Reprinted from Mises.org
[The Dao of Capital: Austrian Investing in a Distorted World. By Mark Spitznagel. Wiley Press, 2013.]
The economy is extremely complex. As Leonard Read taught, no single individual in the world knows how to make something as simple as a pencil. The level of complexity has only increased over time with the expansion of knowledge, technology, transportation, and international trade. Our individual labor is increasingly focused on a narrower slice of the overall process of production.
Even the static picture, if it could be seen, is complicated by the fact that our world is a work in progress dating back thousands of years. Look around you and you will see the savings, investments, and work of individuals who are long dead. Previous generations made their choices, some of which have been maintained, repurposed, neglected, or destroyed. Ownership of all that capital is recognized in the form of stocks, bonds, titles, and deeds.
Austrian economics teaches that understanding the “economy” can only be undertaken with the aid of economic theory. There is no formula or equation for understanding the economy. It cannot be measured in any meaningful scientific way. Only the logical construction of cause and effect aid us. A simple example of this is when John trades his three apples to Mary for her three oranges because both John and Mary think they would be better off from doing so.
Mark Spitznagel, a hedge fund manager, tries to take economic theory, specifically Austrian economic theory, and breathe life into understanding how the economy works and why it sometimes doesn’t. In his book, The Dao of Capital: Austrian Investing in a Distorted World, he uses these insights to explain the process of investment that he uses.
The title refers to the paradoxical Chinese philosophy of Daoism. In this philosophy, in order to achieve your goal you must do the opposite, or Shi. For example: “turn right in order to go left.” This is used, ultimately, to underscore the roundaboutness of the market process, where production processes become increasingly more complex in order to become more productive. In investing, for Spitznagel, it means to step back and take small losses in preparation for making larger gains, a variation of “value investing,” where you must keep your vision of the future as one of a process that takes place over time.
As a young trader in the bond pit at the Chicago Board of Trade, the author was lucky enough to come across Hazlitt’s Economics in One Lesson and Mises’sHuman Action. He found in these books a theoretical explanation for the otherwise perplexing world of primary markets at the Chicago Board of Trade. He later partnered with Nassim Taleb of Black Swan fame and later still opened his own firm to employ his concept of “Austrian Investing.”
Spitznagel begins with the metaphor of the forest and the trees. Briefly put, conifers cannot compete with hardwood trees on the fertile plains so they retreat to higher ground that is less fertile and more intemperate where they can outcompete the hardwoods. Here they thrive under harsh conditions, even battling glaciers of various ice ages. This is an illustration of competition and comparative advantage in nature.
Fire plays a role in the competition between conifers and hardwoods, serving to clear small areas with dense underbrush free for new competitions among seedlings. This ebb and flow between conifers and hardwoods shows how apparent losses from fire can lead to strength and an overall growth in productivity. In the economy, firms go bankrupt, products are displaced, and new production processes emerge over time.
In a similar manner, he shows how fire-suppression policies of the government are like government intervention in the economy. Fire-suppression policy aims to put out most forest fires as soon as possible. This can lead to too much underbrush so that fires can become catastrophic is scope. This is an illustration from nature of the havoc caused by government intervention meddling in nature’s competition. In the economy, the government’s central bank can try to suppress recessions and deflation, but this can result in catastrophic depressions, like the Great Depression. As Rothbard showed in his America’s Great Depression, President Hoover’s interventions to suppress deflation and depression only made things worse.
In chapter 3, “Shi: The Intertemporal Strategy,” the insights of the famous military philosophers Sun Tzu and Carl von Clausewitz are discussed in support of the Daoist concept of Shi. This is the concept of strategic advantage in war where you do not hurl your troops headlong directly at enemy positions for an immediate victory. Rather, you conserve your troops and resources and take advantage of points with defensive and strategic advantages in a more roundabout approach to final victory. Military history has confirmed the wisdom of this approach from the battlefields of the American Civil War to the more recent guerilla wars fought against the modern empires of the United States and the Soviet Union. As applied to investment, this discussion is meant to make the reader prepared and even eager to take small losses in order to achieve the ultimate goal of growing your wealth into the future.
Normally, I do not like examples from nature and war to serve as illustrations of the benefits of roundaboutness of production, preservation of capital, and competition, but I will admit that in this case they are effective.
The book takes us on a trip through time to explore the character, history, and contributions of the Austrian economists. He begins with Frédéric Bastiat (the seen and unseen), and moves onto J. B. Say (entrepreneurship), Carl Menger (marginal utility and price formation), Eugen Böhm-Bawerk (roundabout production and interest), and even Henry Ford (the assembly line as an example of roundabout production). This is followed by a fascinating discussion of the critical role of time preference in life before he turns his attention to Ludwig von Mises (monetary and business cycle theories and the market as a process). According to Spitznagel, Mises was “perhaps the greatest economist of all time.”
Since I am not an investment expert, I will not comment on the chapters on investing or the author’s tweaks of Austrian economics that try to bring Austrian economic theory closer to the understanding of reality for the non-economist. However, I applaud the book as a look into the thinking process of a great investor, especially one that has a clear and consistent understanding of the market process, the dangers of government intervention, and the benefits of Austrian economics.