Spitznagel - Zero Rates Take Investors Down A Dangerous Path

This story appears in the August 12, 2013 issue of Forbes.
By Mark Spitznagel of Universa Investments

The U.S. stock market’s return to nominal alltime highs amid artificial zero interest rates is sending yield-hungry investors down a dangerous path, one they hope will continue to lead to quick and easy returns. Such pursuits ignore a reality grounded in some of the oldest human wisdom, dating back 25 centuries to the Daoist sages of ancient China, who eschewed the direct in favor of the indirect–the roundabout that leads to better strategic advantage.

This is the Daoist concept of shi, of avoiding the immediate and decisive clash (what they called li ) with its high risk of loss (the parallel to today’s top-heavy market should be obvious) in order to move decisively later from a stronger position against an enemy vanquished by its overextension. The preeminent industrialists, economists (specifically the Austrians) and military strategists (most notably Sun Tzu of The Art of War and the oft misunderstood Carl von Clausewitz of On War ) have all embraced the roundabout of “going right in order to go left.”

In most strategic human undertakings, particularly in investing, the circuitous is, paradoxically, the superior route–the central point of my book, The Dao of Capital: Austrian Investing in a Distorted World . Indeed, as Austrian economics forefather Eugen von Bohm-Bawerk observed, it is often the only way. The Austrians taught that this is the map of civilization’s progress, forgoing consumption to amass more roundabout capital structures that subsequently result in greater efficiency and productivity.

Yet, for investors, it remains counterintuitive, uncomfortable and often downright foolish to sit on the sidelines during heady times, waiting for better opportunities to come while others rack up easy gains. (Though one never knows precisely when, history shows this artificial-liquidity-fueled rally will end badly.) The roundabout goads us beyond the immediate to adopt a depth-of-field perspective comprised of a series of forward “now” moments and to avoid that which would undermine the opportunities in those forward nows.

Fortunately, we have role models from nature: The leitmotif of The Dao of Capital is the conifer, the towering success story of our planet, which once ruled uncontested (save for the herbaceous dinosaurs) until some 65 million years ago, when aggressive angiosperms (grasses and deciduous trees) emerged and overtook them. To survive, conifer trees developed an adaptive niche, retreating to the unpopular places where the competition couldn’t grow. Even today, in their roundabout growth, they slowly amass the necessary “capital” of thick bark, efficient roots, needled leaves and a tall canopy, gaining strategic shi advantages. Thus the conifer “tortoises” accelerate their growth, eventually exceeding that of the angiosperm “hares” (and even taking their land after wildfires rage).

Great entrepreneurs, too, walk this circuitous path by reinvesting their profits rather than consuming them as dividends or as unproductive cash. Henry Ford, the quintessential example, plowed profits back into operations in an autocatalytic process of tools begetting more tools (steelmaking and foundries to produce parts for the assembly line economically). This is what Bohm-Bawerk called Produktionsumweg, which requires hefty immediate investment costs that often feel like setbacks, wherein the yield-hungry marketplace metes out punishment for the shrinking short-term profits that follow. But this is the very foundation for the capital structures that are the means to higher, though later, production and profit.

No matter how appealing the direct path, it will likely not best take us where we want to go. Most often it leads only to loss–the hare ultimately loses to the accelerating, roundabout tortoise. Thus we must invest like the triumphant, roundabout conifer–and the illustrious entrepreneur. Investors (and policymakers) ignore this universal logic of growth at grave risk to themselves–and to the progress of civilization itself.