The Dao of Capital: Austrian Investing in a Distorted World

by Mark Spitznagel

When the feedback loop is short-circuited by distortion and manipulation, rather than the system being one that cancels out its errors, it is transformed into one that even magnifies them, such that the errors of inappropriate, unhealthy growth take over the system.

The market does not just bob around, rudderless. It is the flock of birds that appears to swoop and dive aimlessly, while hidden within its cascading members are the navigators themselves.

the knowledge of capitalistic investing as an intertemporal process.

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.

Homeostasis is the process of how things “go right.”

homeostasis recalls shi—the propensity of all systems to restore balance through self-righting movements that in a natural world are no more disruptive than ripples on a pond.

The fire, therefore, is not merely destructive, but must be viewed as a catharsis, a cleansing process—an agent of creative destruction, to borrow a term from the Austrians—and part of the cybernetic control and communication within the system to return the forest to homeostatic balance.

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.”

In nature, as in the economy, there must be a free transfer of resources between higher-order and lower-order production.

Investment cannot exceed savings any more than seeding in the forest can exceed land, nutrients, water, and sunlight—but under these interventions, the system acts as if that’s what is happening. This is what makes the boom so delusive and ultimately illusory.

Suppression of the market’s natural homeostatic tendencies—such as proclaiming things to be “too big to fail” or by cutting interest rates when the stock market takes a dive—only make things worse by artificially propping up assets that should be allowed to fail, and free up resources for another, perhaps more productive attempt.

Monetary policy insidiously plays with our time preferences and our very ability to engage in economic calculation. The greater the distortion, the greater destruction needed to correct

Cybernetics focuses on the role of servomechanisms (or “servos” as they are called) that regulate systems through the detection of errors and the responsive use of feedback (specifically, negative feedback that tells a system when it is out of balance, and by how much, in order to correct).

Feedback is crucial, and must be continuously given by and within the system in order to make the necessary, typically small corrections to keep on course.

The concept of “control by information feedback” makes intuitive sense; in order to operate in an environment, one must have input from it and thus make continuous adjustments to compensate for certain conditions or changes in conditions. Each movement is a return to balance in the moment, never expected to be permanent, but to last until the next shift or turn of the wheel is required.

We might also think of balance sought in the homeostatic process in terms of the “basin of attraction,” a scientific concept best illustrated by the traditional shi image of the boulder that is pushed up the steep grade of a hill, only to fall back down to the bottom of the valley. Similarly, when a system is perturbed, forces push it back to the balance of the basin. This is precisely what happens on an infinitesimal scale as a natural market is perturbed by changing time preferences and innovations.

the cybernetic strategy of steermanship: Don’t overcontrol, don’t overgrip, but rather let the system make its mistakes, and then opportunistically bring it back—wei wuwei.

Within the economy, as Hayek stated, the “mutual adjustments” of individual participants occur through negative feedback.

a positive feedback system is actually contrary to the way markets naturally work. In fact, they become positive feedback systems (temporarily) only when they are distorted; the tendency to see only positive feedback processes and thus assume imitation-like strategies (of momentum, carry, etc.)—a simple extrapolation of the seen—is an obvious consequence of our natural shallow depth of field further compressed by the spell of artificially low rates.

A properly functioning market priduces only negative feedback. A broken market produces positive feedback.

Within the cybernetic feedback loop, the detection of “entropy” (the amount of disorganization that exists) forces the system to maintain its structure, in order to avoid a breakdown from disorder.

in a natural economy, rising interest rates are a brake on roundaboutness (and, bizarrely, as per the “capital consumption” discussed in Chapter 7, so too are artificially lowered rates); when rates are higher, it becomes more costly to accumulate a deeper and longer capital structure.

Interest rates

one of the consequences of lower rates is to make us exceedingly unsatisfied with waiting right now (as the lower rate is below what we intrinsically require for waiting—particularly in the immediate). Thus we are “trapped” into grabbing the immediate marshmallows, regardless of and ignoring relatively more abundant marshmallows off in the future.

even a parallel shift of the entire yield curve downward can give more of an artificial stimulus to existing assets with a quick turnaround (such as a quick momentum trade, or a quick dividend), even though normal accounting would make us think the long-term projects would see the biggest jump in demand. Disorder reigns.

The paradox of low rates. They cause shortsighted behavior and not long term.

“Basically, the insight that prices were signals bringing about the unforeseen coordination of the efforts of thousands of individuals was in a sense the modern cybernetics theory, and it became the leading idea behind my work.”12 Hayek gave

order results automatically when things are left alone, an idea that was later developed by Hayek in the twentieth century.

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.

Even the infamous “tulip mania” of 1630—considered the greatest bubble in history—when Hollanders were gripped in a craze of speculation over tulip bulbs, was caused by monetary distortion, even though there was no central bank behind the scenes. At the time, the Netherlands had a “free coinage” policy that allowed those who had silver and gold bullion from the Americas to mint their own coins. By 1630, a large increase in the supply of coins and bullion in Amsterdam far exceeded the market demand, and led to malinvestment and speculation.19

it grows from unhealthy sprouts doomed at their start from a temporary deception, a miscommunication and failure of control within the cybernetic machine.

A recession isn’t simply some stroke of dumb luck, in which people have failed to spend enough; it is characterized by physical distortions in the structure of production. Racking up more government debt is hardly the cure to inadequate saving and physical investment.

As we orient everything to shi, we automatically keep to the roundabout path, refusing to be led astray by distorted perceptions in a world that focuses only on today, as if it is all that matters—indeed, all there is.

To embrace The Dao of Capital, we purposefully and intentionally raise our sights and deepen our field of focus to see that today is but one unit—a single bead in a long strand. We refuse the blinders of myopic time inconsistency, while being well aware that much of the world can see only this way.

we look to our array of shi masters who were able to wait with the cunning patience of the manipulative sage to accrue strategic advantage.

patience as self-inflicted agony, while letting one’s opponent gloat over racked-up points and small victories in the moment.

the reward of being purposefully and intentionally circuitous—to be shi until strategic advantage coalesces into the opportunistic action of li within shi—can be found in the single pinecone loaded with seeds for dispersal on fire-cleared land, the loaded crossbow trained at last on the intended target, and the accumulation of productive capital to advance material society.

Perpetual reversion is the way of the world; no matter how distortion subverts the natural process, in the end it cannot be prevented.

we will be confronted with temptations that could lead us into all sorts of evils, from leverage to blithely following the positive-feedback crowd into the illusion of distorted assets.

you needn’t chase the immediately seen over what should be foreseen.

You can stay true to shi, the roundabout, in its various guises, and wait for the return to homeostasis that will prevail even in the midst of pervasive distortion.

We ask ourselves: How are we exposed to malinvestment? Are we, for instance, investing in what is most manipulated by, whose profitability is most dependent upon, artificially low interest rates? Beyond avoiding it, can we perhaps even benefit from it?

much of the visible is a distraction from a hidden reality, cautioning us not to “learn” from and thus be fooled by data—and moreover by what comes first, the seen;

the roundaboutness of Henry Ford for whom years of developing methods and constructing tools were followed by only minutes in production (sometimes reduced to seconds)—the former were the means to the latter.

Savers and investors, dissatisfied with artificially low interest rates that don’t reflect their actual time preferences, placate themselves by eking out yield and otherwise chasing immediate returns

The lower rates make otherwise marginal investment schemes look good, and otherwise marginal existing capital (having marginal returns) look suddenly profitable, resulting in a scramble to own it and resulting in persistent market maladjustments. The system becomes starved of capital for roundabout production, as capital is trapped in the present—consuming itself, as it were—and thus there are insufficient resources to support the ongoing illusion of economic progress.

Distorting loop of artificially low rates

When, in Mises’s words, “the airy castle of the boom”2 can no longer buttress itself, and either rates rise from higher factor prices or from exhausted credit, it collapses on itself in a mass liquidation of malinvestment—a stock market crash, the homeostatic process en force.

Much to the chagrin of the meddling central bankers, only the stock market is reliably affected (and only for a time) by monetary interventionism.

What a financially distorted world tells us is that the market, just like the overgrown forest, carries within it the seeds of its destructive correction; thus the inevitable bust that follows the boom is not (or at least should not be) an unexpected event.

The objective of roundabout Austrian Investing is not to find a way to make money now, but to position ourselves for better investment opportunities later.

Hyperbolic discounting requires enduring a difficult wait, which is most intense in the earliest steps—from today until tomorrow, from tomorrow to the day after, and so forth. We perceive that the wait will get easier with each step, but that doesn’t help us over the next step, particularly if interest rates have been manipulated all the way down to zero and everyone is piling into the stock market.

our sense of immediacy is made all the more acute, paradoxically, by monetary distortion—feeding an ever-shortening investment horizon.

We, too, need to distance ourselves from the distortion, so that we do not become suckered in by it, which will lead to the opposite of what we intend: buying when the MS index is high and selling as it falls, which—rather than the roundabout path to capital accumulation—is the direct path to capital destruction.