pressure in currencies and upward pressure in gold started in 1968 and was made official on August 15, 1971, when President Nixon ended the Bretton Woods monetary system, leaving the Type 2 monetary system in which the dollar was backed by gold, and going to a fiat monetary system.

Since 2000 we have seen a more gradual and orderly loss of total return in currencies when measured in gold, consistent with the broad fall in real rates across countries during those decades.

In summary the basic picture is that:

  • The average annual return of holding interest-earning cash currency since 1850 was 1.2%, which was a bit lower than the average real return of holding gold, which was 1.3%, though there were huge differences in their returns at various periods of time and in various countries.
  • In about half of the countries since 1850 you would have received a positive real return for holding bills, in half a negative real return, and in cases like Germany you would have been totally wiped out twice.
  • Most of the real return from holding interest-earning cash currency came in the periods when most countries were on gold standards that they adhered to because they were in prosperous periods (e.g., in the Second Industrial Revolution and in the post-1945 boom when debt levels and debt-service burdens were relatively low and income growth was nearly equal to debt growth) until near the end of that long cycle.
  • The real (i.e., inflation-adjusted) return for bills since 1912 (the modern fiat era) has been -0.2%. The real return of gold during this era has been 2.2%. During this period you would only have made a positive real return holding interest-earning cash currency in about half of the countries, and you would have lost meaningfully in the rest (losing over 2% a year in France, Italy, and Japan, and losing over 15% a year in Germany due to the hyperinflation).

The next chart shows the real returns of holding gold throughout the period from 1850 to the present. As shown, from 1850 until 1971 gold returned (through its appreciation) an amount that equaled the amount of money lost to inflation, with the exception of Germany, though there were big variations around that average such as those previously described (e.g., until the 1930s currency devaluations and the end of World War II devaluations of money that were part of the formation of the Bretton Woods monetary system in 1944). Gold stayed steady in price while money and credit expanded until 1971. Then in 1971 currencies were devalued and delinked from gold so there was a shift from a Type 2 monetary system (e.g., notes backed by gold) to a fiat monetary system. That delinking of currencies from gold and going to a fiat monetary system gave central banks the unconstrained ability to create money and credit. In turn that led to high inflation and low real interest rates that led to the big appreciation in the real gold price until 1980-81 when interest rates were raised significantly above the inflation rate, which led currencies to strengthen and gold to fall until 2000. That is when central banks pushed interest rates down relative to inflation rates and, when they couldn’t push them any lower by normal means, printed money and bought financial assets, which was supportive to gold prices.

The Value of Currencies in Relation to Goods and Services

Thus far we have looked at the market values of currencies in relation to the market value of gold. That raises the question about how much of this picture is because we are looking at the value of currencies relative to gold and whether that is an appropriate gauge. The next chart shows the value of interest-rate-earning cash currency in terms of the CPI baskets of goods and services in these currencies, so it shows changes in buying power. As shown the two world wars were very bad, and since then there have been ups and downs. In about half of the currencies interest-rate-earning cash provided a return that was above the rate of inflation, in the other half it provided bad real returns, and in all cases, there were big and roughly 10-year-long swings around these averages. In other words, history has shown that there are very large risks in holding interest-earning cash currency as a storehold of wealth especially late in debt cycles.

The Patterns of Countries Devaluing and Losing Their Reserve Currency Status

Currencies devaluing and currencies losing their reserve currency position aren’t necessarily the same things though they are caused by the same things (debt crises) and a currency losing its reserve currency status comes from chronic and large devaluations. As previously explained, when central banks increase the supply of money and credit it reduces the value of money and credit. This is bad for holders of money and credit but a relief to debt burdens. When this debt relief allows money and credit to flow into productivity and profits for companies, real stock prices rise. But it can also damage the actual and prospective returns of “cash” and debt assets enough to drive people out of those assets and into inflation-hedge assets and other currencies. This leaves the central bank faced with the choice of either allowing real interest rates to rise to the detriment of the economy or preventing rates from rising by printing money and buying those cash and debt assets. Inevitably, they will follow the second path, which reinforces the bad returns of holding “cash” and those debt assets. As explained earlier, when it’s late in the long-term debt cycle, there is a greater likelihood that there will be a breakdown in the currency and monetary system, and the important thing is to tell the difference between systemically beneficial devaluations and systemically destructive ones.

What do these devaluations have in common?

  • In the major cases we looked at, all of the economies experienced a classic “run” dynamic, as there were more claims on the central banks than there was hard currency available to satisfy the claims on that money, which was typically gold, though it was US dollars for the UK reserve currency decline because at that time the British pound was linked to the US dollar.
  • Net central bank reserves start falling prior to the actual devaluation, in some cases starting years ahead of the devaluation. It’s also worth noting that in several cases countries suspended convertibility ahead of the actual devaluation of the exchange rate, such as with the UK in 1947 ahead of the 1949 devaluation, or for the US in 1971.
  • The run on the currency and the devaluations typically came alongside significant debt problems, often related to wartime spending (the Fourth Anglo-Dutch War for the Dutch, the world wars for the UK, Vietnam for the US under Bretton Woods), which put pressure on the central bank to print. The worst situations were when countries lost their wars; that typically led to the total collapse and restructuring of their currencies and their economies. However, winners of wars that ended up with debts that were much larger than their assets and reduced competitiveness (e.g., Great Britain) also lost their reserve currency status, though more gradually.
  • Typically central banks respond initially by not increasing the supply of money so that when their currency and debt are being sold they let short-term rates rise to forestall the devaluation, but that is too economically painful, so they quickly capitulate and devalue. Then, after the devaluation, they typically cut rates.
  • After devaluation, the outcomes diverge significantly across the cases, with a key variable being how much economic and military power the country retained at the time of the devaluation, which impacted how willing savers were to continue holding their money there.
  • More specifically for the major reserve currencies:
    • For the Dutch, the collapse of the guilder was massive and relatively quick in taking place over less than a decade, with the actual circulation of guilders falling swiftly by the end of the Fourth Anglo-Dutch War. This collapse came as the Netherlands entered a steep decline as a world power, first losing a major war against the British and subsequently facing invasion on the continent from France.
    • For the British, the decline was more gradual: it took two devaluations before it fully lost its reserve currency status, though it experienced periodic balance of payments strains over the intervening period. Many of those who continued to hold reserves in pounds did so due to political pressures and their assets significantly underperformed US assets during the same time.
    • In the case of the US, there were two big abrupt devaluations (in 1933 and 1971) and more gradual devaluations against gold since 2000, but they haven’t cost the US its reserve currency status.
    • Typically leading up to a country losing its reserve currency position 1) there is an already established loss of economic and political primacy to a rising rival that creates a vulnerability (e.g., the Dutch falling behind the UK or the UK falling behind the US) and 2) there are large and growing debts that are monetized by the central bank printing money and buying government debt, leading to 3) a weakening of the currency in a self-reinforcing run from the currency that can’t be stopped because the fiscal and balance of payments deficits are too great for cutbacks to close.

As this appendix is getting long, I have decided to cut it here and to follow in a few days with the rest, which consists of brief explanations of the decline phases of the Dutch guilder and British pound and their empires.

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Chapter 3

Chapter 3: The Big Cycles Over The Last 500 Years

Published 05/26/20

Note: To make this an easier and shorter article to read, I tried to convey the most important points in simple language and bolded them, so you can get the gist of the whole thing in just a few minutes by focusing on what’s in bold. Past chapters from the series can be found here: Introduction, Chapter 1 and Chapter 2. Additionally, if you want a simple and entertaining 30-minute explanation of how what a lot of what I’m talking about here works, see “How the Economic Machine Works,” which is available on YouTube.

In Chapter 1 (“The Big Picture in a Tiny Nutshell”), I looked at the archetypical rises and declines of empires and their reserve currencies and the various types of powers that they gained and lost, and in Chapter 2 (“The Big Cycle of Money, Credit, Debt, and Economic Activity”) and its appendix (“The Changing Value of Money”) I reviewed the big money, credit, and debt cycles. In this chapter, I will review the rises and declines of the Dutch, British, and American empires and their reserve currencies and will touch on the rise of the Chinese empire.

While the evolution of empires and currencies is one continuous story that started before there was recorded history, in this chapter I am going to pick up the story around the year 1600. My objective is simply to put where we are in perspective of history and bring us up to date. I will begin by very briefly reviewing what the Big Cycle looks like and then scan through the last 500 years to show these Big Cycles playing out before examining more closely the declines of the Dutch and British empires and their reserve currencies. Then I will show how the decline of the British empire and the pound evolved into the rise of the US empire and US dollar and I will take a glimpse at the emergence of the Chinese empire and the Chinese renminbi.

That will bring us up to the present and prepare us to try to think about what will come next.

The Big Cycle of the Life of an Empire

Just as there is a human life cycle that typically lasts about 80 years (give or take) and no two are exactly the same but most are similar, there is an analogous empire life cycle that has its own typical patterns. For example, for most of us, during the first phase of life we are under our parents’ guidance and learn in school until we are about 18-24, at which point we enter the second phase. In this phase we work, become parents, and take care of others who are trying to be successful. We do this until we are about 55-65, at which time we enter the third phase when we become free of obligations and eventually die. It is pretty easy to tell what phases people are in because of obvious markers, and it is sensible for them to know what stages they are in and to behave appropriately in dealing with themselves and with others based on that. The same thing is true for countries. The major phases are shown on this chart. It’s the ultra-simplified archetypical Big Cycle that I shared in the last chapter.

In brief, after the creation of a new set of rules establishes the new world order, there is typically a peaceful and prosperous period. As people get used to this they increasingly bet on the prosperity continuing, and they increasingly borrow money to do that, which eventually leads to a bubble. As the prosperity increases the wealth gap grows. Eventually the debt bubble bursts, which leads to the printing of money and credit and increased internal conflict, which leads to some sort of wealth redistribution revolution that can be peaceful or violent. Typically at that time late in the cycle the leading empire that won the last economic and geopolitical war is less powerful relative to rival powers that prospered during the prosperous period, and with the bad economic conditions and the disagreements between powers there is typically some kind of war. Out of these debt, economic, domestic, and world-order breakdowns that take the forms of revolutions and wars come new winners and losers. Then the winners get together to create the new domestic and world orders.

That is what has repeatedly happened through time. The lines in the chart signify the relative powers of the 11 most powerful empires over the last 500 years. In the chart below you can see where the US and China are currently in their cycles. As you can see the United States is now the most powerful empire by not much, it is in relative decline, Chinese power is rapidly rising, and no other powers come close.

Because that chart is a bit confusing, for simplicity the next chart shows the same lines as in that chart except for just the most powerful reserve currency empires (which are based on an average of eight different measures of power that we explained in Chapter 1 and will explore more carefully in this chapter).

The next chart offers an even more simplified view. As shown, the United States and China are the only two major powers, you can see where each of their Big Cycles is, and you can see that they are approaching comparability, which is when the risks of wars of one type or another are greater than when the leading powers are earlier in the cycle. To be clear, I didn’t start out trying to make an argument and then go looking for stats to support it; doing that doesn’t work in my profession as only accuracy pays. I simply gathered stats that reflected these different measures of strength and put them in these indices, which led to these results. I suspect that if you did that exercise yourself picking whatever stats you’d like you’d see a similar picture, and I suspect that what I’m showing you here rings true to you if you’re paying attention to such things.

For those reasons I suspect that all I am doing is helping you put where we are in perspective. To reiterate, I am not saying anything about the future. I will do that in the concluding chapter of this book. All I want to do is bring you up to date and, in the process, make clear how these cycles have worked in the past, which will also alert you to the markers to watch out for and help you see where in the cycles the major countries are and what is likely to come next.

The chart below from Chapter 1 shows this play out via the eight measures of strength—education, innovation and technology, competitiveness, military, trade, output, financial center, and reserve status—that we capture in the aggregate charts. It shows the average of each of these measures of strength, with most of the weight on the most recent three reserve countries (the US, the UK, and the Dutch).1

As explained in Chapter 1, in brief these strengths and weaknesses are mutually reinforcing—i.e., strengths and weaknesses in education, competitiveness, economic output, share of world trade, etc., contribute to the others being strong or weak, for logical reasons—and their order is broadly indicative of the processes that lead to the rising and declining of empires. For example, quality of education has been the long-leading strength of rises and declines in these measures of power, and the long-lagging strength has been the reserve currency. That is because strong education leads to strengths in most areas, including the creation of the world’s most common currency. That common currency, just like the world’s common language, tends to stay around because the habit of usage lasts longer than the strengths that made it so commonly used.

We will now look at the specifics more closely, starting with how these Big Cycles have played out over the last 500 years and then looking at the declines of the Dutch and British empires so you can see how these things go.

1) The Last 500 Years in About 4,000 Words

The Rise & Decline of the Dutch Empire and the Dutch Guilder

  • In the 1500-1600 period the Spanish empire was the pre-eminent economic empire in the “Western” world while the Chinese empire under the Ming Dynasty was the most powerful empire in the “Eastern” world, even more powerful than the Spanish empire (see the green dashed line and the red solid line in chart 2). The Spanish got rich by taking their ships and military power around the world, seizing control of vast areas (13% of the landmass of the earth!) and extracting valuable things from them, most importantly gold and silver which were the money of the time. As shown by the orange line in the chart of the relative standing of the great empires, the Dutch gained power as Spanish power was waning. At the time Spain controlled the small area we now call Holland. When the Dutch became powerful enough in 1581, they overthrew the Spanish and went on to eclipse both the Spanish and the Chinese as the world’s richest empire from around 1625 to their collapse in 1780. The Dutch empire reached its peak around 1650 in what was called the Dutch Golden Age. This period was one of great globalization as ships that could travel around the world to gain the riches that were out there flourished, and the Dutch, with their great shipbuilding and their economic system, were ahead of others in using ships, economic rewards, and military power to build their empire. Holland (as we now call it) remained the richest power for about 100 years. How did that happen?
  • The Dutch were superbly educated people who were very inventive—in fact they came up with 25% of all major inventions in the world at their peak in the 17th century. The two most important inventions they came up with were 1) ships that were uniquely good that could take them all around the world, which, with the military skills that they acquired from all the fighting they did in Europe, allowed them to collect great riches around the world, and 2) the capitalism that fueled these endeavors.
  • Not only did the Dutch follow a capitalist approach to resource allocation, they invented capitalism. By capitalism I mean public debt and equity markets. Of course production existed before, but that is not capitalism, and of course trade existed before, but that is not capitalism, and of course private ownership existed before, but that is not capitalism. By capitalism I mean the ability of large numbers of people to collectively lend money and buy ownership in money-making endeavors. The Dutch created that when they invented the first listed public company (the Dutch East India Company) and the first stock exchange in 1602 and when they built the first well-developed lending system in which debt could more easily be created.
  • They also created the world’s first reserve currency. The Dutch guilder was the first “world reserve currency” other than gold and silver because it was the first empire to extend around much of the world and to have its currency so broadly accepted. Fueled by these qualities and strengths, the Dutch empire continued to rise on a relative basis until around 1700 when the British started to grow strongly.
  • The numerous investment market innovations of the Dutch and their successes in producing profits attracted investors, which led to Amsterdam becoming the world’s leading financial center; the Dutch government channeled money into debt and some equity investments in various businesses, the most important of which was the Dutch East India Company.
  • At this time of prosperity, other countries grew in power too. As other countries became more competitive, the Dutch empire became more costly and less competitive, and it found maintaining its empire less profitable and more challenging. Most importantly the British got stronger economically and militarily in the classic ways laid out in Chapter 1. Before they had become clear competitors they had military partnerships during most of the 80+ years leading up to the Fourth Anglo-Dutch War. That changed over time as they bumped into each other in the same markets. The Dutch and British had lots of conflicts over economic issues. For example, the English made a law that only English ships could be used to import goods into England, which hurt Dutch shipping companies that had a big business of shipping others’ goods to England, which led to the English seizing Dutch ships and expanding the British East India Company. Typically before all-out war is declared there is about a decade of these sorts of economic, technological, geopolitical, and capital wars when the conflicting powers approach comparability and test and try to intimidate each other’s powers. At the time the British came up with military inventions and built more naval strength, and they continued to gain relative economic strength.
  • As shown in the chart of relative standing of empires shown above, around 1750 the British became a stronger power than the Dutch, particularly economically and militarily, both because the British (and French) became stronger and because the Dutch became weaker. As is classic the Dutch a) became more indebted, b) had a lot of internal fighting over wealth (between its states/provinces, between the rich and the poor, and between political factions)2 , and c) had a weakened military—so the Dutch were weak and divided, which made them vulnerable to attack.
  • As is typical, the rising great power challenged the existing leading power in a war to test them both economically and militarily. The English hurt the Dutch economically by hurting their shipping business with other countries. The British attacked the Dutch. Other competing countries, most importantly France, took this as an opportunity to grab shipping business from the Dutch. That war, known as the Fourth Anglo-Dutch War, lasted from 1780 to 1784. The British won it handily both financially and militarily. That bankrupted the Dutch and caused Dutch debt and equities, the Dutch guilder, and the Dutch empire to collapse. In the next section we will look at that collapse up close.
  • At that time, in the late 18th century, there was a lot of fighting between countries with various shifting alliances within Europe. While similar fights existed around the world as they nearly always do, the only reason I’m focusing on these fights is because I’m focusing just on the leading powers and these were the leading two. After the British defeated the Dutch, Great Britain and its allies (Austria, Prussia, and Russia) continued to fight the French led by Napoleon in the Napoleonic Wars. Finally, after around a quarter-century of frequent fighting since the start of the French Revolution, the British and its allies won in 1815.

The Rise & Decline of the British Empire and the British Pound

  • As is typical after wars, the winning powers (most notably the UK, Russia, Austria, and Prussia) met to agree on the new world order. That meeting was called the Congress of Vienna. In it the winning powers re-engineered the debt, monetary, and geopolitical systems and created a new beginning as laid out in the Treaty of Paris. That set the stage for Great Britain’s 100-year-long “imperial century” during which Great Britain became the unrivaled world power, the British pound became the world’s dominant currency, and the world flourished.
  • As is typical, following the period of war there was an extended period—in this case 100 years—of peace and prosperity because no country wanted to challenge the dominant world power and overturn the world order that was working so well. Of course during these 100 years of great prosperity there were bad economic periods along the lines of what we call recessions and which used to be called panics (e.g., the Panic of 1825 in the UK, or the Panics of 1837 and 1873 in the US) and there were military conflicts (e.g., the Crimean War between Russia on one side and the Ottoman empire with a coalition of Western European powers as allies on the other), but they were not significant enough to change the big picture of this being a very prosperous and peaceful period with the British on top.
  • Like the Dutch before them, the British followed a capitalist system to incentivize and finance people to work collectively, and they combined these commercial operations with military strength to exploit global opportunities in order to become extremely wealthy and powerful. For example the British East India Company replaced the Dutch East India Company as the world’s most economically dominant company and the company’s military force became about twice the size of the British government’s standing military force. That approach made the British East India Company extremely powerful and the British people very rich and powerful. Additionally, at the same time, around 1760, the British created a whole new way of making things and becoming rich while raising people’s living standards. It was called the Industrial Revolution. It was through machine production, particularly propelled by the steam engine. So, this relatively small country of well-educated people became the world’s most powerful country by combining inventiveness, capitalism, great ships and other technologies that allowed them to go global, and a great military to create the British empire that was dominant for the next 100 years.
  • Naturally London replaced Amsterdam as the world’s capital markets center and continued to innovate financial products.
  • Later in that 100-year peaceful and prosperous period, from 1870 to the early 1900s the inventive and prosperous boom continued as the Second Industrial Revolution. During it human ingenuity created enormous technological advances that raised living standards and made those who developed them and owned them rich.
  • This period was for Great Britain what “the Dutch Golden Age” was for the Dutch about 200 years earlier because it raised the power in all the eight key ways—via excellent education, new inventions and technologies, stronger competitiveness, higher output and trade, a stronger military and financial center, and a more widely used reserve currency.
  • At this time several other countries used this period of relative peace and prosperity to get richer and stronger by colonizing enormous swaths of the world. As is typical during this phase, other countries copied Britain’s technologies and techniques and flourished themselves, producing prosperity and, with it, great wealth gaps. For example, during this period there was the invention of steel production, the development of the automobile, and the development of electricity and its applications such as for communications including Alexander Graham Bell’s telephone and Thomas Edison’s incandescent light bulb and phonograph. This is when the United States grew strongly to become a leading world power. These countries became very rich and their wealth gaps increased. That period was called “the Gilded Age” in the US, “la Belle Époque” in France, and “the Victorian Era” in England. As is typical at such times the leading power, Great Britain, became more indulgent while its relative power declined, and it started to borrow excessively.
  • As other countries became more competitive, the British empire became more costly and less profitable to maintain. Most importantly other European countries and the US got stronger economically and militarily in the classic ways laid out in Chapter 1. As shown in the chart of the standing of empires above, the US became a comparable power economically and militarily around 1900 though the UK retained stronger military power, trade, and reserve currency status, and the US continued to gain relative strength from there.
  • From 1900 until 1914, as a consequence of the large wealth gaps, there became 1) greater arguments about how wealth should be divided within countries and 2) greater conflicts and comparabilities in economic and military powers that existed between European countries. As is typical at such times the international conflicts led to alliances being formed and eventually led to war. Before the war the conflicts and the alliances were built around money and power considerations. For example, typical of conflicting powers that seek to cut off their enemies’ access to money and credit, Germany under Bismarck refused to let Russia sell its bonds in Berlin, which led them to be sold in Paris, which reinforced the French-Russian alliance. The wealth gap in Russia led it to tumble into revolution in 1917 and out of the war, which is a whole other dramatic story about fighting over wealth and power that is examined in Part 2 of this book. Similar to the economically motivated shipping conflict between the British and the Dutch, Germany sank five merchant ships that were going to England in the first years of the war. That brought the United States into the war. Frankly, the complexities of the situations leading up to World War I are mind-boggling, widely debated among historians, and way beyond me.
  • That war, which was really the first world war because it involved countries all around the world because the world had become global, lasted from 1914 until 1918 and cost the lives of an estimated 8.5 million soldiers and 13 million civilians. As it ended, the Spanish flu arrived, killing an estimated 20-50 million people over two years. So 1914-20 was a terrible time.

The Rise of the American Empire and the US Dollar After World War I 3

  • As is typical after wars, the winning powers—in this case the US, Britain, France, Japan, and Italy—met to set out the new world order. That meeting, called the Paris Peace Conference, took place in early 1919, lasted for six months, and concluded with the Treaty of Versailles. In that treaty the territories of the losing powers (Germany, Austria-Hungary, the Ottoman empire, and Bulgaria) were carved up and put under the controls of the winning empires and the losing powers were put deeply into debt to the winning powers to pay back the winning countries’ war costs with these debts payable in gold. The United States was then clearly recognized as a leading power so it played a role in shaping the new world order. In fact the term “new world order” came about in reference to US President Woodrow Wilson’s vision for how countries would operate in pursuit of their collective interest through a global governance system (the League of Nations) which was a vision that quickly failed. After World War I the US chose to remain more isolationist while Britain continued to expand and oversee its global colonial empire. The monetary system in the immediate post-war period was in flux. While most countries endeavored to restore gold convertibility, currency stability against gold only came after a period of sharp devaluations and inflation
  • The large foreign debt burdens placed on Germany set the stage for 1) Germany’s post-war inflationary depression from 1920 to 1923 that wiped out the debts and was followed by Germany’s strong economic and military recovery, and 2) a decade of peace and prosperity elsewhere, which became the “Roaring ’20s.”
  • During that time the United States also followed a classic capitalist approach to resource allocation and New York became a rival financial center to London, channeling debt and investments into various businesses.
  • Other countries became more competitive and prosperous and increasingly challenged the leading powers. Most importantly Germany, Japan, and the US got stronger economically and militarily in the classic ways laid out in Chapter 1. However, the US was isolationist and didn’t have a big colonial empire past its borders so it was essentially out of the emerging conflict. As shown in the chart of the standing of empires above, Germany and Japan both gained in power relative to the UK during this interwar period, though the UK remained stronger.
  • As is typical, the debts and the wealth gaps that were built up in the 1920s led to the debt bubbles that burst in 1929 which led to depressions, which led to the printing of money, which led to devaluations of currencies and greater internal and external conflicts over wealth and power in the 1930s. For example, in the United States and the UK, while there were redistributions of wealth and political power, capitalism and democracy were maintained, while in Germany, Japan, Italy, and Spain they were not maintained. Russia played a significant peripheral role in ways I won’t delve into. China at the time was weak, fragmented, and increasingly controlled by a rising and increasingly militaristic and nationalistic Japan. To make a long story short, the Japanese and Germans started to make territorial expansions in the early to mid-1930s, which led to wars in Europe and Asia in the late 1930s that ended in 1945.
  • As is typical, before all-out wars were declared there was about a decade of economic, technological, geopolitical, and capital wars when the conflicting powers approached comparability and tested and tried to intimidate the other powers. While 1939 and 1941 are known as the official start of the wars in Europe and the Pacific, the wars really started about 10 years before that, as economic conflicts that were at first limited progressively grew into World War II. As Germany and Japan became more expansionist economic and military powers, they increasingly competed with the UK, US, and France for both resources and influence over territories.
  • That brought about the second world war which, as usual, was won by the winning countries coming up with new technologies (the nuclear bomb, while the most important, was just one of the newly invented weapons). Over 20 million died directly in the military conflicts, and the total death count was still higher. So 1930-45, which was a period of depression and war, was a terrible time.

The Rise of the American Empire and the US Dollar After World War II

  • As is typical after wars, the winning powers—most importantly the US, Britain, and Russia—met to set out the new world order. While the Bretton Woods Conference, Yalta Conference, and Potsdam Conference were the most noteworthy, several other meetings occurred that shaped the new world order, which included carving up the world and redefining countries and areas of influence and establishing a new money and credit system. In this case, the world was divided into the US-controlled capitalist/democratic countries and Russia-controlled communist and autocratically controlled countries, each with their own monetary systems. Germany was split into pieces, with the United States, Great Britain, and France having control of the West and Russia having control of the East. Japan was under US control and China returned to a state of civil war, mostly about how to divide the wealth, which was between communists and capitalists (i.e., the Nationalists). Unlike after World War I when the United States chose to be relatively isolationist, after World War II the United States took the primary leadership role as it had most of the economic, geopolitical, and military responsibility.
  • The US followed a capitalist system. The new monetary system of the US-led countries had the dollar linked to gold and had most other countries’ currencies tied to the dollar. This system was followed by over 40 countries. Because the US had around two-thirds of the world’s gold then and because the US was much more powerful economically and militarily than any other country, this monetary system has worked best and carried on until now. As for the other countries that were not part of this system—most importantly Russia and those countries that were brought into the Soviet Union and the satellite countries that the Soviets controlled—they were built on a much weaker foundation that eventually broke down. Unlike after World War I, when the losing countries were burdened with large debts, countries that were under US control, including the defeated countries, received massive financial aid from the US via the Marshall Plan. At the same time the currencies and debts of the losing countries were wiped out, with those holding them losing all of their wealth in them. Great Britain was left heavily indebted from its war borrowings and faced the gradual end of the colonial era which would lead to the unraveling of its empire which was becoming uneconomic to have.
  • During this post-World War II period the United States, its allies, and the countries that were under its influence followed a classic capitalist-democratic approach to resource allocation. New York flourished as the world’s pre-eminent financial center, and a new big debt and capital markets cycle began. That produced what has thus far been a relatively peaceful and prosperous 75-year period that has brought us to today.
  • As is typical of this peaceful and prosperous part of the cycle, in the 1950-70 period there was productive debt growth and equity market development that were essential for financing innovation and development early on. That eventually led to too much debt being required to finance both war and domestic needs—what was called “guns and butter.” The Vietnam War and the “War on Poverty” occurred in the US. Other countries also became overly indebted and the British indebtedness became over-leveraged which led to a number of currency devaluations, most importantly the breakdown of the Bretton Woods monetary system (though countries like the UK and Italy had already devalued prior to that time). Then in 1971, when it was apparent that the US didn’t have enough gold in the bank to meet the claims on gold that it had put out, the US defaulted on its promise to deliver gold for paper dollars which ended the Type 2 gold-backed monetary system, and the world moved to a fiat monetary system. As is typical, this fiat monetary system initially led to a wave of great dollar money and debt creation that led to a big wave of inflation that carried until 1980-82 and led to the worst economic downturn since the Great Depression. It was followed by three other waves of debt-financed speculations, bubbles, and busts—1) the 1982 and 2000 money and credit expansion that produced a dot-com bubble that led to the 2000-01 recession, 2) the 2002-07 money and credit expansion that produced a real estate bubble that led to the 2008 Great Recession, and 3) the 2009-19 money and credit expansion that produced the investment bubble that preceded the COVID-19 downturn. Each of these cycles raised debt and non-debt obligations (e.g., for pensions and healthcare) to progressively higher levels and led the reserve currency central banks of the post-war allies to push interest rates to unprecedented low levels and to print unprecedented amounts of money. Also classically, the wealth, values, and political gaps widened within countries, which increases internal conflicts during economic downturns. That is where we now are.
  • During this prosperous post-war period many countries became more competitive with the leading powers economically and militarily. The Soviet Union/Russia initially followed a communist resource allocation approach as did China and a number of other smaller countries. None of these countries became competitive following this approach. However, the Soviet Union did develop nuclear weapons to become militarily threatening and gradually a number of other countries followed in developing nuclear weapons. These weapons were never used because using them would produce mutually assured destruction. Because of its economic failures the Soviet Union/Russia could not afford to support a) its empire, b) its economy, and c) its military at the same time in the face of US President Ronald Reagan’s arms race spending. As a result the Soviet Union broke down in 1991 and abandoned communism. The breakdown of its money/credit/economic system was disastrous for it economically and geopolitically for most of the 1990s. In the 1980-95 period most communist countries abandoned classic communism and the world entered a very prosperous period of globalization and free-market capitalism.
  • In China, Mao Zedong’s death in 1976 led Deng Xiaoping to a shift in economic policies to include capitalist elements including private ownership of large businesses, the development of debt and equities markets, great technological and commercial innovations, and even the flourishing of billionaire capitalists—all, however, under the strict control of the Communist Party. As a result of this shift and the simultaneous shift in the world to greater amounts of globalism China grew much stronger in most ways. For example, since I started visiting China in 1984, the education of its population has improved dramatically, the real per capita income has multiplied by 24, and it has become the largest country in the world in trade (exceeding the US share of world trade), a rival technology leader, the holder of the greatest foreign reserves assets in the world by a factor of over two, the largest lender/investor in the emerging world, the second most powerful military power, and a geopolitical rival of the United States. And it is growing in power at a significantly faster pace than the United States and other “developed countries.”
  • At the same time, we are in a period of great inventiveness due to advanced information/data management and artificial intelligence supplementing human intelligence with the Americans and Chinese leading the way. As shown at the outset of Chapter 1, human adaptability and inventiveness has proven to be the greatest force in solving problems and creating advances. Also, because the world is richer and more skilled than ever before, there is a tremendous capacity to make the world better for more people than ever if people can work together to make the whole pie as big as possible and to divide it well. That brings us to where we now are.

As you can see, all three of these rises and declines followed the classic script laid out in Chapter 1 and summarized in the charts at the beginning of this chapter, though each had its own particular turns and twists.

Now let’s look at these cases, especially the declines, more closely.

A Closer Look at the Rises and Declines of the Leading Empires Over the Last 500 Years

The Dutch Empire and the Dutch Guilder

Before we get to the collapse of the Dutch empire and the Dutch guilder let’s take a quick look at the whole arc of its rise and decline. While I previously showed you the aggregated power index for the Dutch empire, the chart below shows the eight powers that make it up from the ascent around 1575 to the decline around 1780. In it, you can see the story behind the rise and decline.

After declaring independence in 1581, the Dutch fought off the Spanish and built a global trading empire that became responsible for over a third of global trade largely via the first mega-corporation, the Dutch East India Company. As shown in the chart above, with a strong educational background the Dutch innovated in a number of areas. They produced roughly 25% of global inventions in the early 17th century,4 most importantly in shipbuilding, which led to a great improvement in Dutch competitiveness and its share of world trade. Propelled by these ships and the capitalism that provided the money to fuel these expeditions, the Dutch became the largest traders in the world, accounting for about one-third of world trade.5 As the ships traveled around the world, the Dutch built a strong military to defend them and their trade routes.

As a result of this success they got rich. Income per capita rose to over twice that of most other major European powers.6 They invested more in education. Literacy rates became double the world average. They created an empire spanning from the New World to Asia, and they formed the first major stock exchange with Amsterdam becoming the world’s most important financial center. The Dutch guilder became the first global reserve currency, accounting for over a third of all international transactions.7 For these reasons over the course of the late 1500s and 1600s, the Dutch became a global economic and cultural power. They did all of this with a population of only 1-2 million people. Below is a brief summary of the wars they had to fight to build and hold onto their empire. As shown, they were all about money and power.

  • Eighty Years’ War (1566-1648): This was a revolt by the Netherlands against Spain (one of the strongest empires of that era), which eventually led to Dutch independence. The Protestant Dutch wanted to free themselves from the Catholic rule of Spain and eventually managed to become de facto independent. Between 1609 and 1621, the two nations had a ceasefire. Eventually, the Dutch were recognized by Spain as independent in the Peace of Munster, which was signed together with the Treaty of Westphalia, ending both the Eighty Years’ War as well as the Thirty Years’ War.8
  • First Anglo-Dutch War (1652-1654): This was a trade war. More specifically, in order to protect its economic position in North America and damage the Dutch trade that the English were competing with, the English Parliament passed the first of the Navigation Acts in 1651 that mandated that all goods from its American colonies must be carried by English ships, which set off hostilities between the two countries.9
  • The Dutch-Swedish War (1657–1660): This war centered around the Dutch wanting to maintain low tolls on the highly profitable Baltic trade routes. This was threatened when Sweden declared war on Denmark, a Dutch ally. The Dutch defeated the Swedes and maintained the favorable trade arrangement. 10
  • The Second Anglo-Dutch War (1665–1667): England and the Netherlands fought again over another trade dispute, which again ended with a Dutch victory. 11
  • The Franco-Dutch War (1672-1678) and the Third Anglo-Dutch War (1672-1674): This was also a fight over trade. It was between France and England on one side and the Dutch (called the United Provinces), the Holy Roman Empire, and Spain on the other.12 The Dutch largely stopped French plans to conquer the Netherlands and forced France to reduce some of its tariffs against Dutch trade,13 but the war was more expensive than previous conflicts, which increased their debts and hurt the Dutch financially.
  • The Fourth Anglo-Dutch War (1780-1784): This was fought between the Dutch and the rapidly strengthening British, partially in retaliation for Dutch support of the US in the American Revolution. The war ended in significant defeat for the Dutch, and the costs of the fighting and eventual peace helped usher in the end of the guilder as a reserve currency.14

The chart below shows the Dutch power index with the key war periods noted.

As shown, the seeds of Dutch decline were sown in the latter part of the 17th century as they started to lose their competitiveness and became overextended globally trying to support an empire that had become more costly than profitable. Increased debt-service payments squeezed them while their worsening competitiveness hurt their income from trade. Earnings from business abroad also fell. Wealthy Dutch savers moved their cash abroad both to get out of Dutch investments and into British investments, which were more attractive due to strong earnings growth and higher yields.15 While debt burdens had grown through most of the 1700s,17 the Dutch guilder remained widely accepted around the world as a reserve currency so it held up solely because of the functionality of and faith in it.17 (As explained earlier, reserve currency status classically lags the decline of other key drivers of the rise and fall of empires.) As shown by the black line in the first chart above (designating the extent the currency is used as a reserve currency) the guilder remained widely used as a global reserve currency after the Dutch empire started to decline, up until the Fourth Anglo-Dutch War, which began in 1780 and ended in 1784.18

The simmering conflict between the rising British and the declining Dutch had escalated after the Dutch traded arms with the colonies during the American Revolution.19 In retaliation the English delivered a massive blow to the Dutch in the Caribbean and ended up controlling Dutch territory in the East and West Indies.20 The war required heavy expenditure by the Dutch to rebuild their dilapidated navy: the Dutch East India Company lost half its ships21 and access to its key trade routes while heavily borrowing from the Bank of Amsterdam to stay alive. And the war forced the Dutch to accumulate large debts beyond these.22

The main reason the Dutch lost the war was that they let their navy become much weaker than Britain’s because of disinvestment into military capacity in order to spend on domestic indulgences.23 In other words, they tried to finance both guns and butter with their reserve currency, didn’t have enough buying power to support the guns despite their great ability to borrow due to their having the leading reserve currency, and became financially and militarily defeated by the British who were stronger in both respects.

Most importantly, this war destroyed the profitability and balance sheet of the Dutch East India Company.24 While it was already in decline due to its reduced competitiveness, it ran into a liquidity crisis after a collapse in trade caused by British blockades on the Dutch coast and in the Dutch East Indies.25 As shown below, it suffered heavy losses during the Fourth Anglo-Dutch War and began borrowing aggressively from the Bank of Amsterdam because it was too systemically important for the Dutch government.


As shown in the chart below the Dutch East India Company, which was essentially the Dutch economy and military wrapped into a company, started to make losses in 1780, which became enormous during the Fourth Anglo-Dutch War.

As deposit holders at the Bank of Amsterdam realized the bank was “lending” freshly printed guilders to save the Dutch East India Company, there was a run on the Bank of Amsterdam.27 As investors pulled back and borrowing needs increased, gold was preferred to paper money, those with paper money exchanged it for gold at the Bank of Amsterdam, and it became clear that there wouldn’t be enough gold. The run on the bank and the run on the guilder accelerated throughout the war, as it became increasingly apparent that the Dutch would lose and depositors could anticipate that the bank would print more money and have to devalue the guilder.28 Guilders were backed by precious metals, but as the supply of guilders rose and investors could see what was happening they turned their guilders in for gold and silver so the ratio of claims on gold and silver rose, which caused more of the same until the Bank of Amsterdam was wiped out of its precious metal holdings. The supply of guilders continued to soar while demand for them fell.

The Bank of Amsterdam had no choice since the company was too important to allow to fail both because of its significance to the economy and its outstanding debt in the Dutch financial system, so the Bank of Amsterdam began “lending” large sums of newly printed guilders to the company. During the war, policy makers also used the bank to lend to the government.29 The chart below shows this explosion of loans on the bank’s balance sheet through the Fourth Anglo-Dutch War (note: there was about 20 million bank guilder outstanding at the start of the war).30


Interest rates rose and the Bank of Amsterdam had to devalue, undermining the credibility of the guilder as a storehold of value.32 Over the years, and at this moment of crisis, the bank had created many more “paper money” claims on the hard money in the bank than could be met so that led to a classic run on the Bank of Amsterdam, which led to the collapse of the Dutch guilder.33 It also led to the British pound clearly replacing the Dutch guilder as the leading reserve currency.

What happened to the Dutch was classic as described in both Chapter 1’s very brief summary of why empires rise and fall and in Chapter 2’s description of how money, credit, and debt work. As for the money, credit, and debt cycle, the Bank of Amsterdam started with a Type 1 monetary system that morphed into a Type 2 monetary system. It started with just coins that led to the bank having a 1:1 backing of paper money by metal, so the bank provided a more convenient form of hard money. The claims on money were then allowed to rise relative to the hard money to increasingly become a Type 2 monetary system, in which paper money seems to acquire a value itself as well as a claim on hard money (coins), though the money wasn’t fully backed. This transition usually happens at times of financial stress and military conflict. And it is risky because the transition decreases trust in the currency and adds to the risk of a bank-run-like dynamic. While we won’t go deeply into the specifics of the war, the steps taken by policy makers during the period led to the loss of Dutch financial power so are worth describing because they are so archetypical when there is a clear shift in power and the losing country has a bad income statement and balance sheet. This period was like that and ended with the guilder supplanted by the pound as the world’s reserve currency and London succeeding Amsterdam as the world’s financial center.

Deposits (i.e., holdings of short-term debt) of the Bank of Amsterdam, which had been a reliable storehold of wealth for nearly two centuries, began to trade at large discounts to guilder coins (which were made of gold and silver).34 The bank used its holdings of other countries’ debt (i.e., its currency reserves) to buy its currency on the open market to support the value of deposits, but it lacked adequate foreign currency reserves to support the guilder.35 Accounts backed by coin held at the bank plummeted from 17 million guilder in March 1780 to only 300,000 in January 1783 as owners of these gold and silver coins wanted to get them rather than continue to hold the promises of the Bank of Amsterdam to deliver them.36

The running out of money by the Bank of Amsterdam marked the end of the Dutch empire and the guilder as a reserve currency. In 1791 the bank was taken over by the City of Amsterdam,37 and in 1795 the French revolutionary government overthrew the Dutch Republic, establishing a client state in its place.38 After being nationalized in 1796, rendering its stock worthless, the Dutch East India Company’s charter expired in 1799.39

The following charts show the exchange rates between the guilder and the pound/gold; as it became clear that the bank no longer had any credibility and that the currency was no longer a good storehold of wealth, investors fled to other assets and currency.40


The chart below shows the returns of holding the Dutch East India Company for investors starting in various years. As with most bubble companies, it originally did great, with great fundamentals, which attracted more investors even as its fundamentals started to weaken, but it increasingly got into debt, until the failed fundamentals and excessive debt burdens broke the company.

As is typical, with the decline in power of the leading empire and the rise in power of the new empire, the returns of investment assets in the declining empire fell relative to the returns of investing in the rising empire. For example, as shown below, the returns on investments in the British East India Company far exceeded those in the Dutch East India Company, and the returns of investing in Dutch government bonds were terrible relative to the returns of investing in English government bonds. This was reflective of virtually all investments in these two countries.


The British Empire and the British Pound

Before we get to the collapse of the British empire and the British pound, let’s take a quick look at the whole arc of its rise and decline. While I previously showed you the aggregated power index for the British empire, the chart below shows the eight powers that make it up. It shows these from the ascent around 1700 to the decline in the early 1900s. In it, you can see the story behind the rise and decline.

The British empire’s rise began before 1600, with steadily strengthening competitiveness, education, and innovation/technology—the classic leading factors for a power’s rise. As shown and previously described, in the late 1700s the British military power became pre-eminent and it beat its leading economic competitor and the leading reserve currency empire of its day in the Fourth Anglo-Dutch War. It also successfully fought other European rivals like France in a number of conflicts that culminated in the Napoleonic Wars in the early 1800s. Then it became extremely rich by being the dominant economic power. At its peak in the 19th century, the UK’s 2.5% of the world’s population produced 20% of the world’s income, and the UK controlled over 40% of global exports. This economic strength grew in tandem with a strong military, which, along with the privately driven conquests of the British East India Company, drove the creation of a global empire upon which “the sun never set,” controlling over 20% of the world’s land mass and 25% of the global population prior to the outbreak of World War I. With a lag, as is classic, its capital—London—emerged as the global financial center and its currency—the pound—emerged as the leading global reserve currency. As is typical its reserve status remained well after other measures of power started declining in the late 19th century and as powerful rivals like the US and Germany rose. As shown in the chart above, almost all of the British empire’s relative powers began to slip as competitors emerged around 1900. At the same time wealth gaps were large and internal conflicts over wealth were emerging.

As you know, despite winning both World War I and World War II the British were left with large debts, a huge empire that was more costly than profitable, numerous rivals that were more competitive, and a population that had big wealth gaps which led to big political gaps.

As I previously summarized what happened in the 1914 to post-World War II period, I will skip ahead to the end of World War II in 1945 and the start of the new world order that we are now in. I will be focusing on how the pound lost its reserve currency status.

Although the US had overtaken the UK militarily, economically, politically, and financially long before the end of World War II, it took more than 20 years after the war for the British pound to fully lose its status as an international reserve currency. Just like the world’s most widely spoken language becomes so deeply woven into the fabric of international dealings that it is difficult to replace, the same is true of the world’s most widely used reserve currency. In the case of the British pound, other countries’ central banks continued to hold a sizable share of their reserves in pounds through the 1950s, and about half of all international trade was denominated in sterling in 1960. Still, the pound began to lose its status right at the end of the war because smart folks could see the UK’s increased debt load, its low net reserves, and the great contrast with the United States’ financial condition (which emerged from the war as the world’s pre-eminent creditor and with a very strong balance sheet).

The decline in the British pound was a chronic affair that happened through several significant devaluations over many years. After efforts at making the pound convertible failed in 1946-47, the pound devalued by 30% against the dollar in 1949. Though this worked in the short term, over the next two decades the declining competitiveness of the British led to repeated balance of payments strains that culminated with central banks actively selling sterling reserves to accumulate dollar reserves following the devaluation of 1967. Around this time the deutschmark began to re-emerge and took the pound’s place as the second-most widely held reserve currency. The charts below paint the picture.

On the following pages we will cover in greater detail the specific stages of this decline, firstly with the convertibility crisis of 1947 and the 1949 devaluation, secondly with the gradual evolution of the pound’s status relative to the dollar through the 1950s and early 1960s, and thirdly with the balance of payments crisis of 1967 and subsequent devaluation. We will focus in on the currency crises.

1) The Pound’s Suspended Convertibility in 1946 and Its Devaluation in 1949

The 1940s are frequently referred to as “crisis years”43 for sterling. The war required the UK to borrow immensely from its allies and colonies,44 and those obligations were required to be held in sterling. These war debts financed about a third of the war effort. When the war ended, the UK could not meet its debt obligations without the great pain of raising taxes or cutting government spending, so it necessarily mandated that its debt assets (i.e., its bonds) could not be proactively sold by its former colonies.

As such, the UK emerged from World War II with strict controls on foreign exchange. The Bank of England’s approval was required to convert pounds into dollars, whether to buy US goods or purchase US financial assets (i.e., current and capital account convertibility was suspended). To ensure the pound would function as an international reserve currency in the post-war era, and to prepare the global economy for a transition to the Bretton Woods monetary system, convertibility would have to be restored. However, because the US dollar was now the international currency of choice, the global economy was experiencing a severe shortage of dollars at the time. Virtually all Sterling Area countries (the UK and the Commonwealth countries) relied on inflows from selling goods and services and from attracting investments in dollars to get the dollars they needed while they were forced to hold their sterling-denominated bonds. The UK experienced acute balance of payments problems due to its poor external competitiveness, a domestic fuel crisis, and large war debts undermining faith in the pound as a storehold of wealth. As a result, the first effort to restore convertibility in 1947 failed completely, and it was soon followed by a large devaluation (of 30%) in 1949, to restore some competitiveness.45

Coming into the period, there were concerns that too quick a return to convertibility would result in a run on the pound, as savers and traders shifted to holding and transacting in dollars all at once. However, the US was anxious for the UK to restore convertibility as soon as possible as restrictions on convertibility were reducing US export profits and reducing liquidity in the global economy.46 The Bank of England was also eager to remove capital controls in order to restore the pound’s role as a global trading currency, increase financial sector revenues in London, and encourage international investors to continue saving in sterling47 (a number of governments of European creditors, including Sweden, Switzerland, and Belgium, were having increasing conflicts with the UK over the lack of convertibility).48 An agreement was reached after the war, under which the UK would reintroduce convertibility swiftly, and the US would provide the UK with a loan of $3.75 billion49 (about 10% of UK GDP). While the loan offered some buffer against a potential run on the pound, it did not change the underlying imbalances in the global economy.

When partial convertibility was introduced in July 1947, the pound came under considerable selling pressure. As the UK and US governments were against devaluation (as memories of the competitive devaluations in the 1930s were fresh on everyone’s minds),50 the UK and other Sterling Area countries turned to austerity and reserve sales to maintain the peg to the dollar. Restrictions were imposed on the import of “luxury goods” from the US, defense expenditure was slashed, dollar and gold reserves were drawn down, and agreements were made between sterling economies not to diversify their reserve holdings to the dollar.51 Prime Minister Clement Attlee gave a dramatic speech on August 6, 1947, calling for the spirit of wartime sacrifices to be made once again in order to defend the pound:

“In 1940 we were delivered from mortal peril by the courage, skill, and self-sacrifice of a few. Today we are engaged in another battle for Britain. This battle cannot be won by the few. It demands a united effort by the whole nation. I am confident that this united effort will be forthcoming and that we shall again conquer.”52

Immediately following the speech, the run on the pound accelerated. Over the next five days, the UK had to spend down $175 million of reserves to defend the peg.53 By the end of August, convertibility was suspended, much to the anger of the US and other international investors who had bought up sterling assets in the lead-up to convertibility hoping that they would soon be able to convert those holdings to dollars. The governor of the National Bank of Belgium even threatened to stop transacting in sterling, requiring a diplomatic intervention.54

The devaluation came two years later, as policy makers in both the UK and the US realized that the pound couldn’t return to convertibility at the current rate. UK exports were not competitive enough in global markets to earn the foreign exchange needed to support the pound, reserves were dwindling, and the US was unwilling to continue shoring up the pound with low interest rate loans. An agreement was reached to devalue the pound versus the dollar in order to boost UK competitiveness, help create a two-way currency market, and speed up a return to convertibility.55 In September 1949, the pound was devalued by 30% versus the dollar. Competitiveness returned, the current account improved, and by the mid-to-late 1950s, full convertibility was restored.56 The charts below paint the picture.

The currency move, which devalued sterling debt, did not lead to a panic out of sterling debt as much as one might have expected especially in light of how bad the fundamentals for sterling debt remained. That is because a very large share of UK assets was held by the US government, which was willing to take the valuation hit in order to restore convertibility, and by Sterling Area economies, such as India and Australia, whose currencies were pegged to the pound for political reasons.57 These Commonwealth economies, for geopolitical reasons, supported the UK’s decision and followed by devaluing their own currencies versus the dollar, which lessened the visibility of the loss of wealth from the devaluation. Still, the immediate post-war experience made it clear to knowledgeable observers that the pound was vulnerable to more weakness and would not be able to enjoy the same international role it had prior to World War II.

2) The Failed International Efforts to Support the Pound in the 1950s and 1960s and the Devaluation of 1967

Though the devaluation helped in the short term, over the next two decades, the pound would face recurring balance of payments strains. These strains were very concerning to international policy makers who feared that a collapse in the value of sterling or a rapid shift away from the pound to the dollar in reserve holdings could prove highly detrimental to the new Bretton Woods monetary system (particularly given the backdrop of the Cold War and concerns around communism). As a result, numerous arrangements were made to try to shore up the pound and preserve its role as a source of international liquidity. These included the Bilateral Concerté (1961-64), in which major developed world central banks gave support to countries via the Bank of International Settlements, including multiple loans to the UK and the BIS Group Arrangement 1 (1966-71), which provided swaps to the UK to offset future pressure from potential falls in sterling reserve holdings.58

In addition to these wider efforts, the UK’s status as the head of the Sterling Area let it mandate that all trade within the Sterling Area would continue to be denominated in pounds and all their currencies would be pegged to sterling. As these economies had to maintain a peg to the pound, they continued to accumulate FX reserves in sterling well after other economies had stopped doing so (e.g., Australia kept 90% of its reserves in sterling as late as 1965).59 Foreign loans issued in the UK during the period were also almost exclusively to the Sterling Area. The result of all this is that for the 1950s and early 1960s, the UK is best understood as a regional economic power and sterling as a regional reserve currency.60 Yet all these measures didn’t fix the problem that the UK owed too much money and was uncompetitive, so it didn’t earn enough money to both pay its debts and pay for what it needed to import. Rearrangements were essentially futile stop-gap measures designed to hold back the changing tide. They helped keep the pound stable between 1949 and 1967. Still, sterling needed to be devalued again in 1967.

By the mid-1960s, the average share of central bank reserves held in pounds had fallen to around 20%, while international trade was overwhelmingly denominated in dollars (about half). However, many emerging markets and Sterling Area countries continued to hold about 50% of their reserves in pounds and continued to denominate much of their trade with each other and the UK in sterling. This effectively ended following a series of runs on the pound in the 1960s. As in many other balance of payments crises, policy makers used a variety of means to try to maintain the currency peg to the dollar, including spending down reserves, raising rates, and using capital controls. In the end they were unsuccessful, and after the UK devalued by 14% versus the dollar in 1967, even Sterling Area countries were unwilling to hold their reserves in pounds, unless the UK guaranteed their underlying value in dollars.

Throughout the 1960s, the UK was forced to defend the peg to the dollar by selling about half of its FX reserve holdings and keeping rates higher than the rest of the developed world—even though the UK economy was underperforming. In both 1961 and 1964, the pound came under intense selling pressure, and the peg was only maintained by a sharp rise in rates, a rapid acceleration in reserve sales, and the extension of short-term credits from the US and the Bank of International Settlements. By 1966, attempts to defend the peg were being described by prominent British policy makers as “a sort of British Dien Bien Phu.”61 When the pound came under extreme selling pressure again in 1967 (following rising rates in the developed world, recessions in major UK export markets, and heightened conflict in the Middle East),62 British policy makers decided to devalue sterling by 14% against the dollar.

After the devaluation little faith remained in the pound as the second-best reserve currency after the dollar. For the first time since the end of World War II, international central banks began actively selling their sterling reserves (as opposed to simply accumulating fewer pounds in new reserve holdings) and instead began buying dollars, deutschmarks, and yen. As you can see in the chart below on the left, the average share of sterling in central bank reserve holdings collapsed within two years of the devaluation. At the same time the UK was still able to convince Sterling Area countries not to diversify away from the pound. In the Sterling Agreement of 1968, Sterling Area members agreed to maintain a floor on their pound reserve holdings, as long as 90% of the dollar value of these holdings was guaranteed by the British government. So although the share of pound reserves in these Sterling Agreement countries like Australia and New Zealand remained high, this was only because these reserves had their value guaranteed by the British in dollars. So all countries that continued to hold a high share of their reserves in pounds after 1968 were holding de facto dollars with the British bearing the risk of a further sterling devaluation.63


By this time the dollar was having its own set of balance of payments and currency problems, but that is for the next installment of this series when I turn to the United States and China.

[1] We show where key indicators were relative to their history by averaging them across the cases. The chart is shown such that a value of “1” represents the peak in that indicator relative to history and “0” represents the trough. The timeline is shown in years with “0” representing roughly when the country was at its peak (i.e., when the average across gauges was at its peak). In the rest of this section, we walk through each of the stages of the archetype in more detail. While the charts show the countries that produced global reserve currencies, we’ll also heavily reference China, which was a dominant empire for centuries, though it never established a reserve currency.

[2] A good example of this is the popularity of the Patriot movement in the Netherlands around this time: Encyclopedia Britannica, The Patriot movement,

[3] While most people think that the ascent of the US came after World War II, it really started here and went on across both wars—and the seeds of that rise came still earlier from the self-reinforcing upswings in US education, innovation, competitiveness, and economic outcomes over the 19th century.

[4] Rough estimate based on internal calculations

[5] Rough estimate based on internal calculations

[6] Rough estimate based on internal calculations

[7] In this piece, when talking about “the guilder,” we generally refer to guilder bank notes, which were used at the Bank of Amsterdam, rather than the physical coin (also called “guilder”).

[8] Encyclopedia Britannica, Eighty Years’ War,

[9] Encyclopedia Britannica, The Anglo-Dutch Wars,

[10] Israel, Dutch Primacy in World Trade, 1585-1740, 219

[11] Encyclopedia Britannica, The Anglo-Dutch Wars,

[12] Encyclopedia Britannica, The Dutch War,

[13] Israel, The Dutch Republic: Its Rise, Greatness, and Fall 1477-1806, 824-825

[14] Encyclopedia Britannica, The Anglo-Dutch Wars,

[15] There was a general rise in foreign investment by the Dutch during this period. Investments in UK assets offered high real returns. Examples include Dutch purchases of stocks in the British East India Company, and the City of London selling term annuities (bonds) to Dutch investors. For a further description, see Hart, Jonker, and van Zanden, A Financial History of the Netherlands, 56-58.

[16] Hart, Jonker, and van Zanden, A Financial History of the Netherlands, 20-21

[17] Quinn & Roberds, “Death of a Reserve Currency,” 13

[18] Encyclopedia Britannica, The Anglo-Dutch Wars,

[19] Encyclopedia Britannica, The Anglo-Dutch Wars,

[20] Encyclopedia Britannica, The Anglo-Dutch Wars,

[21] de Vries & van der Woude, The First Modern Economy, 455

[22] de Vries & van der Woude, The First Modern Economy, 126

[23] de Vries & van der Woude, The First Modern Economy, 685-686

[24] de Vries & van der Woude, The First Modern Economy, 455

[25] de Vries & van der Woude, The First Modern Economy, 455-456 &

[26] This chart only shows the financial results from the Dutch East India Company reported "in patria," e.g., the Netherlands. It does not include the part of the revenue and debt from its operations in Asia but does include its revenues from goods it retrieved in Asia and sold in Europe.

[27] Quinn & Roberds, “Death of a Reserve Currency,” 17

[28] “Guilder” in this case refers to devaluing bank deposits in guilder from the Bank of Amsterdam, not physical coin. For details on the run, see Quinn & Roberds, “Death of a Reserve Currency,” 16.

[29] Quinn & Roberds, “Death of a Reserve Currency,” 17-18

[30] Quinn & Roberds, “Death of a Reserve Currency,” 16

[31] Quinn & Roberds, “Death of a Reserve Currency,” 34

[32] Quinn & Roberds, “Death of a Reserve Currency,” 15-16

[33] The Bank of Amsterdam was ahead its time and used ledgers instead of real “paper money.” See Quinn & Roberds, “The Bank of Amsterdam Through the Lens of Monetary Competition,” 2

[34] Quinn & Roberds, “Death of a Reserve Currency,” 19, 26

[35] Quinn & Roberds, “Death of a Reserve Currency,” 19-20

[36] Quinn & Roberds, “Death of a Reserve Currency,” 16

[37] Quinn & Roberds, “Death of a Reserve Currency,” 24

[38] de Vries & van der Woude, The First Modern Economy, 685-686

[39] Encyclopedia Britannica, The Dutch East India Company,; also see de Vries & van der Woude, The First Modern Economy, 463-464

[40] Historical data suggests that by 1795, bank deposits were trading at a -25% discount to actual coin. Quinn & Roberds, “Death of a Reserve Currency,” 26.

[41] Note: To fully represent the likely economics of a deposit holder at the Bank of Amsterdam, we assumed depositors each received their pro-rated share of precious metal still in the bank's vaults when it was closed (that was roughly 20% of the fully backed amount, thus the approximately 80% total devaluation).

[42] Gelderblom & Jonker, "Exporing the Market for Government Bonds in the Dutch Republic (1600-1800)," 16

[43] For example, see Catherine Schenk, The Decline of Sterling: Managing the Retreat of an International Currency, 1945–1992, 37 (hereafter referred to as Schenk, Decline of Sterling)

[44] See Schenk, Decline of Sterling, 39

[45] For an overview of the convertibility crisis and devaluation, see Schenk, Decline of Sterling, 68-80; Alec Cairncross & Barry Eichengreen, Sterling in Decline: The Devaluations of 1931, 1949, and 1967, 102-147 (hereafter referred to as Cairncross & Eichengreen, Sterling in Decline).

[46] Schenk, Decline of Sterling, 44

[47] Schenk, Decline of Sterling, 31

[48] Alex Cairncross, Years of Recovery: British Economic Policy 1945-51, 124-126

[49] Schenk, Decline of Sterling, 63

[50] Schenk, Decline of Sterling, 48

[51] Schenk, Decline of Sterling, 62

[52] As quoted in Schenk, Decline of Sterling, 62-63

[53] Ibid

[54] Schenk, Decline of Sterling, 66-67

[55] For more detail, see Cairncross & Eichengreen, Sterling in Decline, 139-155

[56] See also Cairncross & Eichengreen, Sterling in Decline, 151-155 for a discussion of other contributing factors

[57] Schenk, Decline of Sterling, 39, 46; for further description, see

[58] For further description of these and other coordinated policies, see Catherine Schenk, “The Retirement of Sterling as a Reserve Currency After 1945: Lessons for the US Dollar?”

[59] John Singleton & Catherine Schenk, “The Shift from Sterling to the Dollar, 1965–76: Evidence from Australia and New Zealand,” 1162

[60] For more detail on the dynamics of the Sterling Area, see Catherine Schenk, Britain and the Sterling Area, 1994

[61] As quoted by Schenk, Decline of Sterling, 156

[62] Schenk, Decline of Sterling, 174

[63] For fuller coverage of this, see Schenk, Decline of Sterling, 273-315

[64] Data from Schenk, "The Retirement of Sterling as a Reserve Currency After 1945: Lessons for the US Dollar?," 25

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