The Dao of Capital

Austrian Investing in a Distorted World

Mark Spitznagel

• Publisher: Wiley
• Year: 2013
• ISBN:
  9781118416679
• Edition: 1
• Topic: Business
• Subtopic: Finance
• Index: Business

As today's preeminent doomsday investor Mark Spitznagel describes his Daoist and roundabout investment approach, "one gains by losing and loses by gaining." This is Austrian Investing, an archetypal, counterintuitive, and proven approach, gleaned from the 150-year-old Austrian School of economics, that is both timeless and exceedingly timely.

In The Dao of Capital, hedge fund manager and tail-hedging pioneer Mark Spitznagel—with one of the top returns on capital of the financial crisis, as well as over a career—takes us on a gripping, circuitous journey from the Chicago trading pits, over the coniferous boreal forests and canonical strategists from Warring States China to Napoleonic Europe to burgeoning industrial America, to the great economic thinkers of late 19th century Austria. We arrive at his central investment methodology of Austrian Investing, where victory comes not from waging the immediate decisive battle, but rather from the roundabout approach of seeking the intermediate positional advantage (what he calls shi ), of aiming at the indirect means rather than directly at the ends. The monumental challenge is in seeing time differently, in a whole new intertemporal dimension, one that is so contrary to our wiring.

Spitznagel is the first to condense the theories of Ludwig von Mises and his Austrian School of economics into a cohesive and—as Spitznagel has shown—highly effective investment methodology. From identifying the monetary distortions and non-randomness of stock market routs (Spitznagel's bread and butter) to scorned highly-productive assets, in Ron Paul's words from the foreword, Spitznagel "brings Austrian economics from the ivory tower to the investment portfolio."

The Dao of Capital provides a rare and accessible look through the lens of one of today's great investors to discover a profound harmony with the market process—a harmony that is so essential today.

Chapter One

The Daoist Sage

Klipp’s Paradox

“You’ve got to love to lose money, hate to make money, love to lose money, hate to make money. . . . But we are human beings, we love to make money, hate to lose money. So we must overcome that humanness about us.”

This is “Klipp’s Paradox”—repeated countless times by a sage old Chicago grain trader named Everett Klipp, and through which I first happened upon an archetypal investment approach, one that I would quickly make my own. This is the roundabout approach (what we will later call shi and Umweg, and ultimately Austrian Investing), indeed central to the very message of this book: Rather than pursue the direct route of immediate gain, we will seek the difficult and roundabout route of immediate loss, an intermediate step which begets an advantage for greater potential gain.

This is the age-old strategy of the military general and of the entrepreneur—of the destroyer and of the very creator of civilizations. It is, in fact, the logic of organic efficacious growth in our world. But when it is hastened or forced, it is ruined.

Because of its difficulty it will remain the circuitous road least traveled, so contrary to our wiring, to our perception of time (and virtually impossible on Wall Street). And this is why it is ultimately so effective. Yet, it is well within the capability of investors who are willing to change their thinking, to overcome that humanness about them, and follow The Dao of Capital.

How do we resolve this paradox? How is it that the detour could be somehow more effective than the direct route, that going right could be somehow the most effective way to go left? Is this merely meant to confuse; empty words meant to sound wise? Or does it conceal some universal truth?

The answers demand a deep reconsideration of time and how we perceive it. We must change dimensions, from the immediate to the intermediate, from the atemporal to the intertemporal. It requires a resolute, forward-looking orientation away from what is happening now, what can be seen, to what is to come, what cannot yet be seen. I will call this new perspective our depth of field (using the optics term in the temporal rather than the spatial), our ability to sharply perceive a long span of forward moments.

This is not about a shift in thinking from the short term to the long term, as some might suppose. Long term is something of a cliché, and often even internally inconsistent: Acting for the long term generally entails an immediate commitment, based on an immediate view of the available opportunity set, and waiting an extended period of time for the result—often without due consideration to or differentiation between intertemporal opportunities that may emerge during that extended period of time. (Moreover, saying that one is acting long term is very often a rationalization used to justify something that is currently not working out as planned.) Long term is telescopic, short term is myopic; depth of field retains focus between the two. So let’s not think long term or short term. As Klipp’s Paradox requires, let’s think of time entirely differently, as intertemporal, comprised of a series of coordinated “now” moments, each providing for the next, one after the other, like a great piece of music, or beads on a string.

We can further peel away Klipp’s Paradox to reveal a deeper paradox, at the very core of much of humanity’s most seminal thought. Although Klipp did not know it, his paradox reached back in time more than two and a half millennia to a far distant age and culture, as the essential theme of the Laozi (known later as the Daodejing, but I will refer to it by its original title, after its purported author), an ancient political and military treatise, and the original text and summa of the Chinese philosophy of Daoism.

To the Laozi, the best path to anything lay through its opposite: One gains by losing and loses by gaining; victory comes not from waging the one decisive battle, but from the roundabout approach of waiting and preparing now in order to gain a greater advantage later. The Laozi professes a fundamental and universal process of succession and alternation between poles, between imbalance and balance; within every condition lies its opposite. “This is what is called the subtle within what is evident. The soft and weak vanquish the hard and strong.”1

To both Klipp and the Laozi, time is not exogenous, but is an endogenous, primary factor of things—and patience the most precious treasure. Indeed, Klipp was the Daoist sage, with a simple archetypal message that encapsulated how he survived and thrived for more than five decades in the perilous futures markets of the Chicago Board of Trade.

THE OLD MASTER

Daoism emerged in ancient China during a time of heavy conflict and upheaval, nearly two centuries of warfare, from 403 to 221 BCE, known as the Warring States Period, when the central Chinese plains became killing fields awash in blood and tears. This was also a time of advancement in military techniques, strategy, and technology, such as efficient troop formations and the introduction of the cavalry and the standard-issue crossbow. With these new tools, armies breached walled cities and stormed over borders. War and death became a way of life; entire cities were often wiped out even after surrender,2 and mothers who gave birth to sons never expected them to reach adulthood.3

The Warring States Period was also a formative phase in ancient Chinese civilization, when philosophical diversity flourished, what the Daoist scholar Zhuangzi termed “the doctrines of the hundred schools”; from this fertile age sprung illustrious Daoist texts such as the Laozi and the Sunzi, the former the most recognized from ancient China and one of the best known throughout the world today. Its attributed author, translated as “Master Lao” or “The Old Master,” may or may not have even existed, and may have been one person or even a succession of contributors over time.

According to tradition, Laozi was the keeper of archival records for the ruling dynasty in the sixth century BCE, although some scholars and sinologists maintain that the Old Master emanated from the fourth century BCE. We know from legend that he was considered to have been a senior contemporary of Kongzi (Confucius), who lived from 551 to 479 BCE, and who was said to have consulted Laozi and (despite being ridiculed by Laozi as arrogant) praised him as “a dragon riding on the winds and clouds.”4 Furthermore, written forms of the Laozi, which scribes put down on bamboo scrolls (mostly for military strategists who advised feuding warlords), are likely to have been derivatives of an earlier oral tradition (as most of it is rhymed). Whether truth or legend, flesh and bones or quintessential myth, one person or many over time, the Old Master relinquished an enduring, timeless, and universal wisdom.

To most people, it seems, the Laozi is an overwhelmingly religious and even mystical text, and this interpretive bias has perhaps done it a disservice; in fact, the term “Laoism” has been used historically to distinguish the philosophical Laozi from the later religious Daoism. Recently, new and important translations have emerged, following the unearthing of archeological finds at Mawangdui in 1973 and Guodian in 1993 (which amounted to strips of silk and fragments of bamboo scrolls), providing evidence of its origins as a philosophical text5—not mystical, but imminently practical. And this practicality relates particularly to strategies of conflict (specifically political and military, the themes of its day), a way of gaining advantage without coercion or the always decisive head-on clash of opposing forces. The Dao of Capital stays true to these roots.

The Laozi, composed of only 5,000 Chinese characters and 81 chapters as short as verses, outlines the Dao—the way, path, method or “mode of doing a thing,”6 or process toward harmony with the nature of things, with awareness of every step along the way. Sinologists Roger Ames and David Hall describe the Dao as “way-making,” “processional” (what they call the “gerundive”), an intertemporal “focal awareness and field awareness”—a depth of field—by which we exploit the potential that lies within configurations, circumstances, and systems.7

The central concept permeating the Laozi is referred therein as wuwei, which translates literally as “not doing,” but means so much more; rather than passivity, a common misperception, wuwei means noncoercive action—and here we see the overwhelming laissez-faire, libertarian, even anarchistic origins in the Laozi, thought by some to be the very first in world history8 (as in “One should govern a country as one would fry a small fish; leave them alone and do not meddle with their affairs”9—a cardinal Laozi political credo most notably invoked in a State of the Union address by President Ronald Reagan). The Laozi also has been deemed a distinctive form of teleology, one that emphasizes the individual’s self-development free from the intervention of any external force. This leads to the paradox of what has come to be known as wei wuwei (literally “doing/not doing,” or better yet “doing by not doing,” or “do without ado”10). “One loses and again loses / To the point that one does everything noncoercively (wuwei). / One does things noncoercively / And yet nothing goes undone.”11

In wuwei is the importance of waiting on an objective process, of suffering through loss for intertemporal opportunities. From the Laozi, “Who can wait quietly while the mud settles? Who can remain still until the moment of action?”12 It appears as a lesson in humility and tolerance, but, as we wait, we willingly sacrifice the first step for a greater later step. In its highest form, the whole point of waiting is to gain an advantage. Therefore, the apparent humility implied in the process is really a false humility that cloaks the art of manipulation; as French sinologist François Jullien noted, “the sage merges with the manipulator,” who, in Daoist terms, “humbles himself to be in a better position to rise; if he withdraws, he does so to be all the more certainly pulled forward; if he ostensibly drains away his ‘self,’ he does so to impose that ‘self’ all the more imperiously in the future.”13 This is the efficacy of circumvention camouflaged as suppleness. And in this temporal configuration is, in the words of Ames and Hall, the Laozi’s “correlative relationship among antinomies”:14 With false humility we deliberately become soft and weak now in order to be hard and strong later—the very reason that, in the Laozi, “Those who are good at vanquishing their enemies do not join issue.”15

In this sense, the Laozi can simply be seen as a manual on gaining advantage through indirection, or turning the force of an opponent against him, through “excess leading to its opposite.”16

THE SOFT AND WEAK VANQUISH THE HARD AND STRONG

Perhaps the most tangible representation of wuwei can be seen in the interplay of softness and hardness in the Chinese martial art taijiquan—not surprising as it is a direct derivative of the Laozi. According to legend, taijiquan was created by a thirteenth-century Daoist priest, Zhangsanfeng. Cloistered on Wudang Mountain, he observed a clash between a magpie and a serpent, and suddenly fully grasped the Daoist truth of softness overcoming hardness.17 The serpent moved with—indeed, complemented—the magpie, and thus avoided its repeated decisive attacks, allowing the snake to wait for and finally exploit an opening, an imbalance, with a lethal bite to the bird. In this sequential patience, retreating in order to eventually strike, was the Laozi’s profound and unconventional military art:

There is a saying among soldiers:

I dare not make the first move but would rather play the guest;

I dare not advance an inch but would rather withdraw a foot.

This is called marching without appearing to move,

Rolling up your sleeves without showing your arm,

Capturing the enemy without attacking,

Being armed without weapons.18

Like Daoism itself, taijiquan has drifted into the more mystical and new age, but its roots remain in its martial application; this is clear today in the powerful blows of the original Chen style taijiquan form, as still practiced in Chen Village (located in Henan province in central China). According to Chen Xin (among the lineage of the eponymous Chen clan) in his seminal Canon of Chen Family Taiji...