The Dao of Capital
The Dao of Capital

The Dao of Capital

To the Laozi, the best path to anything lay through its opposite: One gains by losing and loses by gaining; victory (Location 544)

Who can remain still until the moment of action? (Location 602)

Taijiquan is a physical manifestation of the importance of waiting and exploiting another’s urgency through softness in a clash. (Location 644)

The real force is not in the pushing, but in the yielding. (Location 648)

In the pit was the same mystery, with pauses interrupted by sudden cascades of noise and energy driven by something imperceptible. It (Location 712)

How could he have done so well as a speculator without knowing—or even caring—where the market was heading? (Location 721)

After all, profiting was buying (or selling) at one price and then eventually selling (or buying) it back at a higher (or lower) price. How could this be done without any ability to forecast? The (Location 725)

was that the edge to pit trading was in the order flow—the succession of mini-routs, as I always called them—and in the discipline; it was in a patient response to someone else’s impatience, someone else’s urgency. (Location 727)

would to a child, not as principles, but as privileges: “As a pit trader, you have two privileges and two privileges only: One, you can demand the edge—buy at the bid price, sell at offer price; two, you can give up that edge when you’ve made a mistake.” (Location 752)

What locals do is provide immediacy to those who demand it, meaning they offer prices (a bid price and an ask price) at which they are willing to transact immediately, and in so doing they provide immediate liquidity. In (Location 757)

He accumulates inventory (a position) by transacting against urgent order flow, with the intention of closing out of that inventory profitably once the urgency subsides; (Location 765)

second allotted privilege was “cruel,” as Klipp would say, because it meant immediately closing out a trade once it turned negative (a “mistake”), what he called “always taking a one-tick loss.” (Location 776)

Impatience and intolerance for many such small losses, as well as urgency for immediate profits, Klipp believed, dealt a death blow to traders, an easy and common one. (Location 792)

Expect to lose first, the first loss is a good loss; from that comes greater gain later. (Location 814)

In Klipp’s basic asymmetric strategy, the bigger the gain I waited for, the less frequently it would occur, and the more asymmetric (Location 863)

The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy.”33 (Location 911)

The information conveyed by historical experience cannot be used as building material for the construction of theories and the prediction of future events.”38 (Location 960)

What mattered to the local, their raison d’être, was avoiding a swelling inventory, the result of one-sided urgent order flow (as in only sell orders, for instance). (Location 1006)

This meant that, in fact, when there were no urgent active orders, the economy would (when there was no artificial price setting) be in a state which Mises called stationary (Location 1036)

toward high-frequency traders, for instance, who cease their liquidity-providing activities (and thus create liquidity holes) when markets get too volatile. Why should we expect anything else? (Location 1041)

“Anyone can see the pinecones in the tree. None can see the trees, none can foresee the forest in the pinecone.” (Location 1223)

but all the unfolding opportunities that the conifer somehow “perceives,” whether the forest floor choked with overgrowth, the rocky outcroppings where competitors cannot thrive, or the fertile barrenness of a fire-cleared area, that affect how and where its seeds will grow. As the Laozi tells us, nature is our greatest teacher; (Location 1236)

uncarved block known as pu, a state of pure potential. (Location 1243)

The Laozi advises, quite simply, to see the unappreciated uncarved block, unassuming as the humble pinecone, as being fully ripe with potential of what is yet to be. (Location 1247)

Thus, we are not merely learning about the growth of conifers and how they opportunistically exploit available resources; (Location 1267)

rank among the most enduring of all living things on earth (Location 1276)

With advantages from fast growth to more efficient reproduction with the help of insects (which are attracted to the angiosperms’ flowers, their signature trait), angiosperms have used their prolific and rapid colonization wherever and whenever possible to gain an upper hand over the conifers from which, no doubt, many descended. As (Location 1284)

but can outgrow and outlive their angiosperm competitors. As Figure 2.1 shows, the conifers change their pace of growth in a deceptive coniferous “changeup”: (Location 1290)

For conifers, growth is a patient process that takes tenacity and grit, and most successful with (and even requiring) a roundabout strategy, with slow early stages that create the structure for subsequent fast and efficient development. (Location 1306)

In other words, conifers pay now for productivity gains later. In building efficiencies, they aim first toward means (step one), whereas the angiosperms, in their immediate fast growth, (Location 1309)

Smaller, naturally occurring fires, however, are nature’s way of turning back the clock as resources are released and flow from trees that are not thriving to those that perhaps can. (Location 1373)

Civilizations advance through the accumulation of highly configured capital, which does not thrive amid extreme volatility and destruction; (Location 1384)

into the most barren areas, just as the entrepreneur—the focus and hero of the Austrian tradition—pushes out to the areas overlooked and yet undiscovered by his brethren competitors.) (Location 1404)

This living relic is a testament to the adaptability and longevity of the conifer, not only outsurviving its nearest competitors, but nearly everything else on the planet, as well. (Location 1475)

Through this pedagogy from an ancient tree we best build our understanding of this central roundabout strategy, a universal lesson taking us from the boreal forests to, as we will see, the canonical military strategists stretching across 20 centuries from China to Prussia, and leading us to the great economic thinkers of late nineteenth-century Austria. But perhaps it will still be in the conifer that we see it at its most poignant, in the simple pinecone, and the forest yet to be. (Location 1544)

Both are about war, the deadly preoccupation of the human race and completely anathema to the advancement of civilization, and both carry their authors’ unblinking realism about the bloody and destructive nature of warfare. (Location 1605)

Both recognize that not all battles are decisive; rather, it is far better to deploy the roundabout strategy—that which we have discussed thus far—of patiently achieving an intermediate position of advantage, the teleology of efficacious means toward realizing an eventual, final objective. (Location 1612)

indirect now in order to be direct later—summed up in a single word: shi, by which the wise general gained a strategic advantage over his enemy, “intervening upstream before the conflict unfolds and thus without having to join serious battle subsequently,” (Location 1616)

most important to the military theorist, strategic advantage4—which can be extended to positional advantage or advantageous deployment. We (Location 1624)

War is a clash between major interests, which is resolved by bloodshed—that is the only way in which it differs from other conflicts. (Location 1679)

which is also a conflict of human interests and activities; and it is still closer to politics, which in turn may be considered as a kind of commerce on a larger scale.”16 Doppelgänger Sun Wu and Clausewitz The teleological means-end framework is indeed implied (Location 1681)

(Daoists are certainly not all pacifists.) (Location 1713)

the Sunzi states, “The task of a good general is to calculate in advance and with accuracy every factor, so that the situation develops in a way as beneficial as possible to him; (Location 1717)

Even better, though, in the eyes of Sun Wu is the wise commander who, in recognizing the destructiveness of war, establishes positional advantage and thus uses threat, manipulation, and deterrence to subdue the enemy and convince the opponent to withdraw or surrender without coercion. (Location 1720)

To summarize, a shi strategy boils down to acquiring positional advantage and superiority for an easier, if not assured, victorious fight to follow. Shi is always focused more on the future than the current moment, an emphasis on “upstream,” intermediate aims, or intermediate foci within the field, becoming means, and by which the ultimate ends can be more readily achieved. (Location 1763)

As the “all or nothing” of a pitched battle, li seeks decisive victory in each and every engagement (the “false shortcuts” denounced by the Laozi28)—a model of warfare “bequeathed to us by the Greeks,”29 (Location 1772)

toward subtle and even intangible intermediate steps, while the li strategist concentrates on the current step, the visible power, the direct, obvious route toward a tangible desired end, relying on force to decide the outcome of every battle. Simply (Location 1781)

while shi seeks first the positional advantage of the setup. The former is the aggressor racing against time and (Location 1784)

while shi “is a yin strategy that prefers to go for influence at the expense of immediate profit or advantage.”31 Shi is intertemporal; li is myopic. (Location 1814)

black competes not against the position of white’s stones, but rather against a future position of white’s stones. (Location 1843)

Despite his hatred of Napoleon, Clausewitz studied him and even admired his military tactics; Napoleonic battles would later serve as a centerpiece of Clausewitz’s opus, Vom Kriege. (Location 1892)

Napoleon’s basic strategy was one of upsetting the enemy’s balance so that once the equilibrium was broken, the opponent became an easy defeat. (Location 1907)

what he recognized as the essential differences between the French and the Prussian armies as they waged war. (Location 1915)

Napoleon’s genius abetted by the ‘intellectual poverty’ and moral cowardice of his opposition.” (Location 1918)

Clausewitz describes two kinds of war: one to overthrow the enemy and the other to occupy some frontier districts to be annexed or used for bargaining during peace negotiations. (Location 1988)

“Each strives by physical force to compel the other to submit to his will: his first object is to throw his adversary, and thus to render him incapable of further resistance.” (Location 2001)

Handeln were the “building blocks” of war, both the immediate aims and the “springboards” toward the ends.48 (Location 2012)

tactics and strategy. (Location 2014)

Rather he cautioned that a final peace must be ever-present in the mind, moving backward from that end and focusing on the intermediate positioning to achieve it, die Mittel (“means,” also translated as “instrument”)—just as the Sunzi instructs to “go back” to the “subtle” earlier steps to determine that which “makes victory easy to win.”52 (Location 2033)

This was Clausewitz’s strategic end (leading to peace), the accumulated and pent-up military potential finally emitted in a torrent (or, better yet, not at all). He was very much against spreading forces thinly over a large area of engagement, preferring them to stay together, (Location 2048)

A decisive blow to the center of gravity would ostensibly cause the enemy’s entire structure to collapse, lessening or even eliminating the need for further assault; thus (Location 2057)

his preference for striking when the configuration is optimal, so decisively (or threateningly) that violence then becomes unnecessary. (Location 2058)

Thus, aggression is actually a disadvantage, while nonaggression accrues a decided advantage, as the defender then “reaps where he has not sowed,” (Location 2062)

should seek to minimize early losses, “husbanding reserves” until the point when the balance shifts, and the battle escalates. (Location 2075)

Gaining superior positions from which to subsequently fight more effectively was, in fact, his method, through “delayed riposte.” It (Location 2081)

“In this way it becomes evident how the employment of too many forces in combat may be disadvantageous; (Location 2087)

Rather, in many cases the foreseen emerges through the logical rigor of deduction, based on what one knows (and, to some degree, what one observes and experiences) as a sentient human being. (Location 2226)

inconsistencies in his thinking. For example, Say brought the entrepreneur into the spotlight of economic thought (he is said to have invented the term, which literally means undertaker—which the Austrians call Unternehmer—with the connotation of one who undertakes an adventure (Location 2242)

for unwittingly providing ammunition to the Marxists, who also hail Smith as a founding father. For (Location 2246)

Indeed, warfare and entrepreneurial discovery are antithetical. (Location 2257)

cease this childish practice of comparing industrial competition to war; whatever element of plausibility this faulty analogy has comes of isolating two competing industries in order to determine the effects of their competition. As soon as one introduces into this calculation the effect produced upon the general well-being, the analogy breaks down.” (Location 2258)

Entrepreneurial competition betters the world (though, paradoxically, most often at the expense of most of the competitors); warfare destroys the world (also at the expense of most if not all the competitors). (Location 2264)

in which he argues that the interests of all members of society are harmonious if private property rights are respected. In his view, the primary role of government was to uphold rights to life, liberty, and property, and to prevent injustice. (Location 2322)

With his view that accumulation of capital enriches workers as well as the factory owners, through greater productivity, higher wages, and cheaper goods (all of which would come to pass in industrialized economies as if from Bastiat’s script), (Location 2334)

Bastiat’s and Henry Hazlitt’s Economics in One Lesson, which expands upon it—my and surely many others’ introduction to Bastiat and, ultimately, the Austrians.) (Location 2354)

“we always want to give complicated explanations to the most simple facts, and we think we are clever only by looking for difficulties where there are none”; (Location 2387)

Ludwig von Mises, himself, considered economic science to be neutral and objective, but yet he was polemical (understandable, perhaps, since he witnessed firsthand the horrors of the most extreme state interventionism in Nazism). (Location 2398)

Thus, as Kant argued, a higher form of organization cannot issue forth from a lower form; rather the higher form is encoded in the lower form. (This (Location 2461)

whereby “the animal develops in a pattern leading from the most universal and essential to the more specialized and individual characteristics.”33 (Location 2466)

the value of these ingredients, the factors of production (used to make a final good), is always derived from the value of the consumer good, and not the inverse. (One example given is a bottle of wine that is not valuable because of the land and labor invested in it. Rather, it is because consumers value the wine that the land and the labor invested in winemaking are valuable.47) Menger also (Location 2581)

founder; he foresaw that the policies being pursued by the European powers would lead to a “terrible war ending with gruesome revolutions, the extinction of European culture and destruction of prosperity for people of all nations.” (Location 2616)

Economics, not a love affair, caused Menger’s pupil to kill himself. (Location 2628)

economics is not a science derived from data, but rather uses a priorist methodology, grounded in observation and deduction of human action (thus opening the door for Mises’s praxeology). In essence, Menger’s Principles can be seen as “an exercise in pure theory.” (Location 2664)

As such, Menger also recognized a teleological connection between higher-order production (the means) and lower-order production (the ends of consumer needs)—in (Location 2759)

Menger’s discovery carried a far greater weight in the simple fact that the laws of human needs, themselves, were sufficient to explain the “complex phenomena of the modern exchange economy.”74 (Location 2768)

capital; it allowed goods and capital to be classified as higher order and lower order—itself, an intertemporal process. (Location 2781)

the strategic positional advantage gained in the roundabout way, in the relation of indirect means and conditions to ultimate ends and consequences—that (Location 2924)

translates literally as “detour,” “indirect,” or “roundabout route,” and its economic meaning springs from a pillar of the Austrian School, a man who was truly a cofounder with Carl Menger: (Location 2931)

timed for when they will be demanded—the constantly stalked strategic advantage toward the ultimate end of satisfying the consumer. (Location 2951)

current slice of time in the marketplace and look ahead to anticipate not only what goods consumers will want but importantly when they will want them. (Location 2952)

from the highest order of raw materials (land, ore mined from the ground, timber from the forest) progressively altered with intermediate goods to the lower order that finally reaches the consumer. (Location 2959)

but rather is logically inherent in the market. (Location 2975)

present goods are valued more highly than future goods. (Location 2977)

In Produktionsumweg, one amasses the tools of one’s trade, the intermediate goods that will add proficiency and efficiency to the pursuit, the result of which is realized in the future. As Böhm-Bawerk observed, “That roundabout methods lead to greater results than direct methods is one of the most important and fundamental propositions in the whole theory of production.” (Location 3012)

entrepreneurial ventures naturally do not come with any guarantees of feasibility or profitability). (Location 3044)

savings is not negative, but rather deferred consumption, (Location 3045)

Capital must be thought of as a temporal structure that is always dwindling away. (Location 3053)

It is not just enough to be physically more productive; it has to make economic sense as well. (Location 3067)

other cases, however, the roundabout process yields a desired output good that literally cannot be produced by any shorter, more direct process. (Location 3073)

with capital continuously improved through innovation to create better lower-order goods. (Location 3103)

adaptive learning, incremental steps generated by previous steps and that lead to other steps—each of which becomes, teleonomically, like von Baer’s caterpillar’s means to the yet undiscovered ends of the butterfly. (Location 3105)

Technological advancements become embedded in and mixed with existing technologies to make possible other technologies or consumer goods, which perhaps were not possible (or at least not economically producible) before. (Location 3107)

This is true of all goods in general; thus, there is a positive interest rate. (Location 3112)

that it is the final product that determines the value of the intermediate inputs—e.g., the bottle of wine makes the grapes and the efforts of the vinedressers worthwhile.) (Location 3122)

Böhm-Bawerk showed that the workers who are employed by the entrepreneur are paid immediately for the “full value” of their labor, so long as that value is correctly calculated by including the time element. (Location 3133)

The act of organizing production is effectively the act of lending, as inputs are paid up front in order to command product for sale much later. If (Location 3136)

example of the owner of a house with a market value of £2,000, who paid out exactly £2,000 in wages to the workers who had built it. (Location 3141)

the workers are clearly paid the “full product of their labor,” according to the Marxist dictum. (Location 3143)

the entrepreneur typically assumes the entire risk of whether the worker’s output will end up being marketable; the (Location 3151)

If a firm goes out of business, should it have the right to claw back the wages it disbursed over the years, because in retrospect the workers involved were clearly overpaid? (Location 3155)

However, interest as the cost of time has an entirely different meaning; it is the inherent price one must pay to access capital sooner rather than later, which in turn becomes the threshold for determining one’s return and the prudence of making an investment. (Location 3167)

Faustmann’s ratio, LEV/LRV. The message is clear: When Faustmann’s ratio is greater than one (the LEV is greater than the LRV, or the whole is greater than the sum of its parts), invest in land for forestry (if nothing else you can probably then sell it off as a going forestry operation). (Location 3200)

the axiom of the axe: that timber is economically viable (and thus immature) as long as new growth in tree value as a percentage of the current land and stand value (the return on invested capital, ROIC) exceeds the compounding opportunity cost of owning that land and stand value (the opportunity cost of capital, i). (Location 3276)

the return derived from invested capital compared to the replacement cost of that capital. (Location 3289)

Indeed, the axiom of the axe has become a fundamental canon of corporate finance today. (Location 3292)

that capital: savings. In the nineteenth century, the savings rate in the United States, for instance, rose from 15 percent before the Civil War to 24 percent in the 1870s and 28 percent in the 1880s. (Location 3353)

paradigm of production, the assembly line, as the culmination of vertical integration that depicts the improved efficiency and productivity gained by spanning Böhm-Bawerk’s Jahresringe with factories and power plants to turn coal, iron ore, and steel into automobiles. (Location 3384)

The Austrians described what the Unternehmer knows in his gut. (Ford held similar Austrian views on such things as profits as the source of productive capital that must be reinvested to the ultimate benefit of consumers, (Location 3393)

how the real world works and progresses. Entrepreneurs do not dabble, willy-nilly, in pursuits of fancy, chasing butterflies or endless real optionality; theirs is a practice of assuming an uncomfortable position in the difficult sunk costs required for the tools to achieve their clear goals. (Location 3460)

Their indirectness is always calculated; they know where they are going (though never knowing, of course, if they will actually get there), while keeping their minds open to the evaluation and modification of goals from what is learned along the way. They move in a circuitous fashion from (Location 3464)

“The seeds of bad times are in the mistakes which we make in the good times. Yet in the good times no one wants to hear of the mistakes we may be making. The policy then is to ‘get while the getting is good’.”42 (Location 3525)

German mathematician, “Man muss immer umkehren,” or, loosely, “Invert, always invert”—meaning solutions to difficult problems can often be found by examining them in the inverse. (Location 3572)

is a simpler instance of an intrinsic strategy in perhaps the most roundabout game of ice hockey (the traditional sport of Ford’s north woods “hockeytown” home): the (Location 3582)

using time to tease out imbalances and a seam in the defense and find an open shot or passing lane to the goal, as opposed to charging directly through traffic. (Location 3583)

It is a superior strategy in perhaps more than we think, pervading even the more prosaic games of chance—from the vulnerable “builders” of backgammon to the trapping bluffs of poker (where early bluff losses are a means to eventual big pots when the (Location 3618)

Rather it belongs to the shi strategist, who retreats now (going for a shorter shot to the fairway or taking the walk to first) in order to gain the Ziel of greater positional advantage from which to achieve the ultimate Zweck. (Location 3622)

We are not made with a predilection toward shi, roundaboutness, and capitalistic production and investment. (Location 3721)

This requires a complete inversion of a behavioral pattern known as time inconsistency (and generally expressed mathematically with a hyperbolic discounting model). (Location 3731)

the while holding fast to the self-delusion of being able to be patient later. (And, of course, when later becomes now, we are just as impatient.) (Location 3733)

Unless we find a way to deal effectively with our skewed time expectations, everything we have discussed up to this point becomes moot—a mere intellectual flight-of-fancy with no chance of ever being implemented. (Location 3737)

we must, instead, become strategically patient now—but (Location 3740)

Rather, we are patient now for the sole purpose of becoming intensely and rapaciously impatient later; (Location 3741)

time preference and subjugate our myopic time inconsistency that makes us extremely impatient (with a high time preference) now while anticipating subsequent abundant patience (with a low time preference). (Location 3760)

In fact, it is quite contrary to it. Long term is but a trajectory from now to the distant future that effectively, and by definition, must ignore the sequence of many ripe time slices in the middle. (Location 3784)

the divide between deduction and praxeology in the former and empiricism and historicism in the latter became more distinct over the years and was never (Location 4402)

Spontaneous order (Location 5380)

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information; this scaling is meant to smooth (Location 5665)

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To start, the simplest, back-of-the-envelope strategy would be to buy when the MS index is low and sell when it is high. (Location 5740)

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. (Location 5789)

Implementing this cookie-cutter Misesian strategy is extremely ambitious, even audacious (particularly for professionals), as Chapter 6 reminds us, because of that humanness about us that gives us a high immediate time preference— (Location 5796)

When the MS index goes so low it falls well below 1, then one can act like a corporate raider (particularly common around the last generational low in the MS index in the early 1980s), scooping up good assets that can then be liquidated at a profit—because in the aftermath of a malinvestment purge, title to capital is available for less than the replacement cost. (Location 5815)

The sudden realization of mass correlated entrepreneurial error is Austrian-speak for “stock market crash,” as most if not all companies suddenly are revealed to have been priced wrong, and many are engaged in (and now looking to quickly exit) projects that one minute were considered profitable, and the next not. This is of course the retreating rout, to be followed by the counter-rout. (Location 5821)

of credit expansions as the Austrians suggest? We have already seen (in Figure 9.3) that severe stock market losses (what I’ve called “drawdowns”) follow periods of great distortion. (Location 5837)

Over the past century-plus, there have been sizeable monthly losses of 20 percent or more in the aggregate U.S. stock market, and they have occurred with exceedingly low frequency. By definition, therefore, it would seem we should be able to call such crashes in the stock market tail events. But on closer inspection, a different story emerges in (Location 5844)

If the market perceives (or rather prices) a large loss in the stock market as very unlikely, even when such perception and pricing are unwarranted, obviously tremendous opportunity exists—even if only to protect a portfolio against such deleterious losses. (Location 5905)

I present an analysis of a simplified, prototypical tail-hedged equity portfolio. In this discussion, I move from the commentator I was in previous chapters to practitioner; tail hedging (or Austrian Investing I) is at the center of what I practice in my investment partnerships (and Austrian Investing II of Chapter 10, in combination with Austrian Investing I, is what I practice in my family office). However, while this is something of a glimpse into what I do in my funds, my actual approach is far more nuanced—as it is far beyond the scope and intention of this book. (Location 5913)

even the very generic version of tail hedging is very hard and involves options that are very illiquid, which makes pricing and taking profits very difficult. (Location 5918)

The portfolio I am testing in this study purchases 2-month 0.5 delta puts on the S&P Composite Index (approximately 30 percent out of the money, (Location 5926)

in the case of a 40 percent implied volatility) (Location 5927)

After every month, the 2-month put options position is rolled (the existing options are sold and new 2-month puts are purchased, which resets the position every month). (Location 5929)

Each month the portfolio spends one half of one percent on puts, and the remaining 99.5 percent stays invested in the S&P index. No leverage is employed (and, in fact, typically when the market is down by not even 20 percent the entire portfolio is actually net profitable). (Location 5933)

black swan events have been largely insignificant in at least the last century of capital investment in the United States, including the most recent crisis. (Location 5984)

We either can keep our capital on the sidelines in reserve (what I have called the basic Misesian strategy), or we can enter positions that opportunistically generate capital when its deployment is most effective (the more sophisticated complement of tail hedging, and what I call Austrian Investing I)—shi strategies all. (Location 6062)

An investment strategy that seemed to work on the historical data can famously disappear (assuming it was not a spurious mirage in the first place), as soon as analysts become aware of it—this is one of the central findings in the efficient markets literature. (Location 6078)

Roundabout investing (a very apt synonym for Austrian Investing) is all about the temporal structure of productive capital. As we recall from the slow-growing (at first) conifers and Henry Ford’s capital structure extending from raw materials to automobiles, production by its very nature takes much time. (Location 6084)

Indeed, Austrian Investing II, like Austrian Investing I, is all about the straightforward plan of attack comprised in this book: being patient now in order to be strategically impatient later. (Location 6090)

The telltale sign of what we are seeking is highly productive capital. (Location 6093)

we can always find technological ways of producing more output with our inputs, if only we are willing to wait longer. (Location 6095)

The most profitable capital structures will tend to be very roundabout as well. (Location 6096)

acquiring later-stage advantages of efficiency through present-stage disadvantages—roundaboutness. (Location 6099)

Like Henry Ford, with time Siegfried amasses a roundabout capital structure to make products that people want to buy, when they want to buy them. (Location 6103)

best calculated by dividing a company’s EBIT (operating earnings before interest and tax expenses are deducted) by its invested capital (the operating capital required to generate that EBIT). (Location 6105)

(To put it simply, his enterprise can transform dollars spent on inputs into dollars earned from customers at a much higher rate than he could earn by lending the money out.) (Location 6109)

But his capital likely remains profitable and productive, well above his cost of capital, even if the central bank should suddenly and sharply raise interest rates in the thick of a boom. (Location 6120)

In contrast, Siegfried will be okay, as his business model remains fundamentally sound. (Location 6123)

as he willingly turns his back on the fray of fast growth (that often exists only because of the artificial fertilizer of distortion), and thus is overlooked by those who have no way to appreciate what he is constructing. (Location 6126)

Siegfried cedes what looks like the prime places stampeded with competitors who race for the win, and instead he happily retreats (Wunderhorn in hand) to the rocky places, where the growing is hard at first (as he foregoes his profits today to build his tools of later efficiencies). (Location 6129)

as he amasses his roundabout capital structure, but when the time is ripe, he will emerge with the greatest advantages (and when the field of competition is cleared by the wildfire that destroys unhealthy, malinvested growth, he is still standing, even ready to advantageously invest more). (Location 6132)

high ROIC, which prompts him to keep reinvesting profits into his capital structure to become even more efficient and eventually grow. (Location 6138)

High ROIC firms show consistently and significantly greater increases in their invested capital compared to non-high ROIC firms. (Location 6141)

Consider: The entrepreneur who foresees a profit opportunity in the distant future, and who patiently reinvests earnings into his business year after year in anticipation, has a much greater opportunity for (eventually) posting an enormous ROIC than entrepreneurs who are engaged in short-term projects. (Location 6144)

As Austrian investors (by which I mean capitalistic investors seeking to accumulate productive capital—as opposed to the more common mere gambler-investors seeking to exploit changes in prices on title to capital), (Location 6150)

This, of course, requires something special, a great insight, and an unwavering belief in what is perhaps merely a promising hunch—the Verstehen of Chapter 7. (One might think of this as the burden of the angel investor.) (Location 6156)

we can use our funds to buy title to some of his existing operation. (Location 6160)

Unfortunately, we should presume that it will cost us dearly to get in. The baseline assumption of efficient capital markets would be that other investors are just as keen as we are, and that the price of stock in a Siegfried would already reflect the tremendous economic advantage indicated by his high ROIC (which is of course public knowledge). (Location 6161)

where these superior efficiencies at turning invested and reinvested capital into future earnings are apparently not priced in. (Location 6166)

In addition to casting our net for firms with a high ROIC, we are also looking for firms with a low Faustmann ratio, meaning a low market capitalization (of common equity) over net worth (or invested capital plus cash minus debt and preferred equity) ratio. (Location 6168)

so clearly one might expect high Faustmann ratios (where the whole is greater than the sum of its parts—or the sum of the factors of production) to accompany high ROICs. (Location 6171)

Rather, his first task is to find highly roundabout, productive firms—ones with high ROIC—that possess the circuitous means of economic profit. (Location 6178)

Then, to these Siegfrieds he applies a second filter, or screen, and looks for firms with a low Faustmann ratio. (Location 6179)

Some tricky analyses of financial statements are necessary, and we will have to resist, once again, that very humanness about us. (Location 6184)

Thus, our goal is to identify precisely those firms that—in light of Austrian economics—we expect to eventually progress (or grow their EBIT) and thus deliver (perhaps after a large lag) a substantial return on investment in ownership of the firms. (Location 6187)

For example, a firm with a high ROIC but a correspondingly high Faustmann ratio will be expected to experience its roundabout earnings growth; (Location 6191)

On the other hand, suppose we encounter a firm with a relatively low Faustmann ratio that also has a low ROIC. (Location 6195)

productivity embedded in the physical capital assets of the firm. Yet the firm’s low ROIC makes us pause. If management perceives that the operation cannot earn a higher return on reinvested earnings than the going rate of interest, we can hardly expect them to plow the profits back into the business (and, even if they did, it would be economically destructive malinvestment). (Location 6197)

A firm with a high ROIC will naturally engage in high rates of reinvestment in the business—the managers almost cannot help themselves, as this is a simple matter of putting available funds to work in an outlet with a proven track record and over which they have exquisite control. (Location 6203)

suffer from extremely concentrated time preference, or what the literature calls hyperbolic discounting, discussed extensively in Chapter 6. (Location 6209)

The various equity analysts and investment managers may have concluded that this particular Siegfried will not see its earnings grow any time soon enough. (Location 6211)

other investors apparently underappreciate this lucrative prize, lying as it does just beyond the horizon—and at the end of a roundabout route. (Location 6219)

but in the aggregate, it might also be simply that most investors have a more immediate horizon, a much shallower depth of field, than we do. (Location 6220)

longitudinal strategies, respectively.) This, too, is a highly intertemporal strategy. As was the case in Austrian Investing I, here in Austrian Investing II we find that as we wait—in this case for EBIT to grow and the stock price to subsequently rise—we actively construct the very means of our subsequent superior profits. (Location 6228)

However, the savvy minority of investors—appreciating Austrian insights—can see beneath the surface, and recognize when Crusoe is hungry not because of sloth or ineptitude, but because he is currently investing his resources into building a boat and a net. (Location 6235)

On theoretical grounds, we expect a firm with high ROIC to remain in such standing, as its managers will continue to reinvest in the firm (why wouldn’t they?), and this will only further solidify their positions of competitive advantage. (Location 6244)

Yet in the real world the type of farsighted entrepreneurs who continually reinvest earnings are the very people poised to seize profit opportunities that have eluded others, and they are ahead in the capital-configuration race, so that in the aggregate we expect a persistence in high ROIC. (Location 6259)

will very often show up in the measured return on tangible capital. (Location 6263)

the roundabout is hard, and we are not biologically cut out for it. (Location 6302)

the markets truly look at just the immediate rather than at the longer effects of capital and production processes; these are the two games always at play, with so little competition in the latter. (Location 6314)

Since a Siegfried, by definition, is a farsighted visionary—who can better anticipate future market conditions than his peers, and who has spent years building up a roundabout capital structure accordingly—and whose ROIC far exceeds his cost of capital (and his investment plans are thus generally insensitive to movements in rates), (Location 6327)

). Thus the Siegfried strategy benefits from low MS index regimes (when the S&P Composite has high subsequent returns, as per the previous chapter) and is somewhat hurt by high MS index regimes (when the S&P Composite similarly has low subsequent returns). Overlaying the same intertemporal strategy of the previous chapter—of facilitating opportunistic capital deployment following the routs of distortion—on the present strategy will confer even greater advantages. (Location 6337)

pursuit of Siegfried opportunism. Thus, we can say that Benjamin Graham, considered the father of value investing and security analysis itself, and the horde of value investors who have followed his treatises are, in effect, an estranged brood of Austrians—an unwittingly splintered faction. (Location 6356)

In Graham’s metaphor of the bipolar “Mr. Market” is a sound, though proximate, approach to avoiding the (ultimately Austrian-explained) traps of distortion and entrepreneurial “incompleteness of the imaginations.” (Location 6378)

“Investment is most intelligent when it is most businesslike”6). (Location 6387)

A diligent researcher of stocks, he had a laser focus on capital as the tangible asset and the thing that is ultimately owned in a stock. (Location 6391)

What is the whole relative to the sum of its parts? (It is not clear whether Graham ever read Faustmann or the Austrians directly; though he was fluent in German, he admitted to being unschooled in economics.) In his P/B approach, alone, Graham had good results. (Location 6393)

Traditional value stocks (defined by low P/B and P/E ratios) have been shown to have statistically similar revenue growth as traditional growth stocks, (Location 6399)

have had lower ROIC than growth stocks. (Location 6400)

Consider that P/B and P/E ratios are utterly incommensurable unless we assume all firms have the same basic capital structure. In reality, firms have different degrees of roundaboutness and hence variability in their ROIC; indeed, investors must always delve deeper into the means of economic profit—certainly a central message of this book. (Location 6402)

(Most have forgotten how unpopular—and even ridiculed—Warren’s yielding, zouhua, and very Misesian cash position was in the late 1990s.) (Location 6415)

combines our traditional ROIC screen with a simple EBIT relative to enterprise value screen. (Location 6420)

These cover the variation gamut (though there are certainly countless subvariations on these, including their intersection, such as perhaps the approach of Buffett), and in fact triangulate or cross-verify the Austrian Investing II approach. (Location 6423)

they fail to necessarily isolate what matters: roundabout capital and its price. (Location 6428)

The point is that we have a methodology that separates the wheat from the chaff, focusing on what matters and ignoring what doesn’t. (Location 6446)

For most value investors, even when they see the edge that their approach provides, they do not comprehend it—typically relying on mere nebulous long-term price mean reversions, and Graham famously called it “one of the mysteries of our business, and it is a mystery to me as well as everybody else”; (Location 6450)

Understanding that we are investing in a means to subsequently greater profitability, not greater profits themselves, we see that we must take the detour in order to gain the intertemporal edge of greater tools. Such thinking clears our field of view, giving it that all-important depth. (Location 6456)

Production that leads to entrepreneurial profit is an exceedingly roundabout process, which takes time and capital, and thus patience in acquiring the indirect means of that process; we should not expect such entrepreneurial profit to be easy or even desirable as it starts the process (and made even less desirable by monetary distortion). (Location 6460)

To be roundabout is to expect adversity (as opposed to just the false binary choices of failure and success). (Location 6526)

where the shi strategist pursues positional advantage for later potential, which until the end of the game, appears to be a losing strategy; all the while the li opponent goes for the more comfortable direct assault in hopes of a quick and decisive victory. (Location 6528)

and so have their polar opposites, the military strategists, thus giving us the spectrum of the very creators and destroyers of civilization. (Location 6531)

To overcome our human nature takes stamina, the ability to stay focused on and committed to a goal or objective, like the roundabout conifer that moves beyond the reaches of its competitors and hunkers down among the rocks through survival adaptations such as symbiosis with helpful fungi, (Location 6537)

it was the result of a carefully executed strategy right out of the Sunzi and Vom Kriege. (Location 6549)

as nimble Finnish troops on skis avoided direct clashes and instead maneuvered into position within the snowy, forested terrain in order to gain the upper hand. (Location 6550)

such as assuming that troops would be able to ski without ever being trained for fighting and firing weapons in snow. (Location 6556)

The Finns staged tactical retreats, feigning the rout and luring the enemy into position. (Location 6605)

Bogged down in snow and immobilized by cold, the Red Army could not retreat, no matter the cost (another foolhardy and highly destructive example of li). (Location 6618)

It is also a reminder of inner strength that enables one to carry on in spite of difficulty and obstacles, speaking as it does of character—and character building. (A typical Finnish monument to sisu is a lonely mound of rocks in Lapland, piled slowly and steadily, one by one—perseverance in the making.) (Location 6658)

sisu—delivered as a loving reminder to look within themselves for what they need to persevere and, ultimately, prevail. (Location 6661)

bestows. Angela Duckworth salutes grit in children as a dominant predictor of their future success, describing “gritty individuals” who make slow and steady progress over time despite temporary setbacks as being “tortoise-like.”7 (This description should surely call to mind those accelerating “tortoises,” the tenacious conifers.) (Location 6664)

We mustn’t forget this, and mustn’t allow ourselves to be sidetracked by the sideshows of capitalism (the securities markets)—and rather stand down from that game, and choose for ourselves which game we play. (Location 6681)

Investing, rather than providing precise instructions, is meant to be scaffolding for the roundabout process from which anyone’s degree of capitalistic investment can be better understood and gauged. (Location 6695)

Thus, we heed the stoic’s (and Bastiat’s “good economist’s”) call to get neither too excited about our victories nor too disappointed by our defeats. (I know from much experience, pretty much without exception, that you can always tell an ultimately good trader from a bad one by this simple test—it is equanimity, sisu!) When the game is played correctly, the results are but indirect Mittel to our Zweck. (Location 6697)

This quintessential entrepreneur of the twentieth century understood intuitively that it was all about evermore roundabout means, patiently and laboriously accumulated, followed at last by impatient pursuit of ends in the final stages of production. (Location 6708)

From this perspective, we might even see capitalism, itself, as a Ziel, a way station along the path toward a much bigger Zweck (a far grander shi strategy). We may be making nets and boats with the intention of catching more fish, but what we are actually doing, over many forward slices of time, is advancing society. (Location 6711)

who saw in capitalism an expression of the freedom of the individual to act according to free will and self-determination. (Location 6714)

Yes, children will grab for the immediate marshmallow, but when it comes to development, nature tricks them with the enticement of play that is part of the roundabout accumulation of cognitive abilities, creativity, physical attributes such as strength and balance, and interpersonal relationships, all of which will later bear fruit as the skills and aptitudes deployed by a forward self—the adult. (Location 6739)

but rather noncognitive qualities that include self-control, curiosity, self-confidence, and grit. (Location 6746)

The conifer’s eventual Zweck is not achieved by rushing headlong into the fray, but rather by enduring the uncomfortable places on the rocks. (Location 6764)

exuberance I had to do much of my writing in the (Location 6813)

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