Empires and Endings
To hear a pitch from an American financial advisor these days entails listening to a story about how investing in stocks is the only way to accumulate real wealth. Just look at the S&P 500, they say, which returned something around 9.75% on an annualized basis since 1900. Invest now and invest as much as you can, or else you'll miss out on huge gains. But will we? Without question, the crux of the advisor's sales pitch is backed by historical data. And yet today, many of us don't find the financial advisor's historical data as relevant or persuasive as we once would have. Something about the sales pitch's assumption that the future will closely resemble the past doesn't sit right with us. And after living through the 2016 and 2020 US Presidential Elections and the Pandemic, it doesn't feel right either. But why?
Westerners have all learned about the Roman Empire. We've heard of its aqueducts and coliseums and heard of its legions conquering lands from North Africa to Britain. We know that Rome was the greatest empire of its time. We look at decrepit Italy today, and we know Rome is gone, but we don't focus on why it is gone because we accept that empires rise and fall. In a broad stroke, that is the story of recorded history. Thanks to an inept education system, if Westerners learn history at all, it is only the history of the last 150 years or so. Which, as far as history goes, is only part of the empire cycle.
And conveniently for Americans, the last 150 years tell the part of the American Empire story where the empire rises to become an economic power, then gains military and financial preeminence, such that by several measures, the American Empire became the most dominant empire in world history. As a consequence of our abbreviated study of history and people's general inability to imagine a future that materially varies from the present, most Americans don't consider a future without the American Empire. That is why the financial advisor's pitch is so compelling for most. If the future is anything like the last 150 years, of course the American Empire will continue, and with it, the value of American stocks and other financial assets.
The last 150 years don't tell the whole story for two reasons. First, during the last 150 years, America has done nothing but rise and then rule, so we don't study or understand the other parts of the empire cycle. And second, the ruling empire that preceded and then gave way to the American Empire stepped off the throne as world leader to what, by historical standards, was an unusually soft landing for an empire losing its dominant position. The second point is crucial. When the British Empire ended following World War II, the UK didn't devolve into anarchy, lose its government, or become financially insolvent as so many formerly preeminent empires before them had upon losing their preeminent position. Instead, the UK's language, culture, and legal system essentially continued to dominate the world, albeit under American control. And the UK continues today as one of the world's wealthiest countries with outsize influence over the world's governing systems. Because of this, Americans can't picture a world without the American Empire because they have only seen their empire rise, and they haven't seen an empire fall, at least not as far as history suggests they usually do.
Whether the Roman Empire, the Chinese Tang Dynasty, the Mongol Empire, the Spanish Empire, or the Dutch Empire, at the end of the respective empire, governments crumbled along with the institutions, currencies, and stability that they supported. Needless to say, this left the financial assets of the citizens of the respective empires also depleted. And while Americans haven't seen this from a preeminent empire, they have seen it happen to other powers. According to Ray Dalio in his work Principles for Dealing With The Changing World Order, in the last one hundred twenty years, a financial portfolio classically invested 60% in stocks and 40% in bonds would have lost at least 50% of its value over twenty years in ten world powers. These include Russia, China, Germany (2x), Italy (3x), Japan, Austria, France, and Spain.
Empires rise and fall, and the historical aberration of the last empire transition leaves us without much insight into what an empire falling might look like, but does that mean the American Empire is imminently coming to an end? Of course not. No one knows the timing of the empire cycle. Again, according to Dalio, "great empires typically lasted roughly 250 years, give or take 150 years." The lifespan of an empire isn't predictable with precision. Yet, we know the broad signals of an empire's decline - internal and external disorder, high sovereign debt, ineffective institutions, and a rising power capable of replacing the empire. Look at Dalio's chart that shows the last 1,400 years of empires.
Credit: Ray Dalio
A few things stand out, like China's staying power and how strong the American Empire was at its peak, but none more so than the steepness and depth of the curves showing each empire's decline. Once an empire starts to fall, it falls far and fast. The data available today suggests the American Empire is in decline, but the decline could continue for a long time before the crash. The crash may not occur in the lifetime of anyone currently alive, and the crux of the financial advisor's sales pitch may prove accurate in the short run, the long run, or both. However, the signals of decline and the risk of empire collapse are too great to ignore.
Not only would the American Empire's collapse spell disaster for Westerners' financial assets, a collapse could entail a broader societal deterioration and threats to personal safety. America doesn't have an ascendant ally like Britain did to displace it. The most likely candidates to replace America as the world's preeminent empire have different cultures, languages, and worldviews. And they are distinctly not American allies. If America is displaced from preeminence, her culture, legal institutions, language, and international standards would almost certainly follow her into oblivion.
And the collapse of the American Empire wouldn't be a "black swan" event either. This is not one of those threats with a less than one percent chance of occurring, like a major hurricane, earthquake, or plague. We don't know precisely what the probability of the fall of the American Empire is, at least over the short-term (just as we similarly don't know the precise probability of a hurricane or earthquake hitting a particular location). Still, at least one educated probability estimate is likely much higher than you would expect. In the words of Ray Dalio, "the odds of the US devolving into a... Stage 6 (civil-war-type) dynamic within the next ten years are... around 30 percent."
If the weather forecast tells us there is a 30% chance of rain, many of us are packing an umbrella. One of the world's leading thinkers and investors forecasts a 30% chance of a civil war type event occurring in the near future and yet, most aren't doing anything about it, despite the downside consequences of being unprepared being monumentally greater than any degree of getting wet. The Civil War didn't destroy the budding American Empire, but it almost did. The fact that it didn't kill the empire is almost a historical aberration as other relatively recent civil wars, namely the English Civil Way, the Russian Civil War, the Spanish Civil War, and the Chinese Civil War, all resulted in regime change.
Still, the American Civil War was horrible. 2.5% of the population perished, which would equate to around seven million people today. And beyond the battlefield horrors, the government suspended habeas corpus, which jeopardized all Americans' individual rights and liberties. It isn't a stretch to imagine a future civil war following the same precedents set in the 1860s. Similarly, it isn't hard to imagine a foreign power seizing the opportunity of internal American discord to end America's empire.
Most people don't want to devote their mental space to learning about potentially negative events. Some say it brings them down. Others chalk it up to the adage that there is no sense in worrying about circumstances you can't control. While a civil war type event in the United States would absolutely be negative, and it is unlikely any one person could control such an event, everyone can control their degree of preparedness and, correspondingly, how negative the event is for them.
Preparedness can come in many forms. One of these is financial preparedness, or how you can position yourself so that you aren't wiped out if a civil-war-type dynamic occurs in the United States. A gating question to hiring any financial advisor should be how they will protect clients' assets if the American Empire breaks or even fractures. While many financial advisors worry about the 30% market drawdown, you know the bigger concern is the 100% market drawdowns that have occurred repeatedly throughout history, often at the end of an empire. If your financial advisor hasn't considered the risk of a complete market collapse, it's hard to put too much weight on a sales pitch that accounts for only the good years in the empire cycle. We know better than to hire such an advisor because we know the short-sighted and unimaginative are too common, unlike us.