How Powers Rise and Fall

Tracking the Economic Cycles of Nations: How They Rise and Fall

Economic cycles and how they occur are highly dependent on competitiveness and indebtedness and dependent on the primary drivers of asset values.

Productivity is growing over time as people gain knowledge, innovate, and develop. Productivity is not a strictly linear matter, but it is fairly constant over time. It is also less unpredictable than the processes of credit formation and degradation. This is the trend in US productivity since the end of the Second World War.

trend in US productivity since the end of the Second World War
(Source: US Bureau of Economic Analysis)

As a whole, productivity is not sufficiently volatile to have a material impact on asset price volatility. It is, however, what matters most in the long run.

Asset price instability is a significant feature of debt growth and contraction.

While productivity and debt are the main drivers of economic activity, people’s choice determines their productivity and debt levels. Psychology and culture are also of considerable significance in deciding why some countries prosper (and why they are good places to invest) and why some countries fail (and why they are poor places to invest).

Psychology and society influence people’s attitudes towards employment, recreation, borrowing, spending, and handling confrontation. Different backgrounds have contributed to various psychological prejudices. As countries and empires pass through their life cycle, some cause-and-effect linkages occur to drive these changes, leading some to succeed while others fail. Although there are a lot of commonalities, the life cycle is not quite the same.

How Empires Rise and Fall

Economic conditions influence human nature, and human nature influences economic conditions.

Broadly speaking, there are five phases in the normal life-cycle of a nation or kingdom that include the interplay between the wide reality between circumstances and the interpretation of their circumstances.

  1. In the first phase, countries are poor and see themselves as poor.
  2. Phase two, countries are prosperous and considered themselves to be poor.
  3. For the third phase, countries are rich and see themselves as rich.
  4. In the fourth phase, countries are getting poorer, but they still see themselves as rich.
  5. Finally, in the fifth phase, countries are undergoing a decline and are slow to accept the new reality.

We’re diving into each one separately.

Phase I

At this point, countries are poor and see themselves as so.

These countries are underdeveloped. They mostly have lives that revolve around agriculture and low incomes. They seem to value money a lot, not to squander it. Since they have low savings and low profits, few borrowers can lend to them, and their debt rates are low.

Some of them stay in this stage and some step out of it.

Culture is a big part of who they are – do they have the desire to excel and perform internationally? Geography also plays a part in other situations.

Dispersions are taking place within countries. For example, it is not possible for many people within China to attain wages on par with those in developed countries. They are too far away from urban centers where utilities are offered and where they are active in the development of emerging technology.

Consequently, without access to these centers, they can not compete economically. Moreover, it is not fair to expect a Chinese person’s average income to be in line with that of the average person from Beijing or Shanghai for a very long time, let alone to have an income in line with that of the average US resident. (The US also benefits from becoming the world’s main reserve currency, which has a wealth advantage in the form of being able to borrow more cheaply.)

Countries that finally make the transition to the next level are usually able to build enough savings as they have more than enough resources to thrive.

When countries are poor, they typically have higher rates of financial prudence. As a result, they have higher savings rates because they are afraid that they will not have enough money in the future.

Countries with low wages do appear to have very productive labor, particularly if they are skilled (e.g., China). With low labor costs, countries developing in the next step typically adopt export-oriented economic models. Namely, low value-added goods are cheaply produced and exported to richer countries.

If countries are low-cost producers and have political stability, they would typically be able to attract huge amounts of foreign investment from businesses that want to set up a manufacturing hub there. This offers an inexpensive labor source to improve productivity and allows them to sell to rich countries where buyers benefit from more efficiently manufactured commodities.

Naturally, countries in this first stage need to provide high investment returns because they are risky. Because they can deliver at a low cost, they can usually keep up with these high returns.

At this point, their financial economies are underdeveloped. Their currencies are cheap and are not used internationally as reserves, and their bond and stock markets are not well known. For example, in certain situations, countries with state-controlled economies, such as the former Soviet Union or North Korea today – capital markets, as we know, do not exist at all.

Set exchange rate systems will be widely implemented in these early developing countries. Usually, this means sticking their exchange rates to gold or reserve currency. This reserve currency is usually that of the big block to which they sell (or wish to sell) their goods. This is true beyond the early emerging countries as well.

For example, Hong Kong and Saudi Arabia (among a few other major oil exporters) are pegging their currencies to the US dollar. Switzerland has traditionally indexed its interest rate to the European Union, provided that the EU is the country’s main trade partner.

People are slowly reaching wages that outweigh their spending. They usually save or reinvest surpluses in their businesses, personal means of production, or convert savings into hard assets (such as precious metals, land, and/or real estate).

Countries that produce more wealth and worry about prospects outside their own boundaries also tend to spend capital in other countries. This generally starts with the safest investments globally, normally the sovereign debt of reserve currencies in the world. Thinking at present means USD (the main one), EUR and JPY (the top three represent around 90% of all globally stored wealth) and, to a lesser extent, GBP, CNY, CHF, AUD, and NZD.

Those in early emerging countries value more than they spend on earnings and saving money. As a result, their governments will generally prefer their currencies to remain undervalued. This helps to keep their labor and goods cheap to the rest of the world. It then allows them to create capital at the federal level (also known as international reserves, often from other countries’ sovereign debt).

Countries can move quickly (within decades) through the early emerging stage or never move out of it altogether due to the confluence of factors such as education, skills, and abilities, culture, and geography.

Phase II

Early developing countries are reaching a new phase of their growth (“late-emerging”) where they have more resources than they need to fund their simple living costs, so savings are beginning to grow rapidly.

People’s psychology and behavior in early emerging and late developing countries are comparable, even though their savings and their ability to invest in such savings improve.

Not all that long ago, for example, in the 1980s, China’s poverty rate was almost 90%. Poverty has now been almost removed. However, the financial prudence of most Chinese is still high, having gone through these conditions of deprivation.

They still have a culture that favors work, maintains a managed exchange rate, a high rate of savings, high rates of investment back into their means of production, and high rates of investment in hard assets ( e.g., gold, land, real estate) and sovereign debt in reserve currency countries. Much of their economy is still export-based, but they focus on economic reform that places them at the forefront of services and the newest emerging technology (to make them transition to the next stage).

Their exchange rates also generally remain undervalued, which continues to help their labor and goods remain cheap on the international market. This competition is driven by a strong balance of payments situation ( i.e., how much other countries owe them in comparison to what they owe to other countries).

Their incomes and assets are rising faster (or at least in line with) their debts. The country’s aggregate balance sheet is very sound.

Productivity is increasing rapidly at this point. Technology that is now part of daily life in many countries has been introduced. As income grows in line with productivity, inflation of goods and services is not a matter of concern. Increased production rates also add to their success compared to other nations.

However, at some point, wages are rising faster than production, and loans are rising faster than incomes.

Economic growth leads to too much capital chasing too little products. In other words, demand increases more than output can be expanded by productivity growth.

Moreover, developing countries also add their currencies to reserve currency countries. This implies that they are related to reserve currency countries’ interest rates with faster wage growth and inflation.

Interest rates continue to meet developments in nominal growth rates. While low-interest rates are appropriate for countries with low nominal growth rates, they are too low for countries with higher growth and inflation rates.

Emerging countries with low-interest rates compared to their nominal growth rates have high money and credit growth that drive inflation (because the demand for money and credit is strong).

Emerging markets should typically retain their fixed exchange-rate systems – and thus related monetary policies – before rising inflation levels are too high, investment bubbles arise, and protectionist trade policies disrupt successful market conduct.

Moving towards an autonomous monetary policy is what marks the transition to the next level of growth.

Key signs are:

  1. Rising inflation from income growth and spending over productivity growth;
  2. Over-investment and asset bubbles (excessively loose monetary policy);
  3. Debt growth in excess of (often by a wide margin) income growth;
  4. Trade and current-account surpluses.

Moving towards independent monetary policies is a signal of maturing and practicality. Pegged currency systems that are out of line with fundamentals eventually come to an end.

If they do not pursue an effective monetary policy, they will have one or more of the following effects:

  • Higher exchange rates
  • Higher deposits (aka foreign exchange reserves)
  • Lower real interest rates (which contributes to inflation and asset bubbles)

The currency appreciates.

Internationally, because of their trade surpluses, they often have tensions with other countries. Their labour is cheap, and low-skilled workers in developing countries also see their employment off-shored in those countries that would have employees with better productivity per dollar. That also contributes to capital outflows from the developing world to the emerging nation as further spending takes place.

Floating the currency and seeing it appreciate helps to improve these issues and is also something that has been gained from progressing through the early stages of development.

Floating a currency and encouraging it to rise ensures that the protectionist practices and the export-based market would be weakened. Its workers will become more expensive, and its goods will no longer be as cheap as they are.

Countries want an independent monetary policy. It is the best option a country can select to change the rates of capital and credit in circulation in the light of its own economic conditions (i.e., production relative to inflation).

As a result, no big developing nation has an exchange rate pegged to another. Countries that tend to be small or emerging economies do so out of practical necessity – either have trouble managing monetary policy without a peg or will fail to gain enough confidence in their currency without linking it to gold or the currency of the developed trading partner.

If they step into the next level, their domestic stock and bond markets will become more generally embraced by both domestic and international investors. Lending to the private sector of the country is becoming common.

At this level, these countries are significantly increasing in their growth due to their high savings rates, rapidly rising wages, usually growing foreign-exchange reserves, and modern infrastructure and cities.

As major countries emerge from the late-developing period, they typically develop as world powers. That also causes friction with the world’s dominant forces and may bring damage to the world order.

Phase III

At this third level, countries are not only wealthy but see themselves as such.

Wage approach levels are commensurate with developing countries. Investments in R&D, capital goods, infrastructure, and other tangible assets generate productivity gains.

Those who have experienced poorer times begin to be replaced by those who have only known the better times. As a consequence, the social mindset of the world is shifting. Savings rates begin to fall as they feel less need to protect themselves from their financial situations and more comfortable spending and savor the fruits of their new wealth.

This is generally expressed by higher expenditure on luxury expenditures and riches compared to basic needs. In comparison, workweeks become reduced in both the number of days working and the number of hours.

These countries are increasingly shifting from an export-based economic model to a consumption-based model. They appear to import more from developing countries that are primary exporters, especially low-value-added products.

Investors and businesses in these early-stage developed countries are looking for higher returns by investing in developing countries where labor is cheaper.

The country’s debt and equity markets and its currency are becoming the place to invest for both domestic and foreign investors. Capital raising is becoming popular, the same as financial speculation. The high returns of the past can be extrapolated further. That, together with the growth of these economies, facilitates the acquisition of leveraged financial assets.

Their growth rates are lower and relatively politically stable and have certain features similar to the industrialized economy ( e.g., private property rights). Interest rates are declining, and so are investment returns relative to emerging markets. Their markets are increasingly perceived as safe.

Any country at this level, which is of a large scale, is generally economically, militarily, and technologically strong.

Military growth is expanding, as it is important to defend interests internationally.

Before around halfway into the twentieth century, nations at this point of growth would take hold of foreign governments and essentially turn them into slaves, making them part of their empire. The countries they took over would have cheap labour and other tools to help the empire stay competitive.

Since the US became the world’s main economic and military force since the Second World War, this perspective has shifted. Instead of requiring foreign governments’ control, international agreements have provided access to labor, resources, and investment opportunities.

Phase IV

At this point, countries are getting poorer and still see themselves as wealthy. They are becoming late stage developed economies.

Debts rise relative to output and income until they can no longer do so. (This usually happens as interest rates reach zero, and taking capital and cash out of the system is considerably more difficult.)

Those who were more financially conservative in the preceding two periods of growth are now no longer alive or have less of a part in the economy. The time with increased prosperity produces a mutual psychological change.

They are now used to spending, consuming, and using loans to buy goods, services, and financial funds. Living these lives, they’re not as worried that they don’t have enough money to prosper.

The country’s labor force is becoming more expensive, making it less competitive internationally, especially for low value-added jobs, which are largely off-shore. The rate of growth in their real income is diminishing.

When income growth levels fall, they struggle to keep their spending in line with their incomes, as they have become accustomed to a certain degree of growth. Their spending remains robust, but their savings rates are falling, and their debts are rising. Rising debt-to-income ratios make their balance sheets weaker.

Furthermore, productivity gains are slowing due to less productive spending in R&D, capital goods, and services. When the network gets older, it becomes less effective and, therefore, impossible to repair or update or become a low priority. Funding often becomes a concern for large-scale public investment projects as deficits increase.

Countries at this point have reserve currencies (especially if they are large) that make funding deficits simpler with cheaper borrowing rates. However, as their fiscal and balance of payments situations worsen and long-term liabilities increase, they rely more on their reputation than on their actual financial health and overall competitiveness.

Protecting their global interests through military power is becoming a major part of their spending and sometimes requires war.

At this point, it is normal (though not always true) for these countries to have both a current account deficit and a fiscal deficit.

Investors are still betting on emerging developments to proceed, even though they are impossible to do that. It means that bubbles continue to appear regularly. Investments that have done well are expected to be good rather than expensive. They take on loans to finance acquisitions of financial properties outside their ordinary means. It pushes up their costs and reinforces the bubble. This often impacts various constituencies of the economy – not just creditors, but company owners, individuals, policy leaders, banks, and other financial intermediaries.

Rising asset prices help investors increase their net worth, which helps increase spending, earnings, and borrowing capacity. This further enhances the ability to purchase assets on leverage, increase their prices, and so on, until the bubble bursts.

Bubbles can no longer be able to finance themselves because the acquisitions’ cash flows are not adequate to repay the loans, and no additional money is coming to fund more price rises in the market.

Initially, bubbles are typically made possible by central banks, making monetary policy unnecessarily convenient. Central bankers mostly focus on inflation and growth and achieving the right balance between the two. Inflation and growth are significant, but they generally do not pay enough attention to debt growth related to production, another essential balance. Debt can not increase indefinitely faster than output. Central banks that reel in bubbles by tightening monetary policy are also what pops them.

Financial asset values affect profits, net worth, and creditworthiness. Consequently, when asset prices collapse, there is a detrimental feed-through to the country’s economy and financial stability.

Often, at this point, it’s wars that wreck countries (especially if these conflicts are lost). Perhaps they are bubbles in commodities, utilities, and/or financial properties. And often, both war/external conflict and financial bubbles trigger an economic and geopolitical decline.

The most common characteristic of this stage is the accumulation of debt and long-term commitments that can not be settled with the currency that retains its interest.

Countries that are going through debt-related problems eventually have their central banks printing money to combat them, but this comes at a long-term cost.

When large countries go through this stage, it usually means that they are approaching their decline as great empires.

Phase V

In the last long development stage, countries need to minimize their debt to output ratios and may face a relative decline even though they have not come to terms with this fact.

When bubbles deflate, countries are pressured to reduce their debt compared to their profits. They will do so in four different ways:

  1. Write off or restructure debts. When loans are written off, a new deal may be made to pay a percentage or none at all. This is painful because the debts of one person are the assets of another. So, people who think they own an asset have the property they believed they had partly or fully wiped out. Debt restructuring can involve changing interest rates to boost serviceability. They could prolong the maturity of the debt to give themselves more time to improve their situation. It could also change the balance sheet on which it is. These are the main processes that governments, companies, and individuals are going through to help themselves handle debt that has put them in difficulty.
  2. Austerity. Cut spending to get it back in line with revenue to avoid debt-to-income levels from continuing to rise. It’s hard to do, too. People, businesses, and other governments are dependent on government spending as revenue. Governments that are trying to impose cuts are not politically popular.
  3. Wealth transfer payments. Transfers of capital include money from people who have it to those who don’t. Governments seeking to raise more money to allocate it more efficiently – such as higher tax rates on the wealthy and stronger welfare services and safety lines for the vulnerable – have their constraints. The wealthy continue to protect their properties and want to transfer themselves and their investments elsewhere, so policymakers will lose some big taxpayers if their prices are not affordable. Governments often opt for wealth taxes, which are not widespread, since most capital is illiquid. Moreover, in a crisis in which markets are collapsing and asset values are dropping, the upper classes are losing vast sums of money as primary financial property owners. In the background of debt crises, transfers of capital seldom take place on a scale that makes a major difference in addressing the disparity in resources flow to those who need it most in relative terms.
  4. The development of capital and the monetization of debt. Central banks generate liquidity and monetize the debt directly.

Debt write-downs and restructurings are deflationary, while liquidity formation and debt monetization are inflationary. Reducing debt levels relative to income requires maintaining the right balance between deflationary and inflationary components.

When bubbles burst, and countries are forced to reduce their debt-to-income ratios, private-sector spending, private-sector growth, asset prices, and net worth decline. The downturn becomes self-perpetuating when cash shortages arise, leading to asset selling, leading to lower creditworthiness, and so on, in a negative self-reinforcing loop.

Governments seek to help cover for financing deficits by offering debt, such as bridge loans, and central banks are making funds by supplying liquidity protection. They gradually consider poorer quality collateral to help save the scheme. Fiscal deficits are increasing.

Central banks reduce real (i.e., inflation-adjusted) interest rates, and governments spend on raising nominal GDP above nominal interest rates to prevent debt from growing faster than the economy can.

However, due to low real interest rates, poor economic conditions, and weak currencies, their debt and equity markets will struggle. Other countries are emerging in their early stages of development that are less expensive to invest in.

With large debts, large future commitments, and often large fiscal and balance-of-payment deficits, countries bound to this set of conditions want their currencies to decrease to provide debt relief. Their relative power and influence in the world are declining as other countries come up to challenge them.


Nations and civilizations are rising and collapsing over time. These loops have been going on for thousands of years. They vary based on the scale, culture, and other variables of the region. For this reason, no cycle is precisely the same as another one. However, the process of wealth-producing nations, extending their dominance and power, raising their debts relative to profitability, managing their debts and commitments, and diminishing has been going on for as long as history has been known.

The principles of how civilizations rise and fall have not changed. It is a representation of human nature.

The modern structure of the financial market may be different, the same as monetary systems, but how they operate is the same. Gold used to be money and has remained a reserve asset for thousands of years. Countries, states, and empires will use gold and gold coins as currency. Each coin was worth a certain amount of money. If their debts rose to the point that they could not be serviced, those responsible for creating money would lower each coin’s gold value to produce more of it.

This is not dissimilar to US President Franklin Roosevelt’s devaluing the dollar against gold in March 1933 and violating the “gold clause” in debt contracts. The price or sum of the asset that may be traded for each currency unit has been adjusted in order to produce more revenue. Under Roosevelt’s Executive Order 6102, gold possession was effectively eliminated, and gold was required to be traded for paper currencies at $20.67 an ounce (about $415 an ounce in today’s money).

This allowed more currency to flow into the economy to help solve its debt problems during the Great Depression. About one year later, gold was devalued under the Gold Reserve Act to $35 an ounce (about $700 an ounce in today’s money). Rising the dollar to gold conversion has allowed more people to trade their gold for paper dollars. This benefited the debtors compared to the creditors by making debts and obligations cheaper and easier to pay.

However, passing through this process in its entirety takes a long time, sometimes hundreds of years. As a result, the changes seem inconspicuous to most people who live through them and are usually irrelevant to investors taking shorter-term approaches, even though they matter a lot in terms of the overall picture.

Moreover, in the case of political officials whose terms are usually brief and, in effect, work on narrower time horizons, this development is virtually immaterial to the decisions they make.

This is also why they are expected to occur. Politicians often feel obligated to invest, even though they don’t care how they will pay for it. At a late point, developing economies that usually have big deficits (or declining surpluses if they do have them), heavy loans, and huge amounts of potential commitments will not be compensated for through decreased spending or raised revenues, but instead by the currency.

Consequently, these loops go on in a manner that is generally not well controlled, rendering them vulnerable to occur.

If countries could escape debt growth in excess of income growth and income growth in excess of productivity growth, markets would not get to grips with these classic challenges, and these loops would not exist more or less.