Ray Dalio’s analysis that China is on course to replace the United States as the next global superpower makes absolutely no sense.
You see, Mr. Dalio, who is the founder of the largest hedge fund in the world, made quite a splash with this best-selling book and YouTube hit video, in which he uses 500 years of data to show that some of the greatest empires of all time rose and fell in a cyclical pattern. He calls this pattern the ‘big cycle’. And given the trajectory that the USA and China are on today, Mr. Dalio’s data-based analysis seemingly indicates that today the U.S.A is the declining empire, while China is the rising empire that will soon overtake it as the next leading power.
But, when I took a closer look at it, I discovered that the same data that Dalio uses in his book to show that the USA is a declining power would indicate that China is also a declining power. However, he shows graphs depicting data on debt, money printing, and inequality in his chapter on the decline of the USA. But, unfortunately, he forgot to include the same graphs in his chapter about the rise of China.
So, maybe his well funded team couldn’t find the data for China?
Well, luckily I did. And, taking them into account completely changes Dalio’s analysis about the rise and fall of these two superpowers.
So, let’s first have a look at Dalio’s analysis about the trajectory of these two superpowers and then I’ll show you where it just stops making sense.
Dalio’s Ambitious Empire Theory — USA
To see if an empire is rising or declining, Dalio proposes that we shouldn’t just look at the size of its economy. Instead, he has constructed 8 indices which in his opinion follow each other. First, Dalio claims that historically the rise of empires started after they improved their education system. Then, a better educated workforce produces more innovations which will make the empire more competitive. This in turn means that the empire becomes rich through exports. Of course, all of this new wealth needs to be protected with a bigger military. And, this military reach, then allows the empire to enforce contracts across the globe, which in turn increases the reach of its financial sector. And this ultimately leads the empire’s currency becoming the global reserve currency.
But, and now comes the interesting bit, Dalio claims to have figured out the sequence of events that leads to the rise and fall of empires. This is Dalio’s big cycle theory. And, I think it’s best to illustrate it using his interpretation of the rise and fall of the American empire.
According to Dalio, a typical big cycle goes as follows. First, there is a big conflict, which established a new world order. In the case of the American empire, that conflict was the second world war. This is when the current world order was established, which after the dissolution of the British empire, had the USA at the top of the food chain. Dalio then states that, early in the cycle, the leading power comes to dominate world trade. It is so powerful that nobody is willing to challenge it. This leads to peace and prosperity. What’s more, Dalio states that thanks to its increasing trade dominance the leading power’s currency then becomes a global reserve currency.
For the U.S. you can roughly see how this cycle applies. After the second World War, the U.S. was by far the biggest economy and in the Bretton Woods agreements it’s currency was firmly established as the world’s reserve currency. This was then followed by the prosperous years from 1945 to the early 1970s, which came to be known as the golden age of capitalism.
However, according to Dalio, this is already where the seeds of decline are sown when, gambling on more peace and prosperity, people increasingly start to borrow.
In his book, Dalio uses this graph of private-sector borrowing as a percentage of GDP to make this case for the USA. And, indeed, as you can clearly see, after the 60s U.S. private debt-to-GDP exploded.
So, yeah, so far Dalio’s story seems to fit the rise of the U.S.
Dalio then claims that, this led to a bubble and a big financial wealth gap. And yeah, it is pretty well-known that the U.S. experienced some pretty big bubbles in the early 2000s.
And so, by then, the income gap had grown tremendously. As you can see in this graph, that Dalio also uses, by the 1990s, the top 10 percent of earners in the USA earned over 30% of GDP.
And while wealth inequality is much more difficult to measure, it is estimated to be even worse.
And that brings us to the point where according to Dalio, the U.S. empire started its decline, it was after the big bubble popped in 2008, with private debt just exceeding 170% of GDP.
According to Dalio, after such a big bubble pops, an empire has two choices, printing money or defaulting on its debt. And, in 2008, the U.S. choose the first option, when it started to create a lot of money, via quantitative easing, to save its financial sector.
Next, Dalio, claims that this, along with the continued economic downturn, makes life even harder, increasing social unrest, which he measures as increased partisanship in the U.S. Congress, as well as protests, and discontent in surveys.
So, this is where Dalio claims that the U.S. is right now, well into its decline.
And yeah, in all honesty, this isn’t so controversial.
It is when Dalio tries to apply this same framework to China that his analysis stops making sense.
But, before getting to that, I have to give Dalio points for refraining to make his analysis overtly political, since, to make it, he clearly spoke to people on all sides, Democrats, Republicans, and the Chinese Communist Party.
Perhaps he even used today’s sponsor - Ground News, to make sure his media sources came from all sides of the political spectrum.
You see, Ground News is a website and app that shows you how stories are being covered by the left, center and right-wing press. I used it for researching this and my other China videos, and thought it was quite interesting that, for example, this story on German prime minister meeting Xi, was covered much more by right-wing media whereas this story about the US accusing China of abandoning the UN was covered much more by left-wing sources.
As you can see, Ground news allows you to find out how a story is covered differently by various media sources. What’s more by seeing who covers what, you spot your own media biases. And this in turn, can allow you to ‘check your blindspots’ and find stories that you otherwise would have missed.
So, if you want to improve your media diet, check out Ground News by visiting ground.news/moneymacro or by clicking the link in the video description
Alright, let’s get back to see how Dalio’s blindspots might have messed up his China analysis.
Dalio’s Inconsistent Empire Theory — China
Sure, the start of his analysis is not very controversial. The U.S. isn’t the global powerhouse that it used to be, and yeah China’s empire has clearly been going through the first steps in the cycle.
It has become a trading superpower, nicknamed, the factory of the world. And, as a consequence, China’s economic growth has been extremely impressive, even if it might have been overstated to a large degree.
So, China moving through the first steps of Dalio’s big cycle is not controversial.
What is controversial though, is to claim that this is where China is now. At the start of its cycle. Didn’t China have sky-high debt to GDP, and sky-high inequality as well? Strangely enough, these same graphs that I’ve just shown you, are included in Dalio’s chapter on America. But, they are missing in his China chapter.
Maybe his team couldn’t find the data?
Well, luckily I did. And, taking them into account completely changes Dalio’s analysis, moving China along the big curve, from a rising power to a declining one.
First, excessive borrowing. Remember this graph of private debt to GDP that Dalio used to argue that the USA was declining, well this is what happens if you add China’s private debt-to-GDP to it.
As you can clearly see, while it started out with low debt in the 90s, its private debt to GDP level has already surpassed that of the USA and stood at a whopping 217% in 2020. And while government debt is lower, long-time viewers of my channel will know that there are serious doubts about China’s reported GDP numbers, meaning that in reality, even total debt-to-GDP could be quite a bit higher than that of the USA.
What’s more, if we plot the share of income earned by the top 10 and bottom 90 percent of China, we can see that in inequality terms, the countries already appear to be in similar stages of Dalio’s empire cycle.
And given that China’s home prices have been sliding for 13 months, and there were already runs on some of its banks, I think we can safely move China to a financial bust and economic downturn stage.
But, can we move it further? Beyond the turning point, and to Dalio’s money printing stage?
Well, yes. China recently announced its version of quantitative easing to support its failing financial sector. More importantly, China’s monetary system works quite differently from that of the United States. You see, China’s biggest banks are state-owned and are often used to support Chinese policies. So, when its property bubble got really problematic last month, instead of it printing its own money, China just ordered its banks to create credit and thereby money to save the system. This is the Chinese equivalent of what Dalio calls money printing, and indeed if we look at money created by the central bank and private banks together, we can clearly see that China’s money supply to GDP has long surpassed that of the USA.
So, we can again clearly move China one step further along Dalio’s cycle.
Therefore, if we follow Dalio’s cycle, China, like the USA, should be on the path toward internal conflict.
But, Ray Dalio writes in his book:
China’s internal conflict gauge is average
So, okay, then, China is declining. But, not yet as far as the USA. Well…..
The problem here is that Dalio’s advanced computer-generated index on internal conflict is based on actual conflict events such as protests, political conflict in the form of how polarized the different parties are, and general discontent (based on surveys).
And so, if Dalio says that this measure is at all-time highs for the USA, supported by graphs showing that Democrats and Republicans are more divided than ever, yeah I’ll buy it.
But, in all honesty, it makes no sense that Dalio is using these same types of sources to compare it to a country with just one political party, one where protests are forbidden and where surveys about how the government is doing are notoriously unreliable.
So, yeah, while Dalio’s conflict index might have worked for the Dutch, British empire, and U.S. empires, I don’t think you can use it to learn anything useful about the state of discontent in China.
So, in a nutshell, Dalio’s China analysis makes no sense because if you use the same data that he uses to argue the USA is in decline, you will find China is pretty much in the same place.
Now, here I have to say that Dalio uses more metrics than what I’ve shown here for his own calculations. But, he doesn’t share his calculations with the public. And, while I sent an e-mail to his team asking for access to them, I never got a reply. And so, we are left with the graphs that he uses in his book to show that the U.S. is declining. Graphs that he unfortunately forgot to include in his chapter on China. Graphs that, as I have shown you in this video, clearly show that following Dalio’s own theory, China is already a declining empire, just like the USA.
I think the longer-term picture in China is still bright. Because I know the people and I know the culture and I think it’s good.
And that is fine. I mean, he could even be right. Maybe China WILL be the next superpower given that it has so much untapped potential left. It just seems to be based on Ray Dalio’s ‘gut feeling’ rather than on his data.
At least, that is what it looks like to me. But yeah, am I being unfair to Dalio? Or am I being too kind still, after all I stayed entirely within his framework for this critique. Let me know in the comments or talk to me about it on my Discord server exclusively for channel members and Patrons.