Ray Dalio Commentary: Pick a Side and Fight for It, Keep Your Head Down or Flee

As you know, based on my study of history, I believe there are now and have always been five big, interrelated forces that drive how domestic and world orders change. They are the 1) the big debt/credit/money cycle, 2) the big internal order/disorder cycle 3) the big external order/disorder cycle, 4) acts of nature (i.e., droughts, floods, and pandemics), and 5) human innovation that leads to advances in technology. Today, I am focusing on why I believe we are approaching the point in the internal order-disorder cycle when you will have to choose between picking a side and fighting for it, keeping your head down, or fleeing.

Pick a Side and Fight for It, Keep Your Head Down, or Flee

I believe we now have to face the fact that fighting for democracy as we know itwith thoughtful disagreement and compromises governed by rule of lawis unlikely to work. People like me who had a long shot hope for the emergence of a strong middle that fights against the extremists to bring the country together and makes major reforms to improve the system must recognize that the differences are becoming too irreconcilable for this to happen.

Based on the lessons I learned from studying history about how things typically transpire under similar circumstances, I believe that what we are now seeing is the parties increasingly moving to greater extremism and a fight-to-win at all cost mode. This is threatening the rule of law as we know it and is bringing us closer to some form of civil war. (As I will explain below, this is not necessarily a violent conflict, though that is possible).

When I wrote my book,Principles for Dealing with the Changing World Order, which looked at the rises and declines of domestic and world orders over the last 500 years, I chronicled the six stages of the big internal order cycle, their symptoms, and the cause-effect relationships that drive them. Just like life cycles, these stages are logical and everyone goes through them, typically about once in a lifetime. Toward the end of the cycle, which is where all the signs and symptoms show us to be today, people typically face a choice between fighting for one side or another, keeping their heads down, or fleeing.

When I wrote the book in 2020, I saw the writing on the wall but had hoped for the possibility that we would not cross the brink into a type of civil war, so I estimated the chance of that as about 1 in 3. At the time, this was considered a crazy high estimate (this was before the 2020 election being contested and the January 6th incident). Now I think the risk of some form of civil war is uncomfortably more than 50 percent, and I am confident that in the next year we will know the answer to whether we will cross the brink.

In a Nutshell How It Works

Domestically in the US there are two political sides which are also each divided in two: 1) the right side (i.e., the red Republican team), which is divided into the hard right and the moderate right, and 2) the left (the blue Democratic team), which is divided into the hard left and the moderate left. Throughout history, in the later stages of the cycle of internal order and disorder, both sides become increasingly "hard" (extreme) for logical reasons. This is the part of the cycle that we are in. Classically, at this stage, wealth and values gaps are large, people have lost faith that the system will get them what they want, and the hard right and the hard left become increasingly committed to winning for their constituents at all costs, which eventually means abandoning the rules of the game and the judges and just fighting. In the current case and classically, the sides become unwilling to compromise as compromising is perceived as being weak and people are forced to either pick a side and fight for it, keep their heads down, or flee. You should be prepared to make that choice.

To make the decision only a bit more extreme than it currently is, in looking at these two sides, if you had to choose between a fascist government and a communist government, which would you choose? If you are not knowledgeable about what fascism is (a dictatorship of the hard right) and what communism really is (a dictatorship of the hard left), I urge you to get schooled because if you have to make choices, it's important to really understand them.

The Case at Hand

Most importantly, there are now big irreconcilable differences that are producing win-at-all cost perspectives that are undermining the willingness to accept the judgements of the legal system. That is very relevant to nearly all decision makingmost importantly to legal and political decision making in and beyond the election. We should acknowledge and worry about what's going on and think about its implications. For example, we should pay attention to Maureen Dowd of theNew York Times saying that the Supreme Court is"corrupt, rotten, and hurting America"and the numerous other similar attacks on the system. This is only one of a chorus of such comments. Comments like these beg questions such as 1) what is the definition of corruption, 2) if it is corruption, why don't those who are corrupt get prosecuted and convicted, and 3) if the judicial system and the judges don't make these decisions, how will they be made? Nowadays corrupt seems to mean what those on the other side of the political divide decide is corrupt. It is obvious to me that if people don't rely on the judicial system to make unbiased decisions, decisions will instead be made by revolutionaries on both sides fighting it out. This of course is very relevant to the upcoming election, so let's play out how that will likely go.

It seems to me that if Biden wins, it is likely that Trump and those on the hard right who he represents won't accept the leadership of Biden and the Democratic Party, and that if Trump wins, those on the hard left won't accept Trump's leadership and tactics. What happens next depends on the strength of the legal system, with those on each side seemingly more willing to fight its judgments than abide by them if they don't get what they want. For these reasons, it seems to me that there is a higher than 50 percent chance that democracy as we know it won't run smoothly through the election and beyond, and that the still most popular view that everyone will abide by the votes and the rules (i.e., if we have ABC votes for president, senators, and congressmen, we will have XYZ policies enacted as a function of the system operating as it has operated) won't prove true.

While it is now commonly believed that Trump Republicans are the greater extremists and the Democrats will be moderate, based on how things have transpired in history and what I see today, I'm not so sure. I think it's more likely that both sides will be more extreme than is commonly believed. Given that it is doubtful that President Biden will remain president through his next term, we don't know what part of the Democratic Party will win out in leading its agenda. While there are moderate leaders in the Democratic Party (i.e., Hakeem Jeffries, Gretchen Whitmer, and Josh Shapiro), those of the hard left (i.e., Elizabeth Warren, Bernie Sanders, and AOC) have largely gone quiet, knowing that they would scare away moderate voters so it's better for them to bide their time while they are pushing their hard left agenda behind the scenes. President Biden's appointment of Lina Khan, a political activist of the left, to head the FTC is an example of the current administration using appointments the way Trump is making clear he will have his political appointees use their positions to pursue a hard-left agenda. In the recent past, leading Democrats have also expressed support for rule changes that would swing power their way (i.e., making Puerto Rico and Washington DC states so they could get control of the Senate, adding to the number of Supreme Court justices to get control of it, removing of the filibuster, etc.) Given all of this, I'm not so sure that hard left Democrats are out of the picture or are above using their government powers to achieve their political agenda any more than I believe that hard right Republicans are above doing that.

For all these reasons, it appears to me that we are probably headed toward an existential battle of the hard right against the hard left in which you will have to pick a side and fight for it, or keep your head down, or flee.

By flee, I think that will mostly be from one state to another and we will see increased emphasis on state rights rather than the central government being dominant. A clash between state governments and a fractured central government appears likely, which I would regard as a type of civil war even if not violent. If things get bad enough, some Americans will flee to other countries and foreigners will choose not to be here. Such disorder would also not be good for rule-of-law and our capital markets.

From studying history, I have seen these sorts of civil wars happen many times beforein the French, Russian, German, Italian, Spanish, Chinese, Cuban and several other casesso that the sequence of how this cycle typically transpires is clear and appears applicable to what is happening now in the United States (and in several other countries in varying degrees). For those who are interested, I have copied the section from Chapter Five (The Big Cycle of Internal Order/Disorder) of my book which the describes Stage Five (the pre-civil war stage that I believe we are in) and Stage Six (the civil war stage that I believe that we are in the brink of) of the internal order cycle. To be clear, I am not saying that we will certainly cross the brink into civil warI am saying that there is a much higher probability of some type of civil war (including a non-violent one) than is commonly believed.

By the way, what I described here is about domestic conflict. A similar sort of conflict is happening internationallyi.e., there is a classic great power conflict with the two big sides internationally being the China-Russia side and the US -G7-Australia side and regional conflicts are being sorted out by nations in alliances with these two big sides. But that is a subject for another day. Let's now focus on how the internal conflict dynamic typically works and apply that template to what's happening to internal politics with this excerpt from Chapter Five of Principles for Dealing with the Changing World Order.

Stage 5: When There Are Bad Financial Conditions and Intense Conflict

The most important influence that transpires in a Big Cycle is that of debt, money, and economic activity. Because I covered that cycle comprehensively in Chapters 3 and 4, I won't explain it here in detail. But to understand Stage 5, you need to know that it follows Stage 3, in which there is peace and prosperity and favorable debt and credit conditions, and Stage 4, in which excess and decadence begin to bring about worse conditions. This process culminates in the most difficult and painful stageStage 6when the entity runs out of money and there is typically terrible conflict in the form of revolution or civil war. Stage 5 is the period during which the interclass tensions that go along with worsening financial conditions come to a head. How different leaders, policy makers, and groups of people deal with conflict has a major impact on whether the country will undergo the needed changes peacefully or violently.

You can see signs of this happening now in a number of countries. Those that have adequate financial conditions (i.e., have incomes that are greater than their expenses and assets that are greater than their liabilities) are in relatively good shape. Those that do not are in relatively bad shape. They want money from the others. The problem is that there are many more who are in bad shape relative to those that are in good shape.

You can also see that these different conditions are big drivers of the differences in what is now happening to most aspects of these countries, states, cities, companies, and peoplee.g., their education, healthcare, infrastructure, and well-being. You can also see big cultural differences in how countries approach their stressful conditions, with some approaching them more harmoniously than others who are more inclined to fight.

Because Stage 5 is such a pivotal stage in the internal cycle and because it's the stage that many countries, most importantly the US, are now in, I will devote some time to going through the cause/effect relationships at play during it and the key indicators to watch in examining its progression. Then I will turn more specifically to where the United States stands.

The Classic Toxic Mix

The classic toxic mix of forces that brings about big internal conflicts consists of 1) the country and the people in the country (or state or city) being in bad financial shape (e.g., having big debt and non-debt obligations), 2) large income, wealth, and values gaps within that entity, and 3) a severe negative economic shock.

That confluence typically brings about disorder, conflict, and sometimes civil wars. The economic shock can come about for many reasons, including financial bubbles that burst, acts of nature (such as pandemics, droughts, and floods), and wars. It creates a financial stress test. The financial conditions (as measured by incomes relative to expenses and assets relative to liabilities) that exist at the time of the stress test are the shock absorbers. The sizes of the gaps in incomes, wealth, and values are the degrees of fragility of the system. When the financial problems occur, they typically first hit the private sector and then the public sector. Because governments will never let the private sector's financial problems sink the entire system, it is the government's financial condition that matters most. When the government runs out of buying power, there is a collapse. But on the way to a collapse there is a lot of fighting for money and political power.

From studying 50-plus civil wars and revolutions, it became clear that the single most reliable leading indicator of civil war or revolution is bankrupt government finances combined with big wealth gaps. That is because when the government lacks financial power, it can't financially save those entities in the private sector that the government needs to save to keep the system running (as most governments, led by the United States, did at the end of 2008), it can't buy what it needs, and it can't pay people to do what it needs them to do. It is out of power.

A classic marker of being in Stage 5 and a leading indicator of the loss of borrowing and spending power, which is one of the triggers for going into Stage 6, is that the government has large deficits that are creating more debt to be sold than buyers other than the government's own central bank are willing to buy. That leading indicator is turned on when governments that can't print money have to raise taxes and cut spending, or when those that can print money print a lot of it and buy a lot of government debt. To be more specific, when the government runs out of money (by running a big deficit, having large debts, and not having access to adequate credit), it has limited options. It can either raise taxes and cut spending a lot or print a lot of money, which depreciates its value. Those governments that have the option to print money always do so because that is the much less painful path, but it leads investors to run out of the money and debt that is being printed. Those governments that can't print money have to raise taxes and cut spending, which drives those with money to run out of the country (or state or city) because paying more taxes and losing services is intolerable. If these entities that can't print money have large wealth gaps among their constituents, these moves typically lead to some form of civil war/revolution.

At the time of this writing, this late-cycle debt dynamic is now playing out in the United States at both the state and federal levels, with the main difference between them being that state governments can't print money to pay their debts while the federal government can. The federal government and many state and city governments have large deficits, large debts, and large wealth gaps, and the central bank (the Federal Reserve) has the power to print money. So, at the time of this writing, the central bank is printing a lot of money and buying a lot of federal government debt, which finances the government spending that is much bigger than the federal government's intake. That has helped the federal government and those it is trying to help, though it has also cost those who are holding dollars and dollar debt a lot in real purchasing power.

Those places (cities, states, and countries) that have the largest wealth gaps, the largest debts, and the worst declines in incomes are most likely to have the greatest conflicts. Interestingly, those states and cities in the US that have the highest per capita income and wealth levels tend to be the states and cities that are the most indebted and have the largest wealth gapse.g., cities like San Francisco, Chicago, and New York City and states like Connecticut, Illinois, Massachusetts, New York, and New Jersey.

Facing these conditions, expenditures have to be cut or more money has to be raised in some way. The next question becomes who will pay to fix them, the haves or the have-nots? Obviously, it can't be the have-nots. Expenditure cuts are most intolerable for those who are poorest, so there needs to be more taxation of people who can afford to pay more and there is a heightened risk of some form of civil war or revolution. But when the haves realize that they will be taxed to pay for debt service and to reduce the deficits, they typically leave, causing the hollowing-out process. This is currently motivating movements from some states to others in the US. If bad economic conditions occur, that hastens the process. These circumstances largely drive the tax cycle.

History shows that raising taxes and cutting spending when there are large wealth gaps and bad economic conditions, more than anything else, has been a leading indicator of civil wars or revolutions of some type.

To be clear, they don't have to be violent, though they can be. I see these cycles transpiring in my personal interactions. For example, I live in the state of Connecticut, which has the highest per capita income in the country, the largest wealth gap and income gap in the country, and one of the largest per capita debt and unfunded pension obligations in the country. I see how the haves and the have-nots are focused on their own lives and spend little time worrying about the other because they don't have much contact. I have windows into what the lives of both the haves and the have-nots are like because I have contact with the people in our community of haves and because the work my wife does to help disengaged and disconnected high school students in disadvantaged communities brings her into contact with people who live in the communities of the have-nots. I see how terrible the conditions are in those have-not communities and how the haves (who appear rich and decadent to the have-nots) don't feel rich. I see how they are all focused on their own struggleswith the haves struggling with work/life balance, making sure their kids are well-educated, etc., and the have-nots struggling with finding income, food security, avoiding violence, trying to get their kids a quality education, etc.

I see how both groups are more likely to have critical, stereotypical impressions of each other that make them more inclined to dislike each other than to view themselves empathetically as members of one community in which they should help each other. I see how difficult it can be to help each other because of these stereotypes and because the haves don't feel that they have more than enough or that the have-nots deserve their financial support, and I fear what the future might hold because of the existing circumstances and how they are likely to worsen. I have seen close up how COVID-inflicted health and budget shocks have brought to the surface the terrible conditions of the have-nots and are worsening the financial gaps that could bring about the classic toxic mix dynamic.

Averages don't matter as much as the number of people who are suffering and their power.

Those who favor policies that are good for the wholee.g., free trade, globalization, advances in technology that replace peoplewithout thinking about what happens if the whole is not divided in a way that benefits most people are missing the fact that the whole is at risk.

To have peace and prosperity, a society must have productivity that benefits most people. Do you think we have this today?

What does history show as the path that bankrupt governments can follow to raise productivity that benefits most people? It shows that restructuring and/or devaluing enough of the previously created debt and non-debt obligations helps a lot. That is classic in Stages 5 and 6. Once the restructuring or devaluation reduces the debt burdens, which is typically painful at the time, the reduced debt burdens allow for a rebuilding.

An essential ingredient for success is that the debt and money that are created are used to produce productivity gains and favorable returns on investment, rather than just being given away without yielding productivity and income gains. If it is given away without yielding these gains, the money will be devalued to the point that I won't leave the government or anyone else with much buying power.

History shows that lending and spending on items that produce broad-based productivity gains and returns on investment that exceed the borrowing costs result in living standards rising with debts being paid off, so these are good policies.

If the amount of money being lent to finance the debt is inadequate, it is perfectly fine for the central bank to print the money and be the lender of last resort as long as the money is invested to have a return that is large enough to service the debt. History shows and logic dictates that investing well in education at all levels (including job training), infrastructure, and research that yields productive discoveries works very well. For example, big education and infrastructure programs have paid off nearly all the time (e.g., in the Tang Dynasty and many other Chinese dynasties, in the Roman Empire, in the Umayyad Caliphate, in the Mughal Empire in India, in Japan's Meiji Restoration, and in China's educational development programs over the last couple of decades), though they have long lead times. In fact, improvements in education and infrastructure, even those financed by debt, were essential ingredients behind the rises of virtually all empires, and declines in the quality of these investments were almost always ingredients behind empires' declines. If done well, these interventions can more than counterbalance the classic toxic mix.

The classic toxic mix is usually accompanied by other problems. The more of the following conditions that are in place, the higher the probability of having a severe conflict like a civil war or revolution.

Decadence

While early in the cycle there is typically more spending of time and money on productive things, later in the cycle time and money go more toward indulgent things (e.g., the finer things, like expensive residences, art, jewelry, and clothes). This begins in Stage 4 when such spending is fashionable, but by Stage 5 it begins to appear grotesque. Often, that decadent spending is debt-financed, which worsens the financial conditions. The change in psychology that typically goes along with these changes is understandable. The haves feel that they have earned their money so they can spend it on luxuries if they like, while the have-nots view such spending at the same time they are suffering as unfair and selfish. Besides increasing resentments, decadent spending (as distinct from saving and investing) reduces productivity.

What a society spends money on matters. When it spends on investment items that yield productivity and income gains, it makes for a better future than when it spends on consumption items that don't raise productivity and income.

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This article first appeared on GuruFocus.