Capitalism is spiralling out of control. That’s what this billionaire reckons.

I think I’ve got a bit of a boy-crush on Ray Dalio.

It’s not that he’s one of the richest people on the planet and the most successful hedge fund manager in history.

(Well, it’s not just that.)

But I actually think he’s got one of the most useful perspectives on where we’re at as a planet right now. And he’s definitely into his ‘statesman’ phase. I guess at 69, and with as much money in the bank as he has, that’s exactly what he should be doing.

And his mission right now?

Saving capitalism.

He reckons there are imbalances in the system that are getting out of hand and threaten to bring the whole show down. If we don’t get on top of them we’re looking at revolution, war, or worse.

And reading him explain the reasons for this, the data behind his views, and his ideas about what we should do about it, I’ve never had so many “That’s what I think too!” moments.

And this really feels important. I agree. I think we’re at a cross roads. And so I want to give his message a broader reach.

So, for your reading pleasure, I’m going to give you the super quick version here, with a bit of my own spin on things.

This all comes from a piece he wrote for Linked-In. If you have the time, it’s definitely worth a read. But for the cheat-sheet, read on.

This is: RAY DALIO SAVES THE WORLD

Dalio starts by putting his views in context. Although he is one of the richest people on the planet now, he had relatively humble beginnings, and he owes his success to the things the American Dream gave him:

I was fortunate enough to be raised in a middle-class family by parents who took good care of me, to go to good public schools, and to come into a job market that offered me equal opportunity…

…At age 12 one might say that I became a capitalist because that’s when I took the money I earned doing various jobs, like delivering newspapers, mowing lawns, and caddying and put it in the stock market when the stock market was hot. That got me hooked on the economic investing game which I’ve played for most of the last 50 years.

To succeed at this game I needed to gain a practical understanding of how economies and markets work. My exposure to most economic systems in most countries over many years taught me that the ability to make money, save it, and put it into capital (i.e., capitalism) is the most effective motivator of people and allocator of resources to raise people’s living standards.

Over these many years I have also seen capitalism evolve in a way that it is not working well for the majority of Americans because it's producing self-reinforcing spirals up for the haves and down for the have-nots.

This is creating widening income/wealth/opportunity gaps that pose existential threats to the United States because these gaps are bringing about damaging domestic and international conflicts and weakening America’s condition.

I think that most capitalists don’t know how to divide the economic pie well and most socialists don’t know how to grow it well, yet we are now at a juncture in which either a) people of different ideological inclinations will work together to skilfully re-engineer the system so that the pie is both divided and grown well or b) we will have great conflict and some form of revolution that will hurt most everyone and will shrink the pie.

I believe that all good things taken to an extreme can be self-destructive and that everything must evolve or die. This is now true for capitalism.

This is the TLDR version. Capitalism is awesome but it is coming off the rails. This is creating an ‘existential threat’ for every capitalist country, Australia included.

What actually is capitalism?

Capitalism is one of those things that means different things to different people, so Dalio starts with his own definition, which is actually one of the best I’ve read:

Over the years, I’ve had exposure to all sorts of economic systems in most countries and have come to understand why the ability to make money, save it, and put it into capital (i.e., capitalism) is an effective motivator of people and allocator of resources that raises people’s living standards.

It is an effective motivator of people because it rewards people for their productive activities with money that can be used to get all that money can buy.

And it is an effective allocator of resources because the creation of profit requires that the output created is more valuable than the resources that go into creating it.

Being productive leads people to make money, which leads them to acquire capital (which is their savings in investment vehicles), which both protects the saver by providing money when it is later needed and provides capital resources to those who can combine them with their ideas and convert them into the profits and productivities that raise our living standards.

That is the capitalist system.

He also fingers what I think is the key flaw in communism and socialism:

… Communism’s philosophy of “from each according to his ability, to each according to his needs” turned out to be naïve because people were not motivated to work hard if they didn’t get commensurately rewarded, so prosperity suffered.

Capitalism, which connects pay to productivity and creates efficient capital markets that facilitate savings and the availability of buying power to fuel people’s productivity, worked much better.  

No System is Perfect

However, Dalio is wise enough to recognise that even though capitalism as a system has many advantages, no system is perfect, and there are many ‘institutional’ elements you have to get right too:

I’ve also studied what makes countries succeed and fail by taking a mechanistic perspective rather than an ideological one because my ability to deal with economies and markets in a practical way is what I have been scored on…

In a nutshell, poor education, a poor culture (one that impedes people from operating effectively together), poor infrastructure, and too much debt cause bad economic results.

The best results come when there is more rather than less of: a) equal opportunity in education and in work, b) good family or family-like upbringing through the high school years, c) civilized behavior within a system that most people believe is fair, and d) free and well-regulated markets for goods, services, labor, and capital that provide incentives, savings, and financing opportunities to most people.

This is really where we get to the heart of things. A lot of the successes of early capitalism (e.g most of the twentieth century) were possible because capitalism had strong institutional support.

However, that support is steadily eroding, and that’s putting capitalism into crisis.

And a lot of that erosion is coming from the way capitalism currently operates. Dalio has a heap of charts about how capitalism is currently creating ‘downward spirals’ that make the rich richer and the poor poorer, but there is one that is a good summary of it all.

It shows that the real household income of the bottom 60% of Americans has actually gone nowhere for almost 50 years.

And it actually gets worse if you look at the income distribution in more detail. The top 5% are killing it. The bottom 10% are getting hammered. The wealth gap is America is the worst it’s been since 1930.

These stats are all for America, and Australia is doing a lot better. However we are definitely on the same course as America, even if we are still a decade or two behind.

Spiralling Out of Control

Dalio then outlines how these inequitable wealth outcomes are creating reinforcing feedback loops – loops that create downward spirals for poorer Americans.

• Poorer families have lower levels of education, health, and nutrition.
• This leads to lower levels of productivity, which leads to lower levels of income.
• Lower income prospects and problematic social behaviours lead to crime and higher levels of incarceration.
• These factors create a poverty cycle, which is almost impossible to escape.

These outcomes are not just bad for poorer folks, they weaken America as a nation:

The previously described income/wealth/opportunity gap and its manifestations pose existential threats to the US because these conditions weaken the US economically, threaten to bring about painful and counterproductive domestic conflict, and undermine the United States’ strength relative to that of its global competitors.

… While the pursuit of profit is usually an effective motivator and resource allocator for creating productivity and for providing those who are productive with buying power, it is now producing a self-reinforcing feedback loop that widens the income/wealth/opportunity gap to the point that capitalism and the American Dream are in jeopardy.

But what can we do about it?

Dalio has a number of useful prescriptions about how America should fix it’s problems, and I suggest you read the rest of the piece if you want to know more.

However, a little grimly, Dalio notes that this is going to require bi-partisan support to get it done.

However, the prospects for bipartisanship fall as inequality increases. As he notes, in America and across the world, populism is on the rise, and politics everywhere is becoming more intense and combative.

The interesting chart he shows to make this point is a long-running study on the ideological positions of Americas two biggest parties.

What it shows is that both parties are becoming more extreme, as the whole nation becomes more polarised.

If we’re hanging our hopes on our politicians working together and getting stuff done, then things are looking a little grim.

There Is Still Hope

I guess Dalio is still hopeful. He wouldn’t have bothered with all of this if he wasn’t.

But still, we’re talking about really re-engineering the foundations of society – creating structures that balance out the worst excesses of capitalism… at a time when political tensions are running red hot.

That’s challenging, but a worthy mission. And as Dalio points out, the stakes couldn’t be higher.

Modern democracy depends on us getting it right.