Rise and fall of debt-ridden empires

Image: Ekaterina Astakhova


The decline phase, in general, is motivated by internal economic weakness, as well as internal struggles or costly external struggles, if not both.

“History repeats itself,” argues Ray Dalio in his book, Principles for Dealing with the Changing World Order, released in 2021, in a great archetypal cycle. He observed that all Empires go through: a phase of leadership, peaceful growth and prosperity; a phase of loss of competitiveness and productivity, with a crisis resulting from the previous super expansion with debt; and a period of decline, in the form of loss of financial power, internal conflicts, and wars or revolutions.

the phase of tree (or bullish) begins when a series of conditions are met. A leadership capable of designing a system to increase the country's wealth and power emerges.

A solid education is not limited to teaching knowledge and skills. It also fosters and cultivates character development in society so that civility and a nurturing work ethic prevail.

The better education the country has, the more intense the transition from more basic production to one where innovative producers are found. Incorporate new technologies. Society is open to incorporating all possible knowledge, whether its own or that of others, in order to discover new ways of doing things.

It makes the workers, the government and the army move in the same direction and work together harmoniously. Avoid coups d'état in favor of the military caste. The country in question becomes more productive and is able to be more competitive in international markets. Its economy now has a greater weight in global trade.

When a country trades more with the rest of the world, it is obliged to protect the routes of these economic relations to guarantee a security framework for its interests abroad. It implies being better prepared against any foreign attack, a defense only achieved when more military strength is developed.

In political terms, the merchant castes, the ruling oligarchs and the military are allied. Worse, these conservatives often act against the reformist social democratic interests of the organized labor and intellectual-savvy castes.

If managed well, the virtuous circle of the upswing leads to strong growth in tax revenue, which is used to fund investments in infrastructure, education, and research and development. The country becomes an economic-financial system capable of encouraging and empowering those with the capacity to generate or obtain wealth.

To achieve this, the country needs to have a well-developed capital market, especially in terms of financing via loans, issuance of debt securities (debentures) and the stock market. It enables Individuals to convert their reserves into financial investments, suitable for financing innovation and development, and/or partnering with Legal Entities in fortune (profits and dividends) and in misfortune (losses and damages).

All the great empires developed an international financial center, capable of attracting and distributing the capital available at each time. The country expands its international transactions to become the dominant trading empire.

As more and more transactions are denominated in its currency, more of the rest of the world wants to deposit its foreign exchange reserves in that currency. This allows the country to borrow more money at lower interest rates compared to other countries.

This series of relationshipsCause-and-effect es makes the axes of power, in fields such as finance, politics or military, mutually supportive.

At the peak, the phase close to the peak, the country sustains the impulses responsible for its rise, init embodies the rewards of successes, but “plants the seeds” of further decline. Over time, obligations accumulate, breaking the positive reinforcement circumstances that feed the tree at the beginning of the expansion cycle.

Individuals and legal entities in the now rich and powerful country earn more, their economic structures are more expensive and less competitive in relation to other countries, where there are people willing to work more for less. Foreigners, naturally, copy the methods and technologies of the power, reducing their competitiveness.

Individuals and corporations in the leading country get richer and start not working as much as they used to. They enjoy more leisure, seek more fun, to enjoy life even with luxury and ostentation – and they become less productive and decadent in moral values ​​and effort. People, when doing well, increasingly bet on the good times continuing – and go into debt to make this bet by anticipating their expected ability to pay.

In capitalist systems, financial gains are obtained unequally and differences in wealth increase progressively. They are self-reinforcing, because the rich use their greatest resources to expand decision-making power at will. Inflate financial bubbles.

They seek to influence the political system, trying to divert it to their own benefit, and thus grant their children greater privileges, such as access to occupations and/or appointments to better positions. All of this generates increasingly strong differences in moral values, political positions and personal opportunities for social advancement, giving rise to a class division between the rich (“the haves”) and the poor (“the have nots”).

The least favored feel the capitalist system is unfair, so resentment increases. While the standard of living for most people may continue to rise, these disagreements and resentments translate into major political conflicts.

The financial scenario of the leading country begins to change. Its currency as a foreign exchange reserve, throughout the world, has the exorbitant privilege of being able to continue to borrow excessively. Ultimately, “their society becomes consumerist and financing comes from the communists.” The country accumulates large debts with the rest of the world.

Although it can increase its purchasing power in the short term, in the medium or long term it implies the weakening of the country's financial health and, along with it, the depreciation of the national currency. When indebtedness and expenses grow, intensely and excessively, its finances weaken, not least because it spends to support international military conflicts far from the interests of its population, but justified by the war industry to maintain the power of its empire.

The costs of maintaining and defending the empire become increasingly greater given the revenue generated to support it. Maintaining this world power generates diminishing returns.

When the richest countries go into debt, taking loans from the poorest, emerging countries capable of saving more, this is one of the first signs of change in the structures of global power and wealth. If the Empire begins to run out of new creditors, countries with an accumulation of their currency in international reserves begin to look for a way to sell and liquidate these positions.

Hence the currency itself, previously considered a standard reference for international trade, loses its attractiveness in the rest of the world. As it is used less and less to buy, save, lend or invest, the Empire's strength begins to decline.

The decline phase is generally driven by internal economic weakness as well as internal struggles or costly external struggles, if not both. The decline of the empire occurs gradually until it rises more suddenly.

When debts become unsustainable due to insufficient income generation, there is an economic recession. The Empire can no longer borrow the money necessary to roll over its debts, has great difficulty obtaining a sufficient surplus to pay them and faces the choice between printing more depreciating national currency or failing to pay its debts.

The easiest option is to print (and further depreciate) the national currency. By devaluing the currency, it increases the cost of imports, in an open economy, and accelerates inflation.

In these moments, when the government struggles to finance itself, in poor economic and financial conditions, significant differences arise in politics, moral values ​​and wealth. This “mixture of culture” leads to an increase in internal conflicts between rich and poor, between different ethnic or religious groups, between the left and the right, etc.

Political extremism soon manifests itself in the form of populism (“speaking on behalf of the people” when it won the election by a small majority), whether on the left or on the right. Left-wing militants advocate redistributing wealth, while right-wing supporters seek to keep wealth in the hands of the rich.

In this 'anti-capitalist phase', all problems are attributed to capitalism, businessmen, rentiers and elites in general, including cultural ones. During this period, taxes on the rich often increase, and when they see their wealth and well-being at risk, they take refuge with their assets and currencies in other, safer places (“tax havens”). These leaks reduce the country's tax revenues, worsening the vicious cycle.

When the flight of wealth is very harmful, the government tries to prevent it from getting worse by taking desperate measures. Anyone looking for an exit, to avoid loss, panics.

These turbulent conditions hurt investment in new ventures and productivity, shrinking income-generating potential and causing more conflicts over their division. Populist leaders take advantage of this anti-government environment.establishment, promising to take over and restore order.

Democracy is challenged. It fails to stop the illegality of neo-fascist groups. the option for a populist leader “against everything” seems to be the last resort.

If internal conflicts intensify, the outbreak of a revolution or civil war is possible with the assumption of redistributing wealth and abruptly changing the existing order. The challenge is to make a peaceful transition while maintaining the existing democratic order, but history often shows that the opposite has happened.

When there is a rising great power capable of challenging the dominant great power and the existing world order, the risk of a major international conflict breaking out increases. It gets worse if an internal conflict unfolds within the current great power. The rising power will seek to exploit this internal weakness if it has armed an army comparable to that of the hegemonic power.

Defense requires a sharp increase in military spending, precisely when the power's domestic economic conditions are deteriorating and it is increasingly difficult to finance such budgetary expansion. These external conflicts are usually resolved through tests of power, where the former power faces a difficult choice, torn between fighting to maintain its position or withdrawing and accepting its decline in the international arena.

Wars are terribly expensive. They realign the world order and adjust it to the new reality of wealth and power. Countries dependent on the currency as a reserve and on the debt securities of the decadent Empire lose belief in their power and decide to liquidate such positions.

The great cycle ends. All these forces – debt, civil war or internal revolution, foreign war and the loss of the national currency's status as the standard international reserve currency – align and a major shift in the world order takes place.

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Brazil of banks (EDUSP).

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