The Dao of Capital

In The Dao of Capital, Mark Spitznagel describes his Daoist and roundabout investment approach, whereby “one gains by losing and loses by gaining.” In this sweeping tour de force of economics and strategic thinking, he presents 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.

Spitznagel—hedge fund manager and tail-hedging pioneer, with one of the top returns on capital of the financial crisis, as well as over a career—takes the reader 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. The destination is Spitznagel’s central investment methodology—Austrian Investing—where victory comes not from waging the immediate decisive battle, but rather from the roundabout approach of seeking the intermediate positional advantage, 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 the Austrian economic tradition into a cohesive and highly effective investment methodology. From identifying the monetary distortions and non-randomness of stock market routs (Spitznagel’s bread and butter) to highly productive assets, Spitznagel—in Ron Paul’s words from the Foreword—“brings Austrian economics from the ivory tower to the investment portfolio.”

Chapter One: The Daoist Sage is available online by clicking here.

Pit Traders, Pinecones and the Paradoxical Shi

The Dao of Capital begins with Spitznagel’s reminiscences from the Chicago Board of Trade where, as a pit trader under the careful tutelage of a wise old grain trader named Everett Klipp, he was introduced to the market process, with teachings that unknowingly echoed the ancient wisdom of the Daoists and the seminal book known as the Laozi (or Daodejing). From there, in Chapter 2, the book moves to the natural world and central pedagogy that builds on nature’s strategy and logic of productive and opportunistic growth. The leitmotif of the conifer illustrates the roundabout in the growth patterns of individual trees (slow at first and then accelerating), as well as intergenerationally (trees that grow in rocky, inhospitable places later disperse their seeds to take root in fertile areas cleared by wildfire).

The strategy of the conifers was also evident in history’s canonical military strategists, as explained in Chapter 3, starting with Sun Wu (Master Sun), whose often superficially quoted teachings in the Sunzi provide us with the core concept of shi, which has multiple meanings but can be thought of as strategic positional advantage.

The same thinking is also found within Vom Kriege (On War), the often-misinterpreted writings of Carl von Clausewitz, who advocated going for the means of key strategic points at which to weaken the enemy and thus better achieve the final objectives of victory and peace.

Enter the Austrians

In Chapter 4, Spitznagel delves more deeply into roundabout strategic thinking with a discussion of those who fought ideological battles: proto-Austrian Frédéric Bastiat, who challenged the Marxists and gave us the seen and the foreseen, and Austrian School founder Carl Menger, who took an a priorist stance as he jousted with the German Historicists. From Menger, the book moves in Chapter 5 to the man who put the Austrian School on the map: Eugen von Böhm-Bawerk, whose insights on the relationship between saving, investment, and capital accumulation are highly relevant to today’s investors who seek deeper theoretic understanding of the market process. Böhm-Bawerk’s capital theories illustrate the roundabout of Produktionsumweg to amass deeper and increasingly efficient productive capital structure (as exemplified by Henry Ford, who turned coal and steel into cars for the masses).

The difficulty of the roundabout cannot be underestimated, as explained in Chapter 6, because of our inherent time preferences and myopic time inconsistencies. People exhibit a much stronger discounting (per unit of time) in the immediate future, compared to the distant future, a phenomenon sometimes called “hyperbolic discounting”—the effect of which is not yet fully appreciated in the behavioral finance literature.

In Chapter 7, the great Mises teaches us that “the market is a process,” drawing from his insights from the early and mid-20th century when he explained real-world entrepreneurship and the booms and busts of the business cycle. The distortion of interventionism—the root cause of booms and busts—short-circuits the natural governors within systems, whether forests or markets. Yet, as illustrated in Chapter 8, the forces that return the system to homeostasis persist and will eventually prevail, although reversions will be, almost by definition, extremely messy.

Austrian Investing—Applying Austrian Thinking in the Market

Across the span of the first eight chapters, Spitznagel establishes the foundation of The Dao of Capital, the roundabout means toward our desired ends. This is then fully applied in the last two chapters, where the author breaks important new ground with a discussion of capitalistic investment strategies known as Austrian Investing—so named because it relies heavily on the insights of the Austrian School. Austrian Investing I (Chapter 9) shows how to gauge distortion in the system using a measure Spitznagel calls the Misesian Stationarity index (after the principles of Mises). Using the MS index, investors can better know when to stay out of the market or, using a more sophisticated strategy (well beyond the reach of retail investors and even many professionals) known as tail-hedging, even exploit stock market crashes. (Spitznagel rigorously shows that, when the MS index is high, as it is today, a crash is no longer a “black swan” or “tail event.”)

In Austrian Investing II (Chapter 10), Spitznagel employs Böhm-Bawerkian principles to pursue productive, roundabout capital structures in which to invest, focusing on companies that exhibit promise though not immediately surging profits.

In the Epilogue, Spitznagel sums up the roundabout by homing in on a key ingredient in its arduous pursuit, a lesson straight from the boreal forest—sisu.

From start to finish, 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.