Chapter 4
The Austrian School: Economics Through Time
The Austrian School of economics provides the theoretical foundation for the roundabout approach to investing. Founded by Carl Menger in 19th century Vienna, this tradition views economics through a temporal lens, focusing on how human choices unfold across time - a perspective that fundamentally differentiates it from other economic schools of thought.
Menger established the Austrian School with his groundbreaking 1871 book "Principles of Economics," introducing a distinctly deductive, teleological, and humanistic approach. Unlike contemporaries who sought mathematical equilibrium and aggregate statistics, Menger focused on explaining real people's actions through means-ends relationships. His meticulously kept notebooks reveal a structured framework where goods serve as means (Mittel) for satisfying needs (Bedurfnis) to achieve desired ends (Zweck). This framework emphasized the subjective nature of value and the importance of individual human action in economic decision-making.
Menger's most significant contribution was his theory of goods, where he distinguished between "goods of the first order" that directly satisfy needs (like bread, clothing, or shelter) and higher-order goods (like flour, manufacturing equipment, or skilled labor) that contribute indirectly to production. Crucially, he demonstrated that production factors' value always derives from the final consumer good, not vice versa - a principle known as "imputation." This insight revolutionized understanding of capital theory and value formation. Economic progress, Menger argued, comes from "the increasing employment of goods of higher order" - a concept that became essential to Austrian Investing and modern capital theory.
This approach faced fierce opposition from the German Historical School, leading to the famous Methodenstreit (method dispute) of the 1880s and 1890s. The Austrians, led by Menger, defended deductive reasoning, methodological individualism, and economic liberty, while their opponents, under Gustav Schmoller, advocated strict empiricism, historical relativism, and state intervention. This wasn't merely an academic debate - it represented what Ludwig von Mises later called "a clash of two orthodoxies; the Bismarck orthodoxy versus the Jefferson orthodoxy." The dispute's implications extended far beyond methodology, touching on fundamental questions about the role of government, individual freedom, and the nature of economic progress.
The Austrian School's emphasis on time, subjective value, and capital structure would later influence major economists like Friedrich Hayek, Ludwig von Mises, and Murray Rothbard, who expanded these ideas into comprehensive theories of business cycles, monetary policy, and market processes. Their insights continue to provide valuable frameworks for understanding economic phenomena and investment decisions in modern markets.
Chapter 5
The Roundabout Path to Productivity
Eugen von Bohm-Bawerk expanded Menger's ideas with his concept of Produktionsumweg-the roundabout method of production. This approach involves taking indirect paths that ultimately yield greater productivity than direct ones. While seemingly counterintuitive, this principle demonstrates how investing in longer, more complex production processes can dramatically increase efficiency and output quality.
Consider Henry Ford's River Rouge plant-the epitome of Produktionsumweg. This fully integrated operation included steelmaking, foundry, body-making, sawmill, rubber processing, cement plant, power plant and assembly. Instead of simply purchasing components from suppliers, Ford created an industrial ecosystem where raw materials entered one end and finished automobiles emerged from the other. This roundabout production process initially consumed enormous time and capital but ultimately delivered extraordinary efficiency-by 1923, Ford was producing two million vehicles annually, with a new car completed every 24 seconds. The plant's success demonstrated how vertical integration and process control could revolutionize manufacturing.
The process must create future productivity advantages in one of two ways: either by making more units with the same inputs or producing goods impossible through direct methods. It creates an "autocatalytic process" where capital goods become catalysts for further production. For example, a machine tool that makes other machine tools, or computer systems that enable the design of more advanced computers. Each step builds on previous ones in an adaptive learning process, with technological advancements becoming embedded in existing technologies. This compounds over time as innovations stack upon each other.
Bohm-Bawerk's favorite metaphor for capital was a tree's growth rings-konzentrische Jahresringe-depicting the capital structure as concentric circles. The inner rings represent higher-order capital goods (furthest from consumption), with production moving outward over time toward final consumption goods. Advanced economies have more rings, reflecting more years and more circuitous production processes. This metaphor effectively illustrates how modern economies build layer upon layer of productive capacity, with each ring representing investments in increasingly sophisticated production methods.
Modern examples of Produktionsumweg include semiconductor fabrication plants, which require billions in investment and years of construction before producing a single chip, yet ultimately enable exponential increases in computing power. Similarly, Amazon's massive investment in warehouse automation and logistics infrastructure exemplifies how roundabout production methods can transform entire industries through enhanced efficiency and scale.
Chapter 6
The Psychology of Time Preference
Time preference-our inherent bias toward immediate gratification-stands as the greatest obstacle to roundabout investing. We naturally favor immediate, direct action over indirect, roundabout approaches. This hardwired tendency creates time inconsistency: we're impatient now while deluding ourselves we'll be patient later.
Bohm-Bawerk revolutionized economics by integrating time, psychology, and emotion into capital theory. He recognized that our inability to "feel in advance" future emotions creates a disconnect between our present and future selves-a "defect of will" rather than knowledge. This temporal myopia explains why we sacrifice future well-being for immediate gratification.
The tragic case of Phineas Gage illustrates this neurologically. After a 13-pound iron bar shot through his head in 1848, Gage survived with basic faculties intact but lost his ability to plan for the future. His teleological functioning was severely impaired, providing the first clinical evidence that specific brain regions control temporal reasoning and impulse control.
The mature brain operates as a dual system: the "cool" cognitive system (the shi system) is contemplative and capable of strategic action, while the "hot" emotional system (the li system) drives immediacy and impulsiveness. Walter Mischel's famous 1972 "marshmallow test" demonstrated this capacity in children, showing that those who could delay gratification achieved better outcomes later in life.
On Wall Street, this time preference distortion creates catastrophic risk management failures. Traders with "knockout" requirements (needing to exceed profit thresholds or lose their jobs) overwhelmingly choose strategies with frequent small gains but infrequent huge losses-optimizing for career survival rather than long-term returns.
Chapter 7
The Austrian Business Cycle Theory
Ludwig von Mises inherited theories from Menger and Bohm-Bawerk, refined them, and developed Austrian Business Cycle Theory (ABCT) to explain economic booms and busts. In a 1954 lecture, Mises declared "Za market ist a process"-five simple words conveying that markets cannot be viewed as static entities but as teleological processes driven by participants' purposeful goals.
The Austrian perspective sees business cycles resulting from government intervention in money and banking. When central banks artificially lower interest rates, they create false signals that lead entrepreneurs to embark on unsustainable projects. This creates an illusion of prosperity while actually causing capital consumption-the opposite of genuine economic progress.
Imagine a simple economy called Nibelungenland. When consumers naturally save more, interest rates fall as time preferences decrease. Entrepreneurs shift resources toward more roundabout production methods, creating genuine economic progress. But when a central bank artificially lowers rates, it creates apparent profitability for everyone. Without real savings to fund new capital accumulation, a resource crunch develops-"the central bank can print money, but it can't print land!" This creates a physically impossible situation where contradictory production methods appear profitable simultaneously.
The artificial boom eventually collapses. What seemed like prosperity is revealed as mere credit-induced distortion. Only entrepreneurs whose businesses were profitable without the artificial interest rate changes survive relatively unscathed.
Chapter 8
Homeostasis: The Market's Self-Correcting Nature
The market, like all natural systems, constantly seeks balance through self-correction. Never static, it functions through continuous discovery, balancing and rebalancing based on available information. When functioning naturally, markets achieve equilibrium through internal governance, depending on accurate communication among participants. This process operates through countless daily transactions, price signals, and behavioral adjustments made by millions of individual actors responding to local conditions and incentives.
This process closely resembles how forests maintain balance through periodic small wildfires. When angiosperm-dominated areas become overgrown, they become vulnerable to fires that clear the land, allowing patient conifers to reseed. These fires function as natural regulators that control unsuitable growth and maintain balance with available resources. The process involves complex interactions between different species, soil conditions, weather patterns, and natural cycles that have evolved over millions of years. Regular small fires clear underbrush, release nutrients, and create diverse habitats that support ecosystem health.
However, when these natural correction mechanisms are suppressed-whether through fire suppression in forests or bailouts in markets-the system accumulates dangerous imbalances. The catastrophic 1988 Yellowstone fire that destroyed over one-third of the park demonstrates the dangers of suppression. By preventing smaller, natural blazes for decades, forest managers inadvertently created perfect conditions for an unprecedented conflagration. Dead wood accumulated, forest density increased beyond sustainable levels, and when conditions aligned, the result was devastating.
Similarly, central banking's interventionist approach that began with the 1984 Continental Illinois "too big to fail" bailout and the subsequent "Greenspan put" of 1987 has created dangerous market imbalances. Programs like TARP prevent rational market adjustments, making eventual corrections exponentially more destructive. This pattern has repeated with increasing frequency and magnitude, from the dot-com bubble to the 2008 financial crisis, each intervention creating moral hazard and encouraging even riskier behavior. The Federal Reserve's expanding balance sheet and near-zero interest rate policies have distorted natural price discovery mechanisms and resource allocation.
The surprising solution to avoid economic depressions-like avoiding epic forest fires-is to let the homeostatic system work: "Don't just do something, sit there." This counter-intuitive approach recognizes that markets, like ecosystems, have evolved sophisticated self-regulating mechanisms. Small, frequent corrections prevent the buildup of systemic risks and maintain long-term stability. Just as forest managers now understand the value of controlled burns, economic policymakers must recognize that attempting to eliminate all market corrections ultimately leads to larger, more devastating crashes.
Chapter 9
Austrian Investing I: Exploiting Distortion
Austrian Investing begins with recognizing market distortions created by monetary intervention. When central banks artificially lower interest rates, they drive stock prices above their natural levels, creating what Spitznagel calls an elevated Misesian Stationarity (MS) index-the ratio of stock market value to the replacement value of underlying capital.
Historical analysis since 1901 reveals regular, mean-reverting cycles in this index that represent the footprints of monetary distortion. When the MS index is high, subsequent market returns tend to be poor, and the risk of crashes increases dramatically. These crashes aren't random "black swan" events but predictable consequences of monetary distortion.
The simplest Austrian investment strategy is straightforward: buy stocks when the MS index is low and sell when it is high. Testing this approach over more than a century shows it outperforms the S&P Composite by more than two percentage points annually-beating not just professional stock pickers but also the average hedge fund manager, with far less risk.
A more sophisticated approach uses put options as tail hedging tools to profit from inevitable corrections. By allocating a small portion of the portfolio (0.5% monthly) to out-of-the-money puts while keeping the rest invested in stocks, investors can generate significant outperformance during periods of high distortion.
This strategy embodies the roundabout approach-accepting small immediate losses (monthly put costs) to achieve larger future gains when crashes occur. Each option represents a "seed in time," a chance to profit from future market corrections and the subsequent higher returns available when investing after a crash.
Chapter 10
Austrian Investing II: Finding Productive Capital
While Austrian Investing I focuses on market-wide distortion, Austrian Investing II shifts to individual firms and their capital structures. This approach seeks highly productive "roundabout" capital-what Spitznagel calls "Siegfrieds" after the entrepreneurial hero from his Nibelungenland parable.
A true Siegfried shows a high return on invested capital (ROIC), continually reinvests profits to become increasingly roundabout, and isn't overly sensitive to interest rate fluctuations. Unlike companies that collapse when cheap credit disappears, Siegfried remains fundamentally sound even during liquidations.
Empirical evidence confirms that Siegfrieds tend to remain Siegfrieds. Firms with 75% or higher ROIC at the start of a decade typically maintain elevated returns through the period. This persistence reflects the advantage of entrepreneurs who continually reinvest earnings and stay ahead in the capital-configuration race.
A portfolio strategy selecting the lowest Faustmann ratio firms (price relative to replacement value) among those with ROICs above 100% dramatically outperforms the S&P Composite Index. The market systematically undervalues these highly productive firms because their EBIT growth temporarily declines as they become more roundabout-sacrificing today for growth tomorrow.
Austrian Investing can be viewed as value investing's intellectual forerunner, providing clarity to what Benjamin Graham's approach only approximated. Production that leads to entrepreneurial profit is an exceedingly roundabout process requiring time, capital, and patience in acquiring indirect means.
Chapter 11
The Sisu of Roundabout Thinking
The roundabout path requires what Finns call sisu-a concept encompassing guts, courage, toughness, tenacity and determination. More than momentary grit, sisu represents intertemporal endurance that sustains through an arduous path of seemingly insurmountable challenges. This distinctive Finnish characteristic emerged from centuries of survival in harsh Nordic conditions, where long-term planning and resilience were essential for survival.
The 100-day Winter War of 1939-1940 exemplifies this principle in dramatic fashion. Outgunned Finnish forces successfully defended against the much larger Soviet army through carefully executed strategy straight from Sunzi and Clausewitz. Nimble Finnish troops on skis avoided direct clashes, maneuvering within snowy forests to gain positional advantage. Using "motti" tactics-named after the Finnish word for a cord of firewood-they divided larger Soviet units into smaller, manageable sections before methodically neutralizing them. This indirect approach allowed a force of 300,000 Finns to effectively resist an army of over 1 million Soviets.
Modern psychology increasingly recognizes sisu's value, with researchers like Angela Duckworth identifying "gritty individuals" who make steady progress despite setbacks as "tortoise-like"-reminiscent of tenacious conifers. Her research shows that grit predicts success better than IQ or talent across various fields, from West Point cadets to spelling bee champions. This quality proves essential in capitalism, which requires enduring present disadvantage for future superior advantage. Successful entrepreneurs like Jeff Bezos exemplify this principle, sustaining Amazon through years of losses to build long-term market dominance.
If a strategy doesn't require grit, it aligns with neither roundabout thinking nor capitalistic progress. Throughout history, strategic thinkers from diverse backgrounds-Daoists, militarists, economists, industrialists-have demonstrated commitment to these universal principles. The Japanese concept of "kaizen" (continuous improvement), German "mittelstand" companies' multi-generational perspective, and Warren Buffett's value investing approach all embody this patient, indirect path to success.
The humble pinecone serves as a daily reminder of nature's roundabout strategy-the tenacious persistence that allows conifers to outlast their competitors by enduring uncomfortable places, ultimately achieving conquest through apparent disadvantage. Some species, like the Jack Pine, require forest fires to release their seeds, demonstrating nature's ultimate roundabout strategy. This seemingly mundane object contains infinity-a visible reminder of the practical discipline required to pursue intermediate means as strategic advantage for achieving ultimate ends through the roundabout route. The pinecone's spiral pattern, following the Fibonacci sequence, further symbolizes how mathematical precision underlies nature's indirect paths to growth and survival.
Chapter 12
The Dao of Capital: A Universal Strategy
The masters across diverse traditions-from ancient Daoist philosophers like Laozi and Zhuangzi to military strategists like Sun Tzu, from successful grain traders to Austrian economists like Ludwig von Mises-share a common wisdom captured in the profound concept of shi. This principle encompasses strategic positional advantage, latent potential, optimal disposition, and natural propensity. Like water finding its path downhill, shi represents the accumulated force that develops through patient positioning.
By orienting everything to shi, we follow the roundabout path, refusing the distorted perceptions that focus only on immediate gratification. This requires developing an intertemporal view-seeing life not as isolated moments but as an interconnected series extending beyond our own lifetime. This perspective allows us to plant seeds today that may only bear fruit for future generations, much like the ancient Chinese practice of planting bamboo forests that would take years to mature.
The reward for being intentionally circuitous manifests in multiple domains: in nature's patient regeneration after forest fires, in the archer's precise targeting through careful aim rather than rushed shots, and in productive capital accumulation through delayed consumption. As economist Eugen von Bohm-Bawerk noted about the roundabout approach: it is "so much the better that it is often the only way!" This insight applies equally to business investment in infrastructure, personal skill development, and relationship building.
With these masters as guides, we navigate a world increasingly dominated by immediacy and instant gratification. We follow Mark Spitznagel's paradoxical approach of loving to lose and hating to win in the short term, recognizing that temporary setbacks often pave the way for greater victories. We embrace the strategic indirection advocated by Sun Wu and Carl von Clausewitz, who understood that the most effective path to victory often appears to lead away from the target. We heed Frederic Bastiat's warning to look beyond immediate effects to see the long-term consequences of our choices, whether in economics, policy, or personal decisions.
The Dao of Capital transcends its application as an investment strategy-it represents a universal approach to achieving lasting success through strategic positioning and patient persistence. This wisdom manifests in nature's seasonal cycles, in the growth of great enterprises from humble beginnings, and in the development of enduring personal capabilities through sustained effort rather than quick fixes.
