The Fallacy of The Diversified Portfolio

Given the current state of affairs in the investment markets – particularly that fundamentals have long ceased mattering and tweets move the markets instead – I think a frank discussion is called for.

It’s an article of faith amongst financial planners that one must diversify his or her portfolio; that their investments must be spread across several economic sectors: transportations, utilities, growth stocks, emerging markets, and so on. And, of course, there’s a certain reasonableness to it: Those market segments go up and down at differing times (or at least used to), and no one knows enough to pick precise winners and losers. And so, spreading the money out means that you’re less likely to be wiped out by a surprise move.

The problem is that this type of diversification, while fine so far as it goes, misses the proverbial elephant in the room. And that elephant is capable of rendering diversification moot… as in blowing through it like tissue paper.

And so I think this is important to point out. A lot of decent people are relying upon “diversification” to protect their retirement money. And maybe it will. Or, maybe it won’t.

The Core Issues

The deep problem is that people don’t question diversification because “everyone does it,” and “authority says so.” Those are just about the most dangerous phrases known to the human race. The emotional hook is that you’re insulated from blame by staying with the crowd. If you do something different, on the other hand, any error you make can be exploited against you forever. Needless to say, none of this makes for particularly good choices.

But, let’s get right to the point.

Diversified assets – the aforementioned asset classes – are not really diversified. Yes, you may own so much utility stock, so much in foreign bonds and so on, but all those assets are held in a single pot, controlled by others.

That is, 100% of the assets of the typical retiree are held on Wall Street. And they’re all in government registered accounts. Unless you specifically choose to jump through inconvenient hoops, you don’t precisely own the shares of stock you paid for; your broker owns them for you. That’s a complicated generalization, of course (these things are always complicated), but it’s also generally true.

So, your portfolio is diversified so fas as it goes, but it all sits in a single pot, controlled by the lords of Wall Street and their partners at government agencies.

The typical response to this is, “So what? They’ll never take our money!”

The purpose of that statement, however, is to drive away an unpleasant concept. Or, perhaps, to appeal to the gods. Of course governments seize assets, they do it all the time.

FDR seized nearly all the gold in America. He had to wait until everyone was really scared, of course, but he stole the gold, “compensated” its owners at a terrible exchange rate (which he raised once the payments were made), and did it all with impunity.

The bosses of Cyprus shut down all the banks in their country and seized a good portion of the money in all the country’s bank accounts, the government of Ireland swiped €6.5 billion from their National Pensions Reserve Fund, the French parliament took €36 billion from a reserve pension fund, Hungary took $13.5 billion from retirement accounts, Poland took one-third of future contributions to individual retirement accounts.

The IMF has produced papers proudly suggesting “financial repression” to fix economic problems. And back in August 2010, the US Departments of Labor and the Treasury held joint hearings, deciding how best they could take control of all assets in IRAs and 401(k) accounts.

So, yes, they can, and they do, and they keep blueprints for doing so in the future. That means that diversification is valid only until the next time the pot-holders to dig their hands into your assets. 

What Is To Be Done?

Understand, please, I don’t have any perfect solution to sell you. What I’d like is for people to understand that diversification, applied to the usual portfolio, can and will be rendered void when the lords of finance decide it should be. And at that time there will be very little you can do about it.

Those of you who are concerned about such thing can figure out what is best for you. And note, it will always be less convenient than walking the prescribed path. The smooth, easy and wide path is nearly always one that was built for your fleecing.

We all know the alternatives: Bitcoin, cash, gold, real property, investments in local businesses, and so on. These are alternative market segments, and using them creates an actual diversified portfolio.

So, do what you think is best, but be clear on the fact that all your “diversified” investments are held in the same pot, and that pot is under someone else’s control. When things get serious, the people who control that pot will use it as they see fit, not as you see fit.

Maybe that won’t happen for another decade or two. Maybe it will happen next year. Seeing the future is difficult. But seeing the fact that all your money rests in someone else’s hands isn’t too hard.


If you want a deeper understanding of these issues, see:

          FMP issue #7

          Parallel Society #4

          The Breaking Dawn

Who Will Be the Last to Crash?

lasttocrashThis is the question that astute investors are forced to ask themselves these days. No reasonable person believes that a system of ever-expanding debt can resolve painlessly. It simply cannot happen… not, at least, until 2+2 stops equaling four.

But the international money system, while deeply interconnected, can implode in sections. In fact, it’s highly unlikely that it will crash as a single unit.

So, if you have significant moneys to invest, you end up coming back to our question: Who will be the last to crash? Once you decide that, you can concentrate your assets in that place, hoping to come through the crash with at least most of your value intact.

Let’s look at several aspects of this:

#1: Background statistics:

  • World debt is upwards of $200 trillion, and growing steadily. World GDP is $70-some trillion, only about a third of the debt. This debt will not be paid back. Massive amounts of debt will have to be written off in losses.

  • US debt is north of $18 trillion. (Amazingly, *cough*, it hasn’t changed in months *cough*.) Forward promises are north of $200 trillion, meaning that a child born today is responsible to repay $625,000. And since roughly half the US population pays no income tax… and presuming that this newborn will be a member of the productive half… he or she is born $1.25 million in debt. Such repayments will never happen. Most of those debts will not be repaid.

  • Japan is worse off than the US. The UK is bad. Many EU countries are worse.

These numbers, by the way, are ignoring more than a quadrillion dollars of derivatives and lots of other monkey business. (Rehypothecation, *cough*, *cough*.)

#2: No one wants to rock the boat.

Informed men and women understand that the entire system is unstable. Probably a majority of them are simply hoping that it holds together until they die. A few dream that magical new inventions will kick-start the system into a new orgy of debt, blowing an even larger super-bubble that lasts through their hopefully longer lifetimes.

But informed people also know that the system stands almost wholly upon confidence. If the sheep get scared enough to run away, the whole thing ends… and no one is ready for it to end.

So, heavy investors speak in soothing tones. They don’t want to spook the masses.

#3: We’ve already had warning shots.

Last year, the International Monetary Fund (IMF) published a horrifying paper, called The Fund’s Lending Framework and Sovereign Debt. That paper, in turn, was based upon one from December of 2013, called Financial and Sovereign Debt Crises: Some Lessons Learned and Those Forgotten.

The December 2013 document, right at the start, says that “financial repression” is necessary. Here’s what it says (emphasis mine):

The claim is that advanced countries do not need to resort to the standard toolkit of emerging markets, including debt restructurings and conversions, higher inflation, capital controls and other forms of financial repression… [T]his claim is at odds with the historical track record of most advanced economies, where debt restructuring or conversions, financial repression, and a tolerance for higher inflation, or a combination of these were an integral part of the resolution of significant past debt overhangs.

So, in order to fix debt overhangs – currently at horrifying levels – financial repression is not just an option, but required.

And of course, they’ve already had a trial run, when they stole funds directly from individual bank accounts in Cyprus.

The IMF report goes on to say:

[G]overnments can stuff debt into local pension funds and insurance companies, forcing them through regulation to accept far lower rates of return than they might otherwise demand.

[D]omestic defaults, restructurings, or conversions are particularly difficult to document and can sometimes be disguised as “voluntary.”

We have a pretty good idea of what’s coming down the pike.

But again, Goldman’s Muppets are not to be told about this. And truthfully, most of them don’t want to know.

#4: We have no view of what’s happening in the back rooms.

People make large bets on what Janet Yellen and the Fed will decide next, but when we do that, we overlook something very important:

Yellen is merely an employee of the Federal Reserve, not an owner. And we don’t know who the owners are.

We do know that the Fed is owned by private banks, and that it has a monopoly on the creation of US currency, but we really don’t know who owns the shares. The true owners are almost certainly reflected in the roster of primary dealers, who skim Federal Reserve units as they’re being made, but we don’t know much more than that.


Who are the people that Yellen takes orders from?

What do these people want?

What are their long-term positions?

Who might they protect, aside from themselves?

We don’t have real answers to any of these questions. From our perspective, the guts of the machine are hidden behind a curtain.

#5: The US is playing to win.

One thing we do know is that the US has a strong hand. Within a general deflationary situation, the Fed can print away. And they’re propping up the US markets quite well… for now.

Feeling their power (after all, they can blow up more stuff than anyone else!), the US is throwing their weight around, forcing nearly every bank in the world to play by their rules. (Think FATCA and fining foreign banks.) And for the moment, it is working.

Bullying everyone else over the long term may, however, not be viable. No one – especially people like Putin and the Chinese bosses – likes to be slapped around in public. And they are not powerless.

Conclusion: Most Bets Are on the US

Europe isn’t looking good. Japan isn’t looking good. The UK is holding, but as mentioned above, its numbers are horrible. Switzerland seems to be in-between strategies. China has problems. Russia has problems. The BRICS have never been stable.

That leaves the US. My impression is that most serious investors would rather hold dollars than yen or euros; most big businesses too. Their bets are on that the US will crash last.

So, are the Fed and the US Treasury doing this intentionally? Are they quietly pulling the pins out from under the others, making sure that they’ll be the last currency standing? I have no inside information, but I’d bet on it.

Remember, the gang on the Potomac has most Americans believing that whatever they do overseas is pure and holy. Furthermore, 99% of their serfs will reflexively obey any order they give. So, why shouldn’t they play dirty? They have the best bombs and a somnambulant public.

For now.

Paul Rosenberg