The Dao of Capital: Austrian Investing in a Distorted World

by Mark Spitznagel

The Federal Reserve can intervene in the market and meddle with interest rates, but ultimately cannot escape the immutable nature of free market economics. Politicians may warp a monetary system to their liking but they cannot repeal economic laws that determine the nature of money. As I have said in the past and stand by today, distortion and corruption through monopoly control can benefit the few at the expense of the many for long periods of time, but eventually the irrefutable laws of nature will win. Free choice in the market is the only way economic calculation can come about.

Ironically, there is a consensus in America against government price controls in favor of free markets, until it comes to the most important price of all—the price of time, or interest rates.

Now more than ever, investors need to recognize the distortion in the system, which has reached near unprecedented proportions. Unhealthy growth of assets that would not exist without the deadly fertilizer of intervention is creating a tinderbox that will, in the not so distant future, erupt in massive wildfire.

Chairman Mao knew these words from the Laozi: “If a small country submits to a great country / It can conquer the great country. Therefore those who would conquer must yield / And those who conquer do so because they yield.”

ALll theese chinese concepts remmindd me offmoddern chinas moves against the west

To the Laozi, much of the exterior world is but exterior diversion, much perception is a distraction from a hidden reality—though one which requires diligent attention. It states this most succinctly in “Venture not beyond your doors to know the world / Peer not outside your window to know the way-making. . . . The farther one goes / The less one knows.”

“We see only things, entities, events; we do not directly experience the forces and laws that govern nature.”

Economics in One Lesson is an expansion on the essay, “That Which Is Seen, and That Which Is Not Seen,” by nineteenth-century French economist Frédéric Bastiat

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy.”

Degrees of impatience—what the Austrians call time preference, the singular source, in Mises’s view, of interest rates—in waiting and forgoing immediate profits (or consumption) and even bleeding capital (such as through costly capital expenditures), was a logical part of our humanness

Taken to its logical conclusion, a society’s time preference could not be repudiated, and the actual market rate of interest had to correspond to the underlying fundamental “originary” rate of interest. Any vain attempt to do otherwise, as when market interest rates are artificially set through monetary intervention, would mislead production and would result in an imbalance and distortion in the economy. Over time, forces would grow stronger and stronger to eliminate that imbalance, and would inevitably succeed in violently driving the artificial rate back to its natural level, and thus the scheme would come to a necessary end. This inevitable seeking of balance from an artificial imbalance, this reversion of opposites, was, to Mises, the very source of “the cyclical fluctuations of business,” “the trade cycle,” or, more precisely, the boom and bust cycle

Understanding this process of liquidity is basically about understanding that any market exchange must be perceived as mutually beneficial to both parties.

“Anyone can see the pinecones in the tree. None can see the trees, none can foresee the forest in the pinecone.”

As the Laozi tells us, nature is our greatest teacher; indeed a major Daoist theme, inseparable from the totality of its message, is to observe and learn from nature.

“make hay while the sun shines.”)

Through its adaptive strategy that has allowed it to survive over hundreds of millions of years, the patient and persistent conifer teaches us that it is far better to avoid direct, head-on competition for scarce resources and, instead, to pursue the roundabout path toward an intermediate step that leads to its eventual position of advantage.

The Chiltern-Mt. Pilot National Park in northwestern Victoria, Australia, is home to a diverse mix of wildlife. What drew botany researchers to the park, from 2004 to 2010, was the opportunity to test the slow-seedling hypothesis in a unique laboratory-like environment with two distinct samples: a control group of conifers in a largely homogeneous stand and another comingled group of conifers and angiosperms seeded together. Specifically, botanists studied the interaction between a type of conifer known as callitris, related to cypress trees, and eucalyptus, the angiosperm that populates the park’s extensive forests, both of which had reseeded in the park after a high-intensity fire in 2003. In areas in which seedlings from both species mixed, the callitris clearly lost to its faster-growing eucalyptus neighbors. Callitris seedlings were, on average, shorter and less healthy than the eucalyptus. In addition, seed cones were absent on the shorter callitris seedlings, preventing any propagation. In fact, seed cones were produced by only the tallest callitris, which grew most abundantly where the population was largely uniform, in patches of virtually all conifers except for a few angiosperms.

Conifers, obviously, cannot send their seeds to a specific place; however, their seeds are, in a sense, directed. For example, strong winds generated by wildfires suck the wind-borne seeds from trees on the periphery into the ravaged areas. Serotinous cones that open only after exposure to high heat and flame also provide seed to regenerate growth after a fire. Even the trees’ intermittent seed dumps may be attuned to wildfire occurrences. All these factors point to the logic of nature. Although the conifer is a dominant metaphor in this chapter and throughout the book, in the real world of the forest a universal strategy is at work that makes these trees among the most successful forms of organic life.

These hardy trees have thrived for countless decades, perhaps a century or more, despite rocky soil (we have unearthed huge boulders) and harsh elements, particularly during sometimes long, brutal winters. Each time I see them, I cannot help but admire their tenacity and efficiency, making the most out of conditions that stymie their competitors and, thus, allow these conifers to grow unimpeded.

Samme as eucalypts in australia

As we have seen, it is not that the forest would somehow be better off with only conifers and no angiosperms. Rather, a give and take, a search and discovery process, an adapted alertness to opportunities—and always emanating from the imbalances of states of rest—must be allowed to unfold naturally in order to create the most efficient balance of available resources between them.

Nature’s progress, her secret, is in her depth of field, implied in the roundabout path of the conifer, the directional choices that lead right in order to proceed more effectively left.

Both recognize that not all battles are decisive; rather, it is far better to deploy the roundabout strategy—that which we have discussed thus far—of patiently achieving an intermediate position of advantage, the teleology of efficacious means toward realizing an eventual, final objective.

Chijna today

“To win a hundred victories in a hundred battles is not the highest excellence; the highest excellence is to subdue the enemy’s army without fighting at all.”

Even better, though, in the eyes of Sun Wu is the wise commander who, in recognizing the destructiveness of war, establishes positional advantage and thus uses threat, manipulation, and deterrence to subdue the enemy and convince the opponent to withdraw or surrender without coercion. The commander “takes the enemy’s walled cities without launching an attack, and crushes the enemy’s state without a protracted war”

So important is an understanding of shi that the Pentagon, in reports to Congress just a few years ago on the People’s Republic of China, used shi to explain that country’s “grand strategy” of maintaining balance among competing priorities for sustaining momentum in economic development, and maintaining favorable trends in the security environment within which such development can occur (more evidence that the shi concept can be most confounding).

In the natural world, Bastiat also recognized an order that spoke to him of how markets and exchanges among people should be allowed to function freely, as the superior mechanism by which to pursue satisfaction of one’s wants.

In his view, the primary role of government was to uphold rights to life, liberty, and property, and to prevent injustice.

“In the department of the economy, an act, a habit, an institution, a law, gives birth not only to an effect, but to a series of effects. Of these effects, the first only is immediate; it manifests itself simultaneously with its cause—it is seen. The others unfold in succession—they are not seen: It is well for us if they are foreseen.”

The key is to free oneself from a tyranny of first consequences, overvaluing what comes first at the expense of what inevitably comes later. As Bastiat warned, “The sweeter the fruit of habit is, the more bitter are the consequences.”

he believed simplicity to be the “touchstone of truth.”

(This would also be taken up, for instance, by D’Arcy Thompson in his fascinating 1917 book On Growth and Form, which observed quantitatively consistent physical and mechanical rules of biological growth and evolution.)

Geoff west scale

“I have endeavored to reduce the complex phenomena of human economic activity to the simplest elements that can still be subjected to accurate observation, to apply to these elements the measure corresponding to their nature, and constantly adhering to this measure, to investigate the manner in which the more complex economic phenomena evolve from their elements according to definite principles.”

Galls aw

“the inevitability of the demise of his own Troy,” a pessimism that “consumed all the sharp-sighted Austrians.”

I need to overcome this pessimism

Menger took an entirely different approach that embraced universal economic laws, which he deduced from the law of cause and effect using means-ends reasoning.

Menger and his followers were not opposed to using empirical methods to understand the economy. Their objective, as Mises observed, was “to put economic theory on a sound basis and they were ready to dedicate themselves entirely to this cause.”

Focusing on the actions of the individual is one of the core concepts of Austrian economics, as explained by Menger: “There is no economic phenomenon that does not ultimately find its origin and measure in the economically acting human and his economic deliberations.”4 The Austrians don’t shy from studying complex “macro” phenomena, but the crucial point is that they seek to explain such events by tracing them back to the actions and motivations of the individuals involved.

Complexity

They also provide a good example of the distinctively Austrian flavor of empiricism, whereby experience can yield an understanding of general principles (for example, the advantage of using tools), but not ironclad economic laws.

we can think of technology, innovation, and production as adaptive learning, incremental steps generated by previous steps and that lead to other steps—each of which becomes, teleonomically, like von Baer’s caterpillar’s means to the yet undiscovered ends of the butterfly.

before. However, there are constraints, or brakes, on Produktionsumweg: namely, positive time preference and interest rates. Böhm-Bawerk used his “agio theory” to explain interest as flowing from the generally universal higher valuation placed on present versus future goods (e.g., most people would want a good today versus the same good tomorrow, or in a year’s time). This is true of all goods in general; thus, there is a positive interest rate. This framing of the market phenomenon of interest as a result of subjective preferences was a quintessentially Austrian insight and the heart of the theory that earned Böhm-Bawerk such acclaim.

Important insight for climate change

Although Böhm-Bawerk dealt with financial maturity of timber, discounted cash flows, and other elements of capitalization, there is no evidence that he ever heard of a German forester named Martin Faustmann, who some 40 years before the publication of The Positive Theory of Capital had produced the seminal work on forest economics and formalized the use of opportunity cost and capitalization.

The intertemporal aspect of capital shows that it is heterogeneous—a reality that the Austrian tradition embraces (whereas other economic schools of thought typically treat “capital” as an amorphous homogeneous blob, which allows them to grossly undervalue its importance and its modifications).

Need to undrstabd this better

The economic machine breaks, Ford believed, “because of our ignorance of all the natural laws which regulate economic health,” our mistaken belief that business “can run only so long without smashing.”43 (As we will see in Chapter 8, the economic machine does have natural, internal controls that govern it, and they are undermined and short-circuited by the ignorance of interventionism.)

Moreover, the roundabout route may very well be overlooked because all we tend to see is the final product, the ultimate end—while we are blind to what came before, the remote means to that end.

Chesterton fence

This requires a complete inversion of a behavioral pattern known as time inconsistency (and generally expressed mathematically with a hyperbolic discounting model). This pattern, present in all of us and distorted to extreme and even dangerous levels in the cases of addictions, is to be impatient now, all the while holding fast to the self-delusion of being able to be patient later. (And, of course, when later becomes now, we are just as impatient.) We expect to act very differently through time than we actually do, predictably throwing a wrench in our best-laid plans, especially the more roundabout ones. This phenomenon plagues us, in all aspects of life; not just in financial decisions, but also things such as weight loss, learning a foreign language, catching up with old friends, and so forth.

Our live-for-today culture has been invaded, like a deadly virus, by an insidious attitude that teaches this moment is all that matters just because it is all we see and experience—right now. The symptoms of this affliction can be found in the chronically low savings rate in our culture (ranging from financial to even fresh water, soil, and, of course, forests) and, analogously and most incredibly, governmental fiscal deficits that deviously and increasingly rob future generations—our helpless intergenerational forward selves.

But as we will see, there are tragic and revealing circumstances when the structures that allow for intertemporal thinking and action—curbing our high time preference for “now” and favoring a low time preference for “later”—become lost or damaged. In the worst of scenarios the person is left to drift constantly in the present with nary a thought or ability to grasp or plan for the future.

As the old adage goes, we prefer the “bird in the hand” instead of multiple birds in the bush.

As we might expect, research shows that children and young adults with attention deficit hyperactivity disorder (ADHD) exhibit more pronounced hyperbolic discounting and a stronger preference for immediate rewards than those who do not have the disorder. If we extrapolate these findings, how might they apply to adults who do not have attention deficit disorder (ADD), but experience “pseudo-ADD” because of the pressure of multitasking? Is modernity with its ubiquitous productivity-enhancing technology tools turning us into a society of hyper-hyperbolic discounters?

Research is increasingly showing that a restorative for what I’m calling the shi system is time spent in the woods, particularly in children, for whom exposure to nature seems to mitigate the impact of ADHD (or, as Richard Louv calls it, “Nature Deficit Disorder”).33 By the same token, why wouldn’t leisurely, contemplative exposure to a coniferous forest with its edifying successions over time help to stretch out our time perception?

Our evolutionary struggle has intrinsically been one of overcoming our inherent faulty temporal wiring, and inverting our congenital overvaluation of the present. The roundabout strategy (the shi strategy) has been the very strategy of our species’ overwhelming (though uneven) success.

The fact remains that most people are unable to consistently take the roundabout route because of the mental trip wires that exist in all of us, insidious nooses that drag us back to the current moment and the satisfaction of current desires, the pursuit of pleasure and success now. Therein lies a systematic, universal source of edge to the Austrian Investing approach—perhaps the main takeaway of this chapter. But, as Klipp always said, “This is easy for me to say, very difficult or even impossible for you to do.”