Chapter 5: The Big Cycle of Internal Order and Disorder
This cycle depends on how people behave with each other.
- The struggle over the making, taking, and distributing of wealth and power is what influences people’s behavior the most. Though they also struggle over other things, like ideology and religion.
Let’s have a look at the 6 stages of the Internal Cycle.
- A new order begins when a new leadership consolidates power. This leads to…
- The build-up of bureaucracy and resource-allocation systems in the country. They lead to…
- Peace and prosperity. Which leads to…
- Too much spending, debt, and social-economic differences. They lead to…
- Bad financial health and conflicts. They lead to…
- Civil wars and revolution
And the whole cycle starts again.
These cycles take roughly 100 years.
They are linked to each other and oriented upwards due to the tech improvements over time.
Let’s have a closer look at the stages.
Stage 1: A New Order Begins
Stage 1 happens after a revolution is over. Revolutions have two steps:
- Step 1: take down the established order and win
- Step 2: build back power and remove everyone that was loyal to the former order (purge).
Purges are sometimes more brutal than the revolution itself, especially if the winning power struggles.
Leaders that won the revolution must understand the need to go from a military strategy (destroy the enemy) to a political strategy (build and cooperate).
Stage 1 ends when everyone wants to rebuild.
Stage 2: Building Phase
This phase is a phase of early prosperity.
- To be successful the new system has to produce prosperity for most people, especially the large middle class.
The best leaders in this phase are those that can build and compromise.
Eg: Mao was a war leader, Deng Xiaoping was a peacetime leader.
Stage 3: Peace and Prosperity
A lot of creativity, innovation, and production. Debt can be refunded because income rises.
This is when a leader is a visionary who can inspire. The leader can:
- Paint an exciting picture of the future.
- Actually realize it.
- Reap the rewards and reinvest them
- Maintain healthy finances
- Pursue good international relations
Eg: William Gladstone, Bismarck, Deng Xiaoping.
The longer the country stays there, the better it is.
Leaders should avoid the following risks:
- The broadening of social-economic, work, value, opportunity, and income differences
- The development of an elitist cast that gets accessed to privileges due to their status
- Declining productivity
- Bad finances that lead to over-borrowing
Stage 4: The Period of Excess
- Productivity declines as people get lazy. Money and time are spent on luxury and good times, and less on investment and research.
- Debt is used to keep a similar standard of living, which leads to bubbles, which leads to them popping up.
- Lots of military spending
- The country’s capacity to repay decreases.
- Wealth and opportunity differences widen, resentment between classes increases.
The best leaders are good managers that understand the need for restraint, and ensure their people don’t become too soft.
However, few leaders have the courage to do it.
Most countries, after becoming rich, become decadent (Nero in the Roman Empire, Louis XIV in France).
Stage 5: Bad Finances and Conflicts
Many countries are in Stage 5 right now due to bad finances. The countries that have always had good finances are in relatively good shape (Switzerland, Singapore, etc).
The US is in Stage 5 currently, due to the Classic Toxic Mix.
The Classic Toxic Mix
This Mix happens under three conditions:
- Both the country and its people are in bad financial shape.
- Large social-economic and value differences.
- A severe negative economic shock: bubble burst, act of nature, war, etc.
Because governments’ sole responsibility is to avoid total collapse, financial health is the most important.
If the government runs out of buying power, the system collapses.
Revolutions seem to happen when the government goes bankrupt and there are big social-economic inequalities.
One of the central indicators of Stage 5 is when the government creates debt that no one but the central bank is willing to buy.
This is what’s happening in the US currently.
- Places with large social-economic inequalities, large debts, and the worst declines in incomes are most likely to have the greatest conflicts.
-> cities with high salaries and wealth are also the most indebted!
- Higher taxes and more spending in situations of huge social-economic inequalities and a bad economy is a leading indicator of civil wars or revolutions.
When gaps in wealth are large, communities don’t speak to each other, and tensions increase.
This is partly created by policies that “sound good for society”: trade agreements, globalization, technology that replaces people, etc.
Politicians don’t think about the fact that society is an average of those who win it all, and those who lose it all.
And when those who lose get angry, they threaten the entire system.
- Averages don’t matter as much as the number of people who are suffering and their power.
- To have peace and prosperity, a society must have productivity that benefits most people.
- When debt is printed to remedy these problems, it must be used to acquire gains in productivity. If it is distributed to be spent, money will keep its devaluation and the situation will be even worse.
- Debt should be spent on an asset that will help repay it off.
These are education, infrastructure, and research.
The Toxic Mix is often accompanied by the following.
Decadence: defined by the inclination to spend on luxury goods, expensive real estate, art, etc. Decreases productivity.
- When a society spends money on increasing productivity, it improves its future.
Bureaucracy: as time goes by, things complexify, and bureaucracy increases. It becomes a problem when it stands in the way of good deeds. At this stage, there is a need for revolutionary changes.
- Early in the cycle, the bureaucracy is low. At the end of it, it’s high.
Populism and extremism: populism happens when a leader with a strong personality comes in to defend “the people”, the common man. It’s a sign of gaps (values and wealth) between people.
Class warfare: it happens when one group demonizes another and makes it a scapegoat. This can lead to genocides, imprisonment, etc.
- During hard times, members of classes look at others in a stereotypical way.
The Loss of Truth in the Public Domain: polarization and propaganda increase which leads nobody to know what’s true from what isn’t. Fighters often work with the media to gain support and destroy the opposition.
The media then attacks anyone that doesn’t fit their agenda. Free speech takes a hit since people become afraid to speak up due to not wanting to have their lives destroyed.
Raw Fighting Begins
- When people value a cause more passionately than the system it takes place in, the law is in jeopardy.
When two parties care more about winning than the system, fight and revolt break out.
Late in Stage 5, those that control the system use it as a weapon. Some organizations create paramilitary groups to exercise power over people.
Furthermore protests become more and more violent.
- If people die, the fight will likely continue to stage 6.
- Stage 5 becomes stage 6 when the system to resolve disputes stops working.
- The biggest question is when will the system break?
- The biggest risk to democracies is that they produce fragmented and antagonistic decision-making that can be ineffective. This leads to bad policies, which leads to revolutions led by populist autocrats who represent large segments of the population who want to have a strong, capable leader that reestablishes order.
- Different stages require different types of leaders to get the best results.
Stage 6: Revolution
- Civil wars always end up happening. Don’t assume they won’t. Instead, look for the signs that they will.
- When they take place, civil wars install a new internal order.
When the system stops working for the majority, a revolution ensues and changes the system.
Revolutions that succeeded or failed all did so for the same reason: their capacity to create a system that is an economic success (more wealth better redistributed).
Revolutions are always led by the higher middle-class, never by the “people” they often claim to defend. Revolutionaries are charismatic and can work well with others.
Wealth gaps often are the main reason for revolution, but there can be other reasons, such as restricted freedom, or a fight for power.
Sometimes, other countries jump into the revolution to influence it.
- Almost all civil wars had foreign interferences.
- The beginning of revolutions isn’t clear, but the middle clearly is.
The best leaders in civil wars are inspirational generals. They have to be brutal enough to win the battles, and charismatic enough to rally people to their cause.
-> nothing lasts forever – except evolution.
As a result, there isn’t a best system. There is only a best system for each situation, hence systems should evolve often to adapt to the situation at hand.
Chapter 6: The Big Cycle of External Order and Disorder
The Cycle of Internal Order dealt with the inside of countries. This cycle deals with relations countries have with one another.
The stages of this cycle work a bit like the ones of the Internal Cycle, except for one difference.
- International relations are driven by raw power.
Power always prevails, which is why the League of Nations and the UN projects have failed. Countries more powerful than these institutions literally directed them.
There are five types of war between countries:
- Trade/economic wars: establishing tariffs.
- Technology wars: restricting access to certain technologies
- Geopolitical wars: territorial conflicts resolved by negotiating (not by fighting).
- Capital wars: establishing sanctions.
- Military wars: actual fighting.
- All-out wars happen when an existential issue that cannot be solved by any other means is at stake.
Long cycles of peace and prosperity often plant the seed of terrible, violent wars.
- Two certainties about war: 1. It won’t go as planned. 2. It will be far worse than imagined.
Everyone is looking for power. Power is having a strong military. A strong military can be developed if the economy is good enough.
- Military and domestic power go hand in hand.
It takes money to buy military and domestic power, so, if you run out of money, you become weak.
If a country is strong enough to give its people good living standards and protects them from outside, it will survive. Chances for conflict arise when a country is losing power while another is gaining some.
- The greatest risk of war is when two countries have: 1. equal military capacities. 2. irreconcilable and existential differences.
Fighting VS backing down is a tough choice. Both are costly. One, in terms of resources and life, and the other, in terms of status and soft power.
- Win-win outcomes are obtained when both parties know what’s the most important thing for the other.
These negotiations should divide wealth and power well so that everyone is happy.
So, why do stupid wars happen?
- The prisoner’s dilemma: one cannot be sure that the other won’t attack, so one attacks first.
- Escalation
- Cost of backing down is too high
- Misunderstandings when a decision needs to be taken fast
In any way, win-win or lose-lose relationships are cyclical. Win-win relationships happen when times are good, and the other way around.
If you want to win wars:
- Have power, respect power, and use power wisely.
Those who have power will get what they want.
Chapter 7: Investing In Light Of The Big Cycle
- All markets are primarily driven by just four determinants: growth, inflation, risk premiums, and discount rates.
Investing in something is merely the act of giving money today, to get more money tomorrow.
Your likelihood to get more money tomorrow depends on:
- Economic growth: if growth is low, the central bank decreases interest rates to stimulate the economy.
- Inflation: if inflation is low, the central bank decreases interest rates to stimulate the economy.
- Risk premium: how much risk are you willing to take
- Discount rate: it’s the rate of return on risk-free assets (US treasury bonds.)
The Big Cycle (the one that helps empires rise then fall) is the Cycle that explains the boom induced by capitalism, and the subsequent bust.
It’s been happening forever.
Up until 1350, lending money with an interest was forbidden by all main religions because it caused so many disputes.
Rules first changed in Italy where lending became allowed. Cash deposits, bonds, and stocks were “invented”.
This meant entrepreneurs could borrow money and create wealth, promising to repay later. Credit was a promise.
The Medicis excelled at this game. They lent a lot of money and became really rich doing so.
The problem was when they lent too much money that didn’t exist.
Remember that when credit is created, it stimulates the economy in the short term, but it is depressing in the long term.
As a reminder:
- Borrowers borrow money -> debt increases.
- Borrowers spend the money they borrowed -> the economy grows.
- Financial wealth is higher than real wealth (bankers could lend 5X what they had in the bank).
- Too much borrowing -> borrowers won’t be able to repay.
- People run to the bank to get back their cash “in hard form”.
- The state prints money to settle debts
- The money is devalued
- Financial wealth goes back down and is low real relative to real wealth (adjusted for inflation).
- Borrowers borrow money -> debt increases
- Etc
-> this creates the cycle.
When investors invest, they have three risks:
- That their investment does not generate enough returns (appreciation or dividend)
- Having financial ruins (stock market crash)
- Having their money seized (taxes, etc).
Virtually all countries on earth have had a devastating stock market crash at least once since 1900.
Now that we have seen what happens in theory, let’s have a look at what happens in practice.
Part II: How the World Has Worked Over the Last 500 Years
Chapter 8: The Last 500 Years In A Tiny Nutshell
The world was different in 1500, but worked the same way it’s working now.
It was bigger
You could travel roughly 35 km per day.
This meant that your capacity to impact a huge number of people was limited. Europe was one world, US was another one. Russia was another world. Everyone was split from each other. Threats were mostly contained.
Countries didn’t exist
Territories belonged to families that fought each other for wealth and power. When they grew bigger, they were called empires.
Religions were more powerful
Some leaders were said to be head of state by the will of God.
The world was less egalitarian
Serfdom still existed, and not everyone was treated equally.
The empires in Europe, were:
- The Habsburgs: controlled Austria, part of Germany, Spain, and part of Italy.
- The Bourbon: they controlled France
- The rest were the republics of Milan, Venice, and Florence.
- The Church controlled the Papal States.
In Asia:
- The Ming family ruled over China. They were much more advanced and developed than Europe, with a good financial system, a good bureaucracy, an army made out of 1 million soldiers, and an enormous fleet. The Ming were so powerful that they closed China and retired in opulence, leaving the state to their ministers who fought for power. Corruption arose, and the whole Empire declined.
- India and Japan were divided into several entities.
In the Middle East, the Ottoman Empire ruled with the Persians. In America, the Aztecs ruled in Mexico, and the Incas, in Peru.
Africa was split into dozens of kingdoms.
The most important changes that happened were caused by new ideas, mostly about how people should behave with one another.
The Commercial Revolution (1100-1500)
The numerous invasions of Europe by the Ottoman Empire led merchants to use the sea and not the land to trade, which developed commerce. A shift from autocracy to republics modeled on the Roman Empire led several Italian cities to develop trade. They became richer.
The Renaissance (1300-1600)
The Renaissance was a period during which Europe went from a system where God was the explanation for everything that happened, to a system where each phenomenon was believed to have a cause.
That led people to search for the cause, which led to many scientific discoveries, and the fast spreading of ideas thanks to the invention of the printing press in 1436.
The Age of Exploration and Colonialism (1400–1700)
The technological advances of the Renaissance enabled technology to improve, which led Europeans to travel in search of riches.
Spain and Portugal established trading empires in America, Asia, and Africa.
The amount of gold and other precious metals the Spanish brought back to Europe led to rising inflation.
Europe eventually started trade with China.
The Reformation (1517-1648)
This period was a period of revolt against the corrupt Catholic Church. It brought down the European order and established Protestantism.
Protestantism led to the Thirty Years’ War in the Holy Roman Empire (Germany mainly) that ended with one of the most important events ever to happen in internal relations: the Treaty of Münster and Osnabrück.
The New World Order Following the Thirty Years’ War (1648)
The Treaty of Münster and Osnabrück established the Peace of Westphalia. The idea was that countries would now have clear, delimited borders, and that people were sovereign within these borders.
The Dutch emerged out of this war as the leading economic power.
The Invention of Capitalism (1600s)
The development of equity markets enabled the rich to invest in entrepreneurs that created considerable amounts of wealth in returns.
The Scientific Revolution (1500s–1600s)
The Scientific Revolution was a heritage of the Renaissance. It led to the development of the scientific method (Francis Bacon) and many other discoveries.
European governments started to invest in and support research, particularly in the UK.
Economic output grew and European powers became more competitive.
The First Industrial Revolution
The scientific discoveries and the freeing of capital enabled the improvements and invention of machines that led countries to become much more productive.
First, agricultural techniques were improved, which led people in the countryside to move to cities that saw their population booming (due to more births and lower death rates).
The Enlightenment and the Age of Revolutions (1600s–1700s)
The Enlightenment was the application of the Scientific Method to people’s behavior. It increased the right of the individual and decreased the importance of the state, the group.
These ideas of rationality and individuality led to revolutions (1689 in the UK, 1765 in the US, 1789 in France).
The chaos brought up by revolutions led to the rise of Napoleon in France which changed the course of Europe.
The Napoleonic Wars and the New World Order that Followed (1803–1815)
Napoleon was defeated in 1815 in Waterloo (Belgium). The world order was redesigned in the Congress of Vienna and the British emerged as the leading power. They created the Pax Britannica (British Peace).
Western Powers Move into Asia (1800)
The British went to India and China, and the US went to Japan.
China and Japan realized they had to modernize themselves if they hoped to resist the Europeans.
Second Industrial Revolution (1850–early 1900)
The second industrial revolution mainly concerned steam-powered engines and benefitted the US.
Invention of Communism (1848)
Communism was invented to address the socio-economic gaps and the nature of capitalism itself. It led to several communist revolutions (Cuba, Russia, China, etc) in the 20th century.
The 20th century had two big cycles of boom and bust, two world wars, and two new world orders.
