Understanding the Future from History

Note: As a corollary to the post previously written and continuing an effort to understand the current predicament we find ourselves in- I revisited Ray Dalio's (Founder of Bridgewater Associates, the world's largest hedge fund) Economic Principles and the framework espoused therein, to gauge where in the economic cycle we are. 

The Ray Dalio Framework

To ascertain where in the economic cycle we are, one must understand the interplay of three concepts (as seen in Figure 1):

1. Productivity gains- Denoted by Real GDP per Capita, this has more or less seen a linear progression through the last century. 
2. Long term debt cycle- Since the times of Old Testament (which also calls for the need to wipe out debt once every 50 years- better known as Jubilee), cycles of credit creation and bust have persisted in our economy. Credit and spending rises faster than income levels which in turn generates higher incomes and networth through increased aggregate demand. This cycle, however, cannot persist forever and as the cost of servicing the debt rises beyond a certain limit, so does the chance of its default. This pushes the economy through a arduous process of deleveraging before the economy is capable of going back into the consumption phase.  
3. Short term debt cycle- What is commonly known as the business cycle, is primarily controlled by the money supply and velocity in the economy. When rate of spending grows at a faster clip than the economy's ability to produce we witness heightened rates of inflation. To curb this, tighter monetary policies are sanctioned leading to a contraction in the economy. Such recessions end with a reversal in monetary policy in order to stimulate demand, and the cycle replays. 

Figure 1: Interplay of the three concepts

Implications of this Framework

At the very least, viewing the events of this century through the lens of Dalio's framework, exposes the folly of calling the Financial Crisis of 2008-09 a concluded recession. Quantitative easing to the extent we have seen (see Figure 2) in all the developed economies should have been more than enough to spur spending and therefore aggregate demand in a post recession world. This however isn't the case. Deflation and lack of growth are still at the front of every central banker's mind in these economies, as they wallow in the denial of their ineffectiveness to salvage economic growth. It is not monetarists that the world needs now; it is time for the Keynesians to shine. 

Figure 2: Money Supply in USA

The inability of easy monetary policy in spurring credit growth and the rather high levels of indebtedness in the developed economies indicate a top in the long term debt cycle. When the cash flow crunch causes the deleveraging process to commence is anyone's guess but a look at Figure 3 indicates that it is likely to be sooner than later. 

Figure 3: Household debt service at an all time high in USA

The over-indebtedness of the borrowers makes sensible lending impossible, thus rendering easy monetary policy as a tool to create easy credit growth, useless. The above charts clearly indicate that the scenario of fundamental imbalance that we find ourselves in today, is most similar to the circumstances seen in the US in the 1930s- a depression, not a concluded recession.

Combating the Implications

It is imperative to study the methods of combating these implications simply to make an educated guess of the what to expect from government policies across the developed world over the next decade.  The debt to income ratio can be tackled down with two sets of policies:

1. Deflationary and Recessionary- Debt reduction methods including austerity.
2. Inflationary and Stimulative- Debt-monetization and heightened government spending.

While parts of Europe has adopted the former, US seems to be on track to adopt more of the latter. This predicament the economy finds itself in, coupled with the election of Donald Trump has paved the path for the Keynesian thought process of 1930s to take over USA today. This recovery, however, will be a onerous process as infra spend is a long term commitment and current level of debt will raise the difficulty level of the conundrum. Figure 4 however demonstrates a template from the past to help determine our expectations of the future.

Figure 4: Federal Budget Surplus/ Deficit in USA

The appendage of fiscal stimulus can only be taken away when we return to normalcy; i.e. "only when capable providers of capital willingly chose to give money to capable recipients of money." For this to occur the populace will go through denial, reluctance to accept lower credit and therefore lower spend levels, acceptance of the new normal, admittance of the fiscal stimulus into their systems and finally ability to run without the appendages again. This elongated deleveraging process will cause a shift in the global economy; the lull period in the developed economies of today will be capitalized. The occurrence of the shift is even more obvious from the Figure 5 below. The developed of the past will become the developed of the future. 

Figure 5: % Share of the World GDP

The Political Cycle Implications

Dalio's framework suggests that there are five stages a country goes through:

1. Countries that are poor and think they are poor- Transition from such a stage is gradual and only initiated with minor structural reforms which results in Foreign Direct Investment in the country in order to take advantage of its low cost of production. India's economic liberalization in the early 1990s would be that reform that has transformed the country over the last two decades. Without such reforms countries can be stuck in this phase for a long time. 
2. Countries that are rich but think they are poor- Such nations are characterized with hard-work, immense amounts of savings as they are unsure of the future and predominantly an export led economy. China in the first decade of this century would be a textbook example of this stage.
3. Countries that are rich and know they are rich- With a generation being born into prosperity, without the conditioning of the hardships faced in the previous two stages, countries that find themselves in the higher decile of nations (in terms of per capita GDP), act like it. Their economic prowess enables them to wield significant dominance over global politics. The "American Empire" that "ruled by speaking softly and carrying a big stick" post World War II is a classic specimen of this stage. 
4. Countries that start becoming poorer but still think of themselves of being rich- Adorned with a phase of leveraging, debts start piling up as income levels do not support the spending sustained in the earlier state of 'richness'. The end days of this stage are denoted by repeated asset bubbles. In hindsight, the first decade of the 21st century in the US which witnessed two massive bubbles- tech bubble in 2000-01 and financial crisis of 2008-09 is likely an example of such a case. Britain between the two world wars would also fit in with this stage. 
5. Deleveraging- With the growing imbalance between credit fueled spending and income, great countries and nation empires of the past go through a phase of decline and those in stage 3 at the time take over from them. 

Dalio's framework of long-term debt cycle leads us to a similar political conclusion for the future of this world as discussed in the previous post. His framework however enables us to better understand the progression from today, to that conclusion while giving us a reasonable guesstimate for a timeline that can be deduced upon using his template. 

Note: To further understand Dalio's framework read his book titled Economic Principles. The link for the same can be found here.

History of the World

Disclaimer: This is my most ambitious post yet for I am trying to condense thousands of years of human history into an essay, sincerely (and most likely foolishly) attempting to recognize patterns therein; in an effort to better understand the resurgence of nationalism today. In writing this I am not trying to make a contention of my historian credentials (for I have none) but merely positing a theory that emerges from my perception of the repeating stories in history.

My hypothesis is that despite differing manifestations, the circular story-lines in history do repeat themselves. The difference in my view stems however from claiming where the cycle starts. Since it is a circular recurrence, there is a chicken and egg problem. Nonetheless, I believe that we have smaller groups (families/ tribes/ nations) that are born and just as children's conscience and minds which are clean slates, wanting to learn from everyone around them- these smaller units engage in trade with everyone around them to gain as much knowledge as possible from them. It is this trade that results in fostering the spirit of globalization and internationalism. As these units expand their numbers and horizons, they start forming beliefs and strong sense of self; quite like an adult. This sense of self stems from generations being born into prosperity directly. As the spirit of nationalism heightens, generations born into prosperity grow detached of the world outside the unit. This inward looking behavior continues resulting in a display of a class struggle within the unit eventually disintegrating into distinct different new units. And so the cycle starts again.

I. Ancient: Hunter gatherers to Civilization to its Collapse

As hunter gatherers, homo sapiens only looked out for themselves at first and later their tribes. As we underwent the neolithic revolution with the discovery of wheel, cereal crop cultivation, mathematics and cursive script, we began settling down and forming urban centers. These urban centers traded with one another in order to gain the best products from each others. The centers that thrived flourished into civilizations- Mesopotamia (3500 BCE), Egypt (3000 BCE) Indus Valley (2500 BCE) and China (2200 BCE onward). As trade grew, a complex economy structure developed with barter system giving way to currency. The regulation of these innovations demanded a central government and sophisticated language and writing skills. With prosperity and a need to legitimize a government, cultures and religion emerged. Religions that started with praying to the natural elements enabling flourishing trade, ultimately resorted to deitification. It is with these deities and the myths conjured to legitimize their being, that competing philosophies started emerging in the world giving rise to the Axial Age (in 8th century BCE). An era of global trade and prosperity was about to give way to more self-centric sentiments. 

Confucianism, Jainism, Buddhism, Jewish Monotheism all emerged approximately in the same century- 6th century BCE. The societies propagating these religions came at odds with the ideal Republic vision espoused by the Greek Philosophers Socrates and later Plato in 5th century BCE. Alexander the Great made an effort of getting the western school of thought into the east but competing theologies had already created regional empires here- Median in Iran, Mauryan in India and Han in China. We had become more inward looking. As these regional empires persisted, heavy costs were levied on peasantry and land-owners born into prosperity increasingly exercised their power of abuse while evading any sense of duty. Pressure on the frontiers and discontentment brewing within led to the collapse of these regional units into smaller groups.

The Han dynasty gave way to the triple kingdom in 220 AD which later disintegrated further with the invasion of the nomadic tribes from the north in 4th century AD. China remained a constellation of small kingdoms until the establishment of Sui dynasty in 581 AD. Similarly the Roman empire disintegrated into warring nations under the Germanic tribes with eastern part of the empire being annexed into the Byzantine empire.

II. Pre-Medieval: Silk road to Crusades to Black Death

The fall of the Roman empire in 5th century AD allowed for the rise of early Islamic conquests. Arab slave trade, Mongol invasion of central and south Asia and the rise of the Ottoman Empire. The Islamic traders set up ports across Africa and Asia to facilitate the trade of gold, spices and other commodities. A second wave of global trade and internationalism had emerged.

All of the newly established nations under the Germanic tribes, associated with the catholic church. While the silk road acted as a bridge for trade between Asia and Europe, the merchant economy of the Islamic civilization along with the goods brought its faith into China, India, West Africa and to Turkey, the door to Europe.

Being born into an era of global prosperity and motivated by a common allegiance to the catholic church, the kings of Europe, 11th century AD onward, launched number of crusades to push back Muslim power and retake the holy land. Their colossal failure at this task was exemplified with the onset of the plague in the 14th century AD which wiped out over a third of the population of Europe.

III. Medieval: Renaissance to Trade to Fall of Imperialism

With an utter lack of resources and will to fight, the European nations entered a phase of rebuilding themselves. The knowledge they gained from the developments of the Islamic world upon their interaction on the battlefield pushed them down the road to Renaissance. Scientific revolution owing to inquisitiveness having witnessed the glory of their opponents, resulted in these nations engaging in innovations and new manufacturing. The curiosity that formed the basis of this knowledge revolution forced them to be master seafarers and trade with new empires as well as continue learning from the old ones. Curiosity served with a dollop of necessity resulted in the third wave of globalization. 

Machinery advanced with greater interaction with the rest of the civilized world and scientific revolution gave way to industrial revolution. Mass scale production of manufactured goods was witnessed for the first time. International trade flourished at first but with a generation born into such prosperity in the post Renaissance Europe, there now arose a need for acquiring customers and markets in order to ensure continuing profits for your nation’s factories.

This economic competition as a consequence gave rise to military challenges, which resulted in the creation of the modern system of nation states having aspirations for economic, linguistic, and hence socio-political dominance. The rise of colonialism and warring imperialistic states eventually plunged these nation states along with their territories at the time, into two gory world wars in the 20th century. With the empires stretched and pressure on the frontier, independence movements gained strength and swept across the ‘oppressed’ colonies resulting in the formation of new groups/ countries across Asia and Africa.

IV. Modern: Unions to Nationalism to ?

By mid 20th century AD, the world was reeling from the losses of the world wars and under the influence of new nations that aspired to gain from all their peers, in the nascent stages of nation-building. The fragile globe at such a stage entered into the fourth wave of globalization with the establishment of the European Union and United Nations respectively. Seeing the debacle of their own imperialistic actions, the European Nations aimed to re-brand themselves as a common market (rather than competing ones as in the past) under a set of common virtues including liberty and democracy. The United Nations was (intentional choice of the prepositional phrase) a valiant attempt by the giants of yesterday to maintain world order by having a forum to help themselves and the newly formed nations of the world. This era of internationalism was propelled even further with the onset of the information age given the improved transportation and communication, especially with the arrival of the World Wide Web.

But as Arnold Toynbee correctly asserts that ‘giants of yesterday are but pygmies of today’. The giants of today are not willing to accept gleefully the world order imposed upon them by those of yesterday (China a case in point for the current -lack of- functioning of the UN, WTO, etc.). In Europe a generation born without the memory of the excesses of the world wars and the imperial states that led to them is likely to take the EU and its advantages as a given. It is the disadvantages that the union brings to them in the way of immigrant crisis or outsourcing of jobs to those with a different linguistic predisposition, etc. that will be now at the forefront of their minds and hence their politics. So the rise of more inward looking behavior is natural; nationalism today is natural or at least given our history it should have been expected of us.

Now what?

To guess what could come next, I go back to my hypothesis,

“As the spirit of nationalism heightens, generations born into prosperity grow detached of the world outside the unit. This inward looking behavior continues resulting in more iteration ultimately ending with a class struggle within the unit. The unit eventually disintegrates into distinct different new units. And so the cycle starts again.”

The first statement is already being proven true given the recent votes in UK, USA, Italy and now possibly in France in 2017. In Europe the EU disintegration could be a stepping stone to setting up newer nations. In China we see the patterns of the Medieval European cycle being repeated- their investments in Africa and Latin America suggest their want to acquire resources, customers and markets. We have seen what forms that can metamorphose into.

I think, in my lifetime, the giant of today (which in hindsight can very well be ‘yesterday’), USA, will be dethroned. Newer nations will appear on the anvil. Gains seen in technology in transportation and communication will stagnate. Emerging powers- China and India- too will see a class struggle emerge within them. While I cannot control these things, a framework enabling me to understand where in this cycle (at times vicious and at time virtuous) of stories we are in, acts as a lens to view current happenings through.