The Dao of Capital: Austrian Investing in a Distorted World

by Mark Spitznagel

It is the very nature of economics as a social science that requires the logical, deductive, a priori approach of praxeology, the term Mises used for the scientific study of human action.

Mises gave the post-war world the unshakeable bedrock of the praxeological nature of economics, explainable only in the context of the subjective actions and behaviors of humans. Mises, the scholar and teacher, took pains that others might understand (though, sadly, much of the world refused to listen).

What critics of the Austrians fail to appreciate is the importance of the idea, as highlighted in the title of Mises’s book, that economics is undeniably the study of human action, which is highly subjective and cannot be reduced to data points and mathematical models.

What remains most important, as discussed in Chapter 4, is that economics cannot be considered positivist (empirical) because there are no constants in human action, the way there are in the natural sciences (such as the charge on an electron, and so forth).

The market facilitates the vital control and communication within the system—a grand homeostatic process.

Keep in mind that when Mises spoke of the perverse effects of inflation, he referred to artificial expansion of bank credit, and hence the total quantity of money in the economy. He did not mean the rise of a price index of some basket of consumer goods, which is what most economists and analysts think of today with the word “inflation.”

The longer the boom lasts, egged on by accommodative central bank policy—and the more distorted the capital structure becomes—the worse the ensuing crash.

In its natural state, a system—from a forest to a market—achieves balance through internal governance and guidance, which depend upon the system’s own ability to internally communicate and react to changing conditions due to the interactions of a variety of players, whether buyers and sellers in a marketplace, trees and herbivorous predators (especially fire) in the forest, or entrepreneurs deciding when and how to become ever more roundabout to meet the ultimate demands of consumers. Within the system, errors will occur and resources will need to be reshuffled; as such, there will be isolated, individual failures, whether we are dealing with forests or factories, banks or bakeries. The process will take care of itself as long as there is integrity within the feedback loop and accurate (nonmanipulated) information is allowed to flow, resulting in a suitable mix and magnitude of growth, given the available resources—whether savings for investment, or sunlight and soil for trees. However, attempts to intervene and manage such systems typically end in a paradox whereby the very opposite of an intended result is achieved; instead of order and balance there is distortion that leads, ultimately, to destruction.

what is not controversial is the notion that capitalism—with private property and free markets—serves as an exceptional institution to mobilize the localized information that is dispersed among many different individuals, each with admittedly subjective goals.

They cannot see the forest because they are trying to save each individual and immediate tree, and in so doing lose all depth of field and of focus on the generations of trees and the intertemporal search for their mix and magnitude of growth within the forest to come. All too often, particularly today, the focus is only on the shocks and fires with a desire to control and prevent. The desire is to interfere and, perhaps innocently, override the system’s natural governors that maintain balance; in so doing, things are made so much worse. We have thus succumbed to a blind faith in bureaucratic authority over natural processes.

As Murray Rothbard would say, the fire “is the ‘recovery’ process,” and, “far from being an evil scourge, is the necessary and beneficial return” of the forest to “optimum efficiency.”

Paradoxical, yes, but forestry practices of old that have regained respect of late underscore the importance of letting small fires burn in order to manage the forest, and to prevent the bigger ones that inevitably and cruelly result from attempts to stop fire. Suppression now undeniably leads to greater destruction later on—once again our “bad economists”

The disastrous Yellowstone fire of 1988 leads to the conclusion that 100 years of fire suppression—a zero-tolerance approach to stamp out even naturally occurring, low-intensity blazes—had made the forest dangerously prone to catastrophe. It becomes clear, then, that low-intensity blazes marshal the resources and oversee an orderly succession in the homeostatic forest, as evident in patterns of heterogeneity—conifers here and angiosperms there. The back and forth of a forest system seeking equilibrium avoids the dangerous overgrowth caused by everything trying to thrive all at once—extracting resources for survival now, foregoing the roundabout strategy. In nature, as in the economy, there must be a free transfer of resources between higher-order and lower-order production.

In its actions in the 1980s, the Federal Reserve telegraphed to the world that it would no longer tolerate fires of any size—which heralded the birth of the “Greenspan put.”

Here, we encounter the profound paradox that government interventions systematically achieve the very opposite of their intended goals. So governments, unlike entrepreneurs, try as they might and despite perhaps good intentions (I’ll give the Paul Krugmans of the world the benefit of the doubt), simply cannot achieve their intended outcomes by interfering with the operation of the system. (They cannot act teleologically, as it were.) Governments and central banks undermine the natural homeostatic process by short-circuiting the governors and adaptive teleological processes in the system.

Instead of functioning as instruments of information, signaling to entrepreneurs how and when best to serve consumers, interest rates are perpetually manipulated by central bank actions to the point of meaninglessness.

Spontaneous order may be thought of as the order that emerges from the interaction of disparate acting agents, in a bottom-up dynamic that emphasizes the role of the individual—not the top-down control of, for instance, state intervention. To specifically reference this internal regulation, Hayek even coined a term, “catallaxy,” to replace the word “economy.” Thus, spontaneous order might be viewed as haphazardly designed though purposeful organization out of what appears to be highly disorganized—the order in the flock, or the ant colony (of Douglas Hofstadter) whose hidden social coordination is like that of neurons creating a coherent mind.17

Spontaneous order is interrupted (and as we have seen, often perilously) by top-town control from intervention to full-on socialism. In a system as complex as the market such attempts at outside, artificial control are doomed to fail. As we know, roundabout production requires the ambiguous and uncertain focus on a future advantage—shi. However, the distortions of interventionism paradoxically morph that into a focus on quick and decisive outcomes—li.

No matter how noble such measures might sound on their own—particularly in the bloody aftermath of a crisis, as if the government were handing out tourniquets—these interventionist actions (like the fire suppression in the forest) only prolong the problem and postpone the restoration of health to the forest.

The ultimate end for the Austrian investor is the same as for any other investor: profit. Yet the means are entirely different; here, they are the central focus. The Austrian investor doesn’t lunge in li fashion immediately for the goal; he doesn’t set out directly to find firms with immediately rising profitability, or firms to hold while others also pile in immediately, or firms with immediate dividend yields, or even underpriced firms per se. Rather, his first task is to find highly roundabout, productive firms—ones with high ROIC—that possess the circuitous means of economic profit. Then, to these Siegfrieds he applies a second filter, or screen, and looks for firms with a low Faustmann ratio. This two-pronged approach would strike most investors as quixotic, simplistic, and even contradictory. By this point in the book, though, the reader should understand that such a commonplace attitude is precisely what will deliver remarkable rewards to the roundabout Austrian investor.

the vast majority of investors encounter a hungry Robinson Crusoe whom they see is catching fewer fish, which seems to make his operation unattractive, and they want no part of it. However, the savvy minority of investors—appreciating Austrian insights—can see beneath the surface, and recognize when Crusoe is hungry not because of sloth or ineptitude, but because he is currently investing his resources into building a boat and a net. The Austrian investor sees the fish jumping offshore, and realizes that Crusoe’s inability to catch them is merely a temporary condition, as Crusoe is preparing himself for the big catch further downstream.

Austrian Investing I and II should both sound somewhat reminiscent of what has come to be known as value investing. Indeed, Austrian Investing can be seen as value investing’s intellectual forerunner, not only drawing on insights older than value investing but, more significantly, providing clarity and focus to its underpinnings and ultimate systematic source of return.

“Many shall be restored that now are fallen and many shall fall that now are in honor.”