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.

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. But instead of falling, the stock market jumped about 4%. 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.

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.

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. The more related things I could understand in this way, the more I could see how they influence each other 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 and a lower-level, detailed perspective simultaneously, looking at the inter-relationships between the most important forces over long periods of time.

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 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.

Debt that is denominated in the world’s reserve currency 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 of the countries that enjoyed this special privilege.

In 2008-9 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, 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 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.

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.

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.

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.

Throughout history wealth was gained by either making it, taking it from others, or finding it in the group.

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.

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.

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 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.

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.

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).

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… Tom Brokaw called the people who went through these times “the Greatest Generation” because of the strength of character it gave them.

  1. Education
  2. Competitiveness
  3. Technology
  4. Economic output
  5. Share of world trade
  6. Military strength
  7. Financial center strength
  8. Reserve currency

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.

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. 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.

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 long run. In other words, when borrowing and spending are strong, the leading empire appears strong while its finances are in fact being weakened.

When the richest get into debt by borrowing from the poorest, it is a very early sign of a relative wealth shift.

The leading country extends the empire to the point that the empire has become uneconomical to support and defend.

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 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.

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 typical resolved through tests of power.

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.

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 structuring that establishes a new order, setting the stage for a new period of building.

As a principle, debt eats equity. 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., debt), one is on the way to having one’s assets sold and going broke.

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. Since government 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.

All countries can create money and credit out of thin air to give to people to spend or to lend it out.

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 and 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.

When the loan is outstanding it is an asset for the lender 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.

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 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.

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.

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.

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 short-term cycles of ups and downs typically last about 8 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.

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.

At the end of the long-term debt cycle there is essentially no more stimulant in the bottle (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.

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.

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.

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.

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 days come when more certificates are turned in than there is money to give.

Private bankers must either default or get bailed out by the government when they get into trouble, while central bankers can devalue their claims 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.

Because I had never seen a devaluation before I didn’t understand how they worked. Then I looked into history and found that in 1933, FDR 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.

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 on policymaker 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 government contributes to the accumulation of debt in its actions and by becoming a large debtor and, when the debt bubble bursts, bail itself and others out by printing money and devaluing it. 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.

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. 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.

When this become 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, 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.

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.

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, it naturally moves from Type 1 to Type 2, or Type 2 to Type 3, so that it has more flexibility to print money.

As a result of having the ability to print the world’s currency the US’s relative financial economic power is multiple times the size of its real economic power.

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.

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 approach is called “quantitative easing” rather than “debt monetization” because it sounds less threatening.

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.

Typically the big cycles start with a new world order — a new way of operating both domestically and internationally that includes a new monetary system and new political systems.

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 other from this money-making upswing.

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.

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.

There are 4 levers that policymakers can pull to bring debt and debt-service levels down:

  • 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. Raising taxes is politically challenging but more tolerable than the first 2 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, 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.

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.

Of the roughly 750 currencies that have existed since 1700, only about 20% remain, and of those that remain all have been devalued.

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.

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.

With the debt, domestic political, and international geopolitical restructuring done, the 1920s was a boom period, which became a bubble that burst in 1929.

History has shown that there are very large risks in holding interest-earning cash currency as a storehold of wealth especially lat in debt cycles.

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 2 most important inventions were 1) ships that were uniquely good that could take them all around the world, and 2) the capitalism that fueld these endeavors.

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.

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.

That period was called “the Gilded Age” in the US, “la Belle Epoque” 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.

The Dutch largely stopped French plans to conquer the Netherlands and force France to reduce some of its tariffs against Dutch Trade, but the war was more expensive than the previous conflicts, which increased their debts and hurt the Dutch financially.

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.

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. 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.

What happened to the Dutch was classic of why empires rise and fall and of how money, credit and debt work.

Although the US has overtaken the UK militarily, economically, politically, and financially long before the end of WW2, it took more than 20 years after the war for the British pound to fully lose its status as an international reserve currency.

When partial convertibility was introduced in July 1947, the pound came under considerable selling pressure. As the UK and US governments were against devaluation, the UK and other Sterling Area countries turned to austerity and reverse 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.

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.

Though the devaluation helped in the short term, over the next 2 decades, the pound would face recurring balance of payment 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 shore up the pound and preserve its role as a source of international liquidity.

The results 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. Rearrangements were essentially futile stop-gap measures designed to hold back the changing tide.

Although the share of pound reserves in these Sterling Agreement countries like Australia and NZ remained high, this was only because these reserves had their values 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.

While there are of course allies and enemies and it is tempting to demonize the enemies, most people and countries are simply pursuing their own interests in the ways they believe are the best for them, so I find it productive to try to see things through their eyes and counterproductive to demonize them. If you hear me say things that sound sympathetic to former or existing enemies, please know that it is because I am seeking accuracy and need to be truthful rather than politically correct in coveying my thinking.

As we saw from studying the Dutch and British empires, capitalism was key to these countries’ successes but also contributed to their failures. It was successful because the pursuit of profit motivated people, and the competitive process of allocating capital and profit making directed resources relatively efficiently to what people wanted enough to pay for. In this system those who allocated efficiently profited, which led to them gaining more resources, while those who couldn’t allocate well died economically.

At the same time, this system of increasing wealth produced widening wealth and opportunity gaps, as well as decadence in the form of people working less and increasingly living on borrowed money. As the wealth and opportunity gaps grew, that produced increasingly widespread views that the system wasn’t fair.

As a principle: During periods of severe economic distress and large wealth gaps, there are typically revolutionarily large redistributions of wealth. When done peacefully these are achieved through large tax increases on the rich and big increases in the supply of money that devalue debtors’ claims, and when done violently they are achieved by forced asset confiscations.

After his 1935 tax bill, then popularly called the “Soak the Rich Tax,” the top marginal income tax for individuals rose to 75% (versus as low as 25% in 1930). By 1941, the top personal tax rate was 81% and the top corporate tax rate was 31% having started at 12% in 1930.

This is another good example of how borrowing in one’s own currency and increasing one’s own debt and deficits can be highly productive if the money borrowed is put into investments that raise productivity that produced more than enough cash flow to service the debt and, even if it doesn’t cover 100% of the debt service, it can be very cost-effective in achieving the economic goals of the country.

When Hitler came to power in 1933 the unemployment rate was 25%. By 1938 it was nil. Per capita income between his coming to power and 5 years later in 1938 increased by 22% and real growth averaged over 8% per year between 1934 and 1938.

Germany’s military spending much faster than any other country because the German economy needed more resources to fuel itself and needed to get these from other countries to it built and used its military power to help get them. One could argue that getting them militarily was more cost-effective than trying to produce goods to trade with others to earn income to buy what was needed.

As in the German case, it could be argued that this path of military aggression to get needed resources was the best path for the Japanese because relying on classic trading and economic practices wouldn’t have gotten them what they needed.

Consider the 3 big choices that one has to make in order to choose a country’s approach to governance:

  1. Bottom-up (democratic) or top-down (autocratic) decision-making.
  2. Capitalist or communist (with socialist in the middle) ownership of production.
  3. Individualistic or collectivistic.

In July and August 1941 FDR responded by ordering the freezing of all Japanese assets in the US, closing Japan’s ability to ship through the Panama Canal, and embargoing all oil and gas exports to Japan. This cut off three-fourths of its trade and 80% of its oil. Japan calculated that it would be out of oil in 2 years. This put Japan in the position of having to choose between backing down and attacking the US.

The most common economic warfare techniques:

  1. Asset Freezes / Seizure: Preventing an enemy / rival from using or selling foreign assets they rely on. These measures can range from asset freezes for targeted groups in a country to more severe measures like unilateral debt repudiation or outright seizures of a country’s assets (some top US policymakers are now talking about not paying our debts to China).
  2. Blocking Capital Market Access: Preventing a country from accessing their own or another country’s capital markets.
  3. Embargoes / Blockades.

Classic wartime economic policies include government controls on just about everything as the country shifts resources from profit making to war making. The government determines:

  1. What items are allowed to be produced.
  2. What items can be bought and sold in what amounts (rationing).
  3. What items can be imported and exported.
  4. Prices, wages, and profits.
  5. Access to one’s own financial assets.
  6. The ability to move one’s money out of the country.
  7. The government issues lots of debt that is monetized.
  8. Relies on non-credit money such as gold for international transactions because its credit is not accepted.
  9. Governs more autocratically.
  10. Imposes various types of economic sanctions on enemies.
  11. Experiences enemies imposing these sanctions on them.

As a principle: Protecting one’s wealth in times of war is difficult, as normal economic activities are curtailed, traditionally safe investments are not safe, capital mobility is limited, and high taxes are imposed when people and countries are fighting for their survival. During difficult times of conflict protecting the wealth of those who have wealth is not a priority relative to redistributing wealth to get it to where it is needed most.

The financial cost of the war was both enormous and inestimable, but based on my research, was in the vicinity of $4-7T in current dollars.

Within countries individuals were not allowed to own or transact in gold because governments wanted to be able to control the supply and value of people’s money and the distributions of people’s wealth. People’s abilities to own gold could threaten the system becaus gold is an alternative money that is not controlled by the government that people could use instead of the government’s money.

It was popularly believed in the mid-1960s that economics was a science so we could expect economic prosperity and the stock market always went up with wiggles around the uptrend so one should make “dollar cost average” purchases. Because of that confident psychology, which was the opposite of the conservative psychology that existed in the 1950s, the stock market hit its high in 1966, which marked the end of the good times for 16 years, until the 1982 stock market bottom, though nobody knew it at the time because the mood was one of great optimism and the decline from the market top looked like one of those dips that one should buy into.

In the 1960s it was great to be middle class. The US was the leading manufacturing country so labor was valuable. Most adults could get a good job, and their kids could get a college education and rise without limitation. Since the majority of people were middle class the majority of people were happy.

After 1945, foreign central banks had the option of holding interest-rate-paying debt or holding non-interest-rate-earning gold. Because dollar-denominated debt was considered as good as gold, convertible into gold, and higher-earning because it provided interest (which gold didn’t provide), central banks shrank their gold holdings relative to their dollar-denominated debt holdings.

Economics and politics have swings between the left and the right in varying extremes as the excesses of each become intolerable and the memories of the problem of the other fade. It’s like fashion — the width of ties and the lengths of skirts.

When debts are in the currencies that central banks have the ability to print and restructure, debt crises can be well-managed, so they are not systematically threatening. Because the Fed could provide the banks that made the loans that weren’t being paid back with money, they didn’t have a cash flow problem, and because the American accounting system didn’t require dhte banks to account for these bad debts as losses, there was no big problem that couldn’t be worked out. I also learned that the value of assets is the reciprocal of the value of money and credit (i.e., the cheaper the money and credit are, the more expensive asset prices are) and the value of money is the reciprocal of the quantity of it in existence, so when central banks are producing a lot of money and credit and making it cheaper, it is wise to be more aggressive in owning assets.

This whole 1971-91 up-and-down debt cycle, which profoundly affected just about everyone in the world, was the result of the US going off the gold standard, the inflation that resulted from it, and having to break the back of the inflation through tight money policies that led to the strength in the dollar and dramatic fall in inflation.

It is notable that 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.***

Notable markers that reflected these developments were making the internet available to the public in 1991, which kicked off the dot-com boom, and the creation of the WTO in 1995 to facilitate globalization.

Most people pay attention to what they get and not where the money comes from to pay for it, so there are strong motivations for elected officials to spend a lot of borrowed money and make a lot of promises to give voters what they want and to take on debt and non-debt liabilities that cause problems down the road. That was certainly the case in the 1990-2008 period.

3 types of monetary policy:

  1. Interest-rate-driven monetary policy.
  2. Printing money and buying financial assets, most importantly bonds.
  3. Coordination between fiscal policy and monetary policy in which the central government does a lot of debt-financed spending and the central bank buys that debt.

When there is a great increase in money and credit, it drives down the value of money and credit, which drives up the value of other investment assets.

One can think of a country’s savings as being its foreign-exchange reserves.

My process is to learn through my direct experiences and through my research, to write up what I have learned, to show it to smart people to have them attack it in order to stress test it, to explore our differences, to evolve it some more, and do that over and over again until I die.

To Americans 300 years is a very long time. For the Chinese it is very recent. While having a revolution or a war that will overturn our systems is unimaginable to an American, it is inevitable to a Chinese person. While most Americans focus on particular events, especially those that are now happening, most Chinese, especially their leaders, see evolutions over time and put what is happening in the context of them. While Americans fight for what they want in the present, most Chinese strategize how to get what they want in the future. As a result of these different perspectives the Chinese are typically more thoughtful and strategic than Americans, who are more impulsive and tactical. I also found Chinese leaders to be more philosophical than American leaders.

Confucianism seeks to bring about harmony by having people know their roles in the hierarchy and know ho to play them well starting from within the family and extending up to the ruler and their subjects, with them bound together by benevolence and obedience. Each person respects and obeys those above them, who are both benevolent and impose standards of behavior on them. All people are expected to be kind, honest, and fair. Confucianism values harmony, broad-based education, and meritocracy.

Legalism favors conquest and unification of “all under heaven” as soon as possible by an autocratic leader. It believes that the world is a “kill or be killed” jungle in which the strength of the emperor’s central government and strict obedience to it must exist without much benevolence given to the people by the emperor / government. The Western equivalent is fascism.

Taoism teaches that the laws of nature and living in harmony with them are of paramount importance. Taoists believe that all of nature is composed of opposites and that harmony comes from balancing them — yin and yang. This plays an important role in how the Chinese seek the balance of opposites.

All of these Chinese systems from the beginning of recorded history were hierarchical and non-egalitarian. Chinese leaders seek to run the country the way they think parents should run the family — from the top down, maintaining high standards of behavior, putting the collective interest ahead of any individual interest, with each person knowing their place and having filial respect for those in the hierarchy so that the system works in an orderly way.

37% of emperors died unnaturally and that more often than not they were killed by the people around them or others in political struggles. Politics in China has traditionally been brutal.

Geographically China is basically one giant plain surrounded by big natural borders with a giant population in that plain.

As far as wars and the philosophies about them are concerned, the goals have traditionally been to ideally win wars not by fighting but by quietly developing one’s power so that it is greater than the opponent’s so that one can then show it and have the opponent capitulate without fighting. There is also the extensive use of psychology to influence the opponents’ behaviors to produce the desired results.

Scholars believe that China’s lack of significant expansion of its empire outside of China is because the land mass of China is so large that controlling it has been more than enough to handle, because it has largely been self-sufficient in resources, and because they have preferred to maintain their culture with a purity that is best achieved through isolation.

Currencies are used for 1) domestic transactions, which the government has a monopoly in controlling and can get away with them being fiat and flimflam, and 2) international transactions, in which case the currencies must be of real value or they won’t be accepted. As a rule, the better money is that which is used for international transactions. The test of the real value of a domestic currency is whether or not it is actively used and traded internationally at the same exchange internationally as domestically.

The British didn’t have anything that the Chinese wanted to trade for so they had to pay for these goods in silver, which was a global money at the time. The British paid out of their savings but were running out of this money, which led the British to smuggle opium into China from India which they sold for silver which was used to pay for the Chinese goods.

Marx’s most important theory / system is about how evolution takes place. It’s called dialectical materialism. “Dialectical” refers to how opposites go together to produce change, and “materialism” means that everything has a material (i.e., physical) existence that interacts with other things in a mechanical way. Marx had disdain for theories that were not connected to reality and that didn’t produce good change.

There are always political fights about how to govern and who should have what powers. They are especially brutal when the power transition process is not crystal-clear and abided by all the key players who have power. Amid this political fighting there are different factions that both fight with the other factions and compromise to make decisions to govern. For the governing system of an entity to survive these factions must put the entity’s survival and prosperity above all else, certainly above any individual’s opinions and power, and reach compromises to achieve that sustainability.

It was a hell of a “buy now, pay later” deal for the Americans. The Chinese liked it because they built their savings in the world’s reserve currency by owning the American IOUs and the Americans got all the cheap stuff by borrowing the money to get it.

If a referendum and move toward independence happened and the new leader let it happen, it would be intolerable for the Chinese people because that leader would be shown to be too weak to lead.

As is typically true in postwar period of peace and prosperity, when the leading power isn’t threatened and the emerging countries aren’t yet threatening, the leading emerging countries can learn a lot from the leading powers as they work in a symbiotic way until the emerging powers become powerful enough to threaten the leading powers.

The biggest reason for the criticism, more important than any of these, is that most people don’t understand the perspectives of those in charge, and they don’t understand the perspective of those in charge, and they don’t understand the range of circumstances that influence their decisions and how they are weighing them. I would have done almost the exact same thing as they did if I were in their shoes.

This controversial move to tighter controls and more extensive leadership by Xi came about because of beliefs that China is entering a more difficult phase in a more challenging world and that at such times unity and continuity of leadership is especially important, and will be even more important over the next few years. During periods of great crisis more autocratic and less democratic leadership tends to be preferred.

Half the emperors left office unnaturally, and of these unnatural exits, about half were deposed by the elites (murdered, overthrown, forced to abdicate, or forced to commit suicide). The next category is death or deposition in civil wars; very few were deposed by (or in) external wars. These stats make clear that in the past the “biggest threat was friends within.”

According to Marxism, communist society is based on material abundance. Only when there is material abundance can the principle of a communist society can be applied. Socialism is the first stage of communism. We permit some people and some regions to become prosperous first for the purpose of achieving prosperity faster.

Either side can force the 2nd path on the other while it takes both sides to follow the 1st path. In the back of the minds of all parties, regardless of which path they choose, should be their relative powers.

When it isn’t clear exactly how much power either side has to reward and punish the other, the 1st path is the safer way because there is great uncertainty around how each side can hurt the other. On the other hand, the 2nd path will certainly make clear which party is dominant and which one will have to be submissive after the hell of war is over.

When there are disagreements, the parties disagreeing will first try to resolve them without going to rules / laws by trying to agree on what to do by themselves. If that doesn’t work, they will try using the agreements / rules / laws that they agree to abide by. If that doesn’t work, those who want to get what they want more than they respect the rules will resort to using their power. When one party resorts to using its power and the other side in the dispute isn’t sufficiently intimidated to knuckle under, there will be a war. A war is a testing of relative power. Wars can be all-out or they can be contained; in either case they will be whatever is required to determine who gets what.

To handle one’s power wisely, it’ usually best not to show it because it will usually lead others to feel threatened and build their counter-threatening powers, which will lead to a mutually threatening relationship. Power is usually best handled like a hidden knife that can be brought out in the event of a fight.

Though it is generally desirable to have power, it is also desirable to not have powers that one doesn’t need. That is because maintaining power consumes resources, most importantly your time and money. With power comes the burden of responsibilities. While most people think that having lots of power is best, I have often been struck by how happy less powerful people can be relative to more powerful people. When thinking about how to use power wisely, it’s also important to think about when to reach an agreement and when to fight. To do that, it is important to imagine how one’s power will change over time. It is desirable to use one’s power to negotiate an agreement, enforce an agreement, or fight a war when one’s power is greatest.

From playing the game I play — i.e., global macro investing — I know how complicated it is to simultaneously consider all that is relevant in order to make winning decisions. I also know that what I do is not as complicated as what those in the seats of power do and I know that I don’t have access to information that is as good as what they have, so it would be arrogant for me to think I know better than they do about what’s going on an dhow to best handle it.

History has shown that the successes of all countries depend on sustaining the strengthening forces without producing the excesses that lead to their declines. The really successful ones have been able to do that in a big way for 200-300 years. None has been able to do it forever.

Are they trying to hasten a conflict (which some Americans think is best for the US because time is on China’s side because China is growing its strengths at a faster pace) or are they trying to ease the conflicts (because they believe that they would be better off if there is no war)? In order to prevent these from escalating out of control, it will be important for leaders of both countries to be clear about what the “red Lins” and “trip wires” are that signal changes in the seriousness of the conflict.

As the fighting becomes tougher a dichotomy emerges between the idealistic descriptions of what is being done (which is good for PR within the country) and the practical things that are being done to win. That is because in wars leaders want to convince their constituents that “we are good and they are evil” because that is the most effective way to really people’s support, in some cases to the point that they are willing to kill or die for the cause. Though true, it is not easy to inspire people if a practical leader explains that “there are no laws in war” other than the ethical laws people impose on themselves and “we have to play by the same rules they play by or we will stupidly fight by self-imposing that we do it with one hand behind our backs.”

Classically, the most dangerous part of the trade / economic war comes when countries cut the other off from essential imports.

The technology war is a much more serious war than the trade war because whoever wins the technology war will probably also win the economic and military wars.

If a company is breaking a law within a country (e.g., Huawei in the US) one would expect to see that crime prosecuted legally so one could see the evidence that shows the spying devices embedded within the technologies. We aren’t seeing this. Fear of growing competitiveness is as large or larger a motivator of the attacks on Chinese technology companies, but one can’t expect policy makers to say that. American leaders can’t admit the competitiveness of US technology is slipping and can’t argue against allowing free competition to the American people, who for ages have been taught to believe that competition is both fair and the best process for producing the best results.

They also believe that the US and European countries are cuturally prone to proselytizing — imposing on others their values, their Judeo-Christian beliefs, their morals, and their ways of operating — and that this inclination developed through the millennia, since before the Crusades.

The US not fighting would be a great geopolitical win for China and a great humiliation for the US. It would signal the decline of the American Empire in the Pacific and beyond in much the same way as the British loss of the Suez Canal signaled the end of the British Empire and beyond. The more of a show the US makes of defending Taiwan the greater the humiliation of a lost war or a retreat would be.

The Chinese leadership knows how terrible a hot war would be and worries about unintentionally slipping into one the way WW1 was unintentionally slipped into. They would much prefer a cooperative relationship if such a relationship is possible and, I suspect, they would happily divide the world into different spheres of influence. Still they have their “red lines” and they expect more challenging times ahead.

The areas that are most important to the Chinese are first those that they consider to be part of China, second those on their borders and those in key supply lanes (Belt and Road countries) or those that are suppliers of key imports, and third other countries of economic or strategic importance for alliances, in that order.

Generally speaking the Chinese appear to want tributary-like relationships with most non-rival countries, though the closer their proximity to China, the greater the influence China wants over them.

The modern term for these capital war moves is “sanctions.” The goal is to cut the enemy off from the capital that the enemy needs because no money = no power.

Because other countries realize that actions taken against China could be take against them, any actions taken against Chinese holdings of dollar assets would likely increase the perceived risks of holding dollar debt assets by other holders of these assets, which would reduce the demand for them. Also, the dollar’s role as a reserve currency largely depends on its being able to be freely exchanged between and working well for most countries, so to the extent that the US puts controls on its flows and / or runs monetary policy in ways that are contrary to the world’s interests in pursuit of its own interests, that makes the dollar less desirable as the world’s leading reserve currency.

Most believe that the general population will choose the leaders on whims and based on what those seeking to be elected will give them in order to buy their support rather than what’s best for them — the general voting population will choose those who will give them more money without caring where the money comes from.

Neither of these systems is always good or bad — that what works best varies according to a) the circumstances and b) how people using these systems are with each other. No system will sustainably work well, in fact all will break down, if a) the individuals in it don’t respect it more than what they individually want and b) the system is not flexible enough to bend with the times without breaking.

When in a superior position, the Chinese tend to want that to be clear, to have the party in a subordinate position know that it is in a subordinate position and to obey and that, if it doesn’t do these things, it will be punished. That is the cultural inclination / style of Chinese leadership.

That is the situation rival great powers typically find themselves in; they need to have ways of assuring that the other has no ways of killing them in order not to go down the path of trying to kill them first. Another big reason that stupid wars happen is because there is a tit-for-tat escalation process that requires each side to escalate or lose what the enemy captured in the last move and be perceived as weak.

Declining empires tend to fight rising empires more than is logical for them to do because the fight / retreat calculation tends to lead one to prefer fighting more than is logical on the basis of the expected outcome alone because a retreat is a defeat.

As Aristotle said a long time ago: “The poor and the rich quarrel with one another, and whichever side gets the better, instead of establishing a just or popular government, regards political supremacy as the prize of victory.”

The monarchy under King John wanted to get more tax money and the nobles wanted to give less tax money. They disagreed over how much say the nobles should have on the matter, so they had a civil war. The nobles won and gained more power to set the rules, which led to what they first called a “council,” which soon became the first parliament, which evolved into the parliament that the English have today. The peace treaty that formalized this deal into law is called the Magna Carta. Like most laws, this one didn’t matter much relative to power so another civil war broke out in which the nobles and the monarchy again fought over wealth and power. In 1225 they wrote up a new Magna Carta that those with power got to interpret and enforce.

In France for most of the 17th and 18th centuries, the king ruled in a balance of power arrangement with 3 other classes: 1) the clergy, 2) the nobility, and 3) the commoners. There were representatives of these groups that voted. The first two, which accounted for only 2% of the population, had more votes or eventually the same amount of votes as the commoners, who made up 98% of the population. They called this 3-class-based internal order that negotiated for power the ancien regime (which means “old order.”) Then practically overnight it changed in a revolutionary way via the French Revolution, when the commoners had enough of that system, overthrew all the others, and took the power for itself.

Having win-win relationships is obviously better than having lose-lose relationships, but they are often very difficult to have, which brings me to the prisoner’s dilemma dynamic.

History shows us that after the fight for power in which the common enemy is defeated, those who united against the common enemy typically fight among themselves for power and those in the losing party do the same as they plan their next attack. I call that the “purge” stage of the balance of power dynamic.

There is a strong pull in most people to favor short-term enjoyment over long-term wellbeing. That plays a big role in driving these cycles. Favoring short-term enjoyments over long-term health naturally exaggerates the highs and the lows of the cycle.

For those reasons it is politically desirable to borrow and spend because a) that allows politicians to provide more without having to raise taxes and b) lenders will readily make loans to the central government regardless of how much debt it has if it has the printing press to assure repayment.

There is no free lunch. While there is a lot of talk now about how one can produce debt and money to spend more without suffering adverse consequences, don’t believe it.

From studying 50+ civil wars and revolutions, it became clear that the single most reliable leading indicator of civil war / revolution is bankrupt government finances, often after an economic shock and when there are big wealth gaps.

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

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 struggles — with the haves struggling work-life balance, making sure their kids are well educated… and the have-nots struggling with finding income, food security, avoiding violence, trying to have their kids well educated…

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 whole — free trade, globalization, advances in technology that replace people — without 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.

Lending and spending on items that produce broad-based productivity gains and return on investment that exceed the borrowing costs result in living standards rising with debt being paid off, so these are good polices. Investing in education at all levels, infrastructure, and research that yields productive discoveries works very well, though they have rather long lead times.

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 (“the finer things in life” like expensive residences, art, jewelry, and clothes). 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 legally acquired 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.

While early in the big cycle bureaucracy is low, it is high late in the cycle, which makes sensible and needed decision making more difficult. That is because things tend to get more complex as they develop until they read the point where even obviously good things can’t be done — necessitating revolutionary changes.

While who is president has changed, the people have not changed, and in the long run what happens in a democracy depends on what the people are like in dealing with the system.

Watch populism and polarization as markers. The more populism and polarization there is, the further along the cycle a nation is in Stage 5, and the closer it is to civil war and revolution. In Stage 5, moderates become the minority. In Stage 6, they cease to exist.

The loss of truth in the public domain.

Not knowing what is true because of distortions in the media and propaganda increases as people become more polarized, emotional, and politically motivated.

In Stage 5 those who are fighting typically work with those in the media to manipulate people’s emotions to gain support and to destroy the opposition.

During the French Revolution, newspapers run by revolutionaries pushed anti-monarchical and anti-religious sentiment, but when those revolutionaries attained power, they shut down dissenting newspapers during the Reign of Terror.

If you have a society where people can’t agree on the basic facts, who do you have a functioning democracy?

Even very capable and powerful people are now too afraid of the media to speak up about important matters or run for public office.

Rule-following fades and Raw fighting begins.

When the causes that people are passionately behind are more important to them than the system for making decisions, the system is in jeopardy. Rules and laws work only when a) they are crystal clear and b) most people value working within them enough that they are willing to compromise in order to make them work well.

Late in Stage 5 it is common for the legal and police systems to be used as political weapons by those who can control them. Also private police systems form — thugs who beat people up and that take their assets, and bodyguards to protect people from these things happening to them.

Because there is not always a clear line between a healthy protest and the beginnings of a revolution, leaders in power often struggle over how to allow protests without giving the perceived freedom to revolt against the system. Leaders must manage these situations well. A classic dilemma arises when demonstrations start to push the limits of revolution. Both giving the freedom to protest and suppressing protests are risky paths for leaders, as either path could lead the revolution to get strong enough to topple the system. No system allows people to bring down the system — in most, an attempt to do so is treason, typically punishable by death. Nonetheless, it is the job of revolutionaries to bring down systems, so governments and revolutionaries test each other to see what the limits are.

A revolution is the process of bringing about revolutionary changes in how the system works. Revolutions needn’t to be violent, though they typically are.

Civil wars, on the other hand, are violent fights for controlling wealth and political power or fights over ideologies that people fee are even more important than themselves.

Crossing the line from Stage 5 (when there are very bad financial conditions and intense internal and external conflict exists) to Stage 6 (when there is civil war) occurs when the system for resolving disagreements goes from working to not working. In other words, it happens when the system is broken beyond repair.

The democratic system, which allows the population to do pretty much whatever it decides to do, produces more bending because the people can make leadership changes and only have themselves to blame. In this system regime changes can more easily happen in a peaceful way. However, the 1-person, 1-vote democratic process has the drawback of having leaders selected via popularity contests by people who are largely not doing the sort of thoughtful review of capabilities that most organizations would do when trying to find the right person for an important job. So, while having great ability to bend, in democracies there is a big risk in not filling the most important jobs with the most capable people. The biggest risk to democracies is that they produce such fragmented and antagonistic decision making that they can be ineffective, which leads to bad results, which leads to revolutions led by populist autocrats who represent large segments of the population who want to have a strong capable leader get control of the chaos and make the country work well for them.

Very simply, what governments do economically is reflected in just 2 types of policy — fiscal and monetary — and each can be either easy or tight. Easy means a lot of debt and money is created, which will lead it to become worth less if the country doesn’t raise productivity by more than a commensurate amount, but it is stimulative for the economy and is an innocuous way of getting money into the hands of those who would not get it through the normal means. Tight means that a lot less debt and money is produced so it will be devalued less, all else being equal, but is is less stimulative to the economy and gets less money into the hands of those who most desperately need it.

Most importantly, we need to pay attention to what borrowing and spending is used for, will it increase productivity and the well-being of most people, or will it not? What matters most is what the system puts the credit and money into.

Reading the stories of the civil wars and revolutions that I studied, such as the Spanish Civil, the Chinese Civil War, the Russian Revolution, and the French Revolution, made my hair curl. The elites and moderates flee, are imprisoned, or are killed.

Typically the people who lead the civil war / revolution were (and still are) well-educated people from middle-class backgrounds.

Typically in revolutions the revolutionaries with these different grievances joined together to make revolutionary changes; so while they looked united during revolution, after winning the revolution, the leaders of it typically fight with each other over issues and for power.

Almost all civil wars have had some foreign powers participating in attempts to influence the outcome to their benefit.

While historians assign dates to the beginnings and ends of civil wars, they are arbitrary.

In fact one might say that revolutions typically come in 2 parts — the first part is the fight to bring down the established leaders and systems, and the second part is the fight to mop up who were loyal to the former leaders and the fight for power among those who won. I call the second part “purges.”

This stage has happened after virtually all revolutions, though in roughly the same degree as the degree of revolutionary changes. At its worst this post-revolution fighting to consolidate power produced some of the most brutal periods in the country’s history — the post-1789 French Revolution period called the Reign of Terror, the post-1917 Russian Revolution period called the Red Terror, the post-1949 Chinese Civil War period called the Anti-Rightist Campaign.

A timeless and universal principle to keep in mind during this stage is that to be successful the system has to produce prosperity for the middle class.

The leaders who are best during this stage are typically very different from those who succeeded in Stage 6 and 1. I call them “civil engineers.” Above all else they need to design and build the system that is productive for most people.

In this stage conditions are improving for almost everyone so most of the next generation are better off than most of the prior generation, so there is broad optimism and excitement about the future. When done well, there is wide and almost equal access to education and merit-based placements in jobs, which draws on the widest possible range of the population to access talents and yields a system that most people believe is fair.

This is the stage in which the temptation to do everything and borrow money to do everything can lead to the movement to the next stage.

During this phase, the archetypical best leader is the “well-grounded, disciplined leader” who understands and conveys sound fundamental behaviors that yield productivity and sound finances and creates restraints when the crowd wants to overdo things. These leaders are the ones who lead the country to continue to reinvest a significant amount of their earnings and their time to being productive when they become richer. However, these leaders are few and far between because their fighting the ebullience of the masses is very unpopular. In almost all cases, after becoming rich, the country (and its leaders) become decadent, borrow to finance excess consumption, and lose competitiveness.

It is a mistake to rigidly believe that any economic or political system is always best because there will certainly come times that that system is not best for the circumstances at hand, and if a society doesn’t adapt it will die. That is why constantly reforming systems to adapt well is best. The test of any system is simply how well it works in delivering what most of the people want.