A Democracy on Crutches

We mustn’t dismiss these possibilities just because they seem ludicrous or too horrible to imagine.

Thomas Homer-Dixon, Professor, Cascade Institute, British Columbia


This month’s Absolute Return Letter deals with a hyper-sensitive topic. Consequently, I decided to seek advice from two long-standing American friends, Austin Erwin and Seth Novatt, both of whom have made invaluable contributions to the final output. Thank you so much to both of you for correcting the errors you spotted in my first draft and for softening my (at times) rather inflammatory language. Having said that, should any of the following contain any factual errors, it is solely my responsibility.

Have I smoked something I shouldn’t have touched?

235 years after the United States of America was first established, the Union is facing one of its biggest challenges ever. In short, parts of the Republican party are toying with things that are very toxic, which is what this month’s Absolute Return Letter is about. I am pretty sure my inbox will fill up with strongly worded messages but so be it. Before you put me in a straitjacket, I suggest you read what I have to say, though. You may not agree with it all, but at least you should listen to the words of a foreign soul who is not so emotionally involved as you might be.

Quite a few observers have already named it a right-wing coup d’état in the making but more on that later. Let’s start somewhere else. As you are probably aware already, the investment strategy at Absolute Return Partners is based upon the six megatrends that we have identified over the years. Our work has identified another problem, namely that US wealth is absurdly inflated when measured as a percentage of US GDP. Simply put, one cannot outgrow the other for longer periods of time. There are some very technical, mathematical reasons for that.

Data on US wealth from the past 200 years or so suggests that the theory works well in practice too. Every time the two have been out of sync, sooner or later, mean reversion has kicked in to re-establish a well-defined balance between wealth and GDP of about 2.8 times, i.e. when the system is in good shape, total US household wealth is about 2.8 times bigger than nominal GDP. The wealth-to-GDP ratio is broadly similar in other countries but not exactly the same, the reason being that capital efficiency (i.e. how much capital it takes to grow GDP by $1) is different from country to country.

Based on the latest statistics provided by the Federal Reserve Bank at the end of the third quarter of last year, total household wealth is now 6.2 times GDP in the US. In other words, a massive correction in wealth is on the cards. Unfortunately, the theory behind holds no hints as to the timing of it.