The Interesting Times: Become Like Water My Friend (Republish)

Photo taken 13,000 ft above sea level on Wheeler Peak, hiked via the Bull of the Woods Trail. Highly recommended!

I did manage to publish a tweetstorm summarizing Francis Fukuyama's Origins of Political Order, one of the best books on geopolitics and world history that I've ever read.

We recorded Mutiny Investing Podcast with Headwaters Volatility CIO Matt Rowe that should come out next week.

I am working on a follow-up article to Reality has a surprising amount of detail on how the concept applies to investing that should also be out in the next couple of weeks.

I will also be sending out the monthly newsletter for Mutiny Fund next week with links for investors interested in learning more about investing in volatility and tail risk. You can sign up to get it here.

Become Like Water My Friend

Editor's Note: This week is a re-run of the July 10 edition of The Interesting Times. It was one of the most popular editions ever, but there was some deliverability issues with our email service provider and some people did not receive it. I've chosen to re-include this week as I've been offline most of the week and don't have a new post to share.

Sun Tzu's The Art of War is a book nominally about, well, war. It’s kind of deceptively titled though. A more accurate title would be “The Art of Not Going to War Unless You Really Can’t Avoid It And Then Still Avoiding Fighting as Much as Possible.” That’s a bit of a mouthful, so probably best to stick the original, but you get the point.

The Art of War applies to competition and conflict in general, on every level from the interpersonal to the international. Its aim is invincibility, victory without battle, and unassailable strength through understanding the physics, politics, and psychology of conflict.

Though it can be abused, war is a helpful metaphor to think about conflict because the stakes for being right are really high. Your company being outcompeted by a competitor stinks, but your country being invaded and decimated and many people dying is like way, way worse so there’s a big incentive to get the strategy right.

What does getting it right look like? The central metaphor of Sun Tzu’s work is water.

“A military force has no constant formation, water has no constant shape. The ability to gain victory by changing and adapting according to the opponent is called genius.”

Genius, in Sun Tzu’s explanation, is to behave like water. Water is strong offensively and defensively.

If you are standing in the ocean as the waves come at you, punching or pushing at the wave is a strictly futile effort, the water simply redirects around you to the points where you are weak. You can neither strike it offensively nor resist it defensively. It flows away from where you are strong to wherever you are weak.

“When the victorious get their people to go to battle as if they were directing a massive flood of water into a deep canyon, this is a matter of formation. When water accumulates in a deep canyon, no one can measure its amount, just as our defense shows no form. When the water is released it rushes down in a torrent, just as our attack is irresistible.”

Water is at once full of power and empty of form, impossible to attack and impossible to resist.

This metaphor has been echoed by many other strategists. Bruce Lee when talking about his fighting style famously said:

“You must be shapeless, formless, like water. When you pour water in a cup, it becomes the cup. When you pour water in a bottle, it becomes the bottle. When you pour water in a teapot, it becomes the teapot. Water can drip and it can crash. Become like water my friend.”

This sound pretty badass but it’s not intuitively obvious to me how I would operate differently in my life or business or investments by “becoming like water.”

As I was reading through The Art of War, I thought of the work of John Boyd, another military strategist most famous for his idea of the OODA Loop. OODA is an acronym standing for:

Observe
Orient
Decide
Act

The OODA loop is often seen as a decision-making model but can be more accurately described as a model of individual and organizational learning and adaptation. It is a model initially developed for military strategy, but is more broadly applicable.

Boyd’s primary focus of study for strategy was the German Blitzkrieg.

Before the Second World War, German generals had gone back and studied earlier military strategists and designed the blitzkrieg style to emulate the maneuver warfare styles of Sun Tzu and Genghis Khan rather than the attrition style of World War I.

World War I had been a long, protracted series of trench warfare. It was less like flowing water and more like banging stones. The Blitzkrieg strategy employed by the Germans was much more fluid and embodied many of Sun Tzu's principles.

There were three central concepts to the Blitzkrieg that Boyd studied: Schwerpunkt, Einheit and Fingerspitzengefühl.

Schwerpunkt literally translates as center of gravity or emphasis.

In military terms, it is usually the geographic point of attack.

In non-military terms, it is probably best understood as focus or the main priority. Having a clear focus, and emphasizing that over any particular tactic, empowers those around you to make decisions for themselves instead of having to run everything by you.

Facebook kept the number of users on huge TV screens around their office for many years. Everyone knew that when they were faced with a decision, they should make whatever decision caused that number to go up.

Einheit translates to something like “mutual trust.”

The German Blitzkrieg commander Heinz Gaedcke explained that one of the essential reasons for the success of the Blitzkrieg was that the German commanders all trusted each other implicitly. They had a relationship where they could look at each other in the eye and know exactly what needed to be done without speaking.

Fingerspitzengefuhl translates literally as a fingertip feeling but is most easily understood as intuitive skill or intuitive knowledge.

A good military commander that has trained well can pattern match in real-time which looks to others like an intuitive feeling for how to manage the battle. The German tank commanders could see where the enemy was weak and know to focus their efforts there. Similarly, good business leaders are able to draw on their experience to know where to focus their effort and resources.

If you have all three of these together, it looks very much like flowing like water. During the German blitzkrieg (which reached Paris in an astoundingly short time), you had all these factors operating together.

Your commanders have Fingerspitzengefuhl, a fingertip feeling, which allows them to sense where a weak point is in the enemy lines pops up.

This weak point becomes the Schwerpunkt or center of focus for the German troops.

Other troops quickly flow to this weak point because they trust their fellow soldiers (Einheit). This lets them break through the enemy lines, forcing the enemy to retreat and regroup.

If you were to look at how these troop movements behaved from a top-down, it would look a lot like flowing water. Little droplets (small groups of troops) probe each point of the enemy’s lines. When they start to sense a weak point and a small breakthrough happens, water (troops) from elsewhere flow towards the weak point. This causes it to weaken further.

Eventually, they fully breakthrough and the rest of the troops flow through the wide hold in the enemy’s lines.

Then the enemy retreats to try and form a new line and the same process repeats. Little probes eventually find a weak point and the rest of the forces flow through. The German troops were flowing like water, moving through the enemy lines at the point of least resistance.

From the enemy’s perspective, it is like trying to fight with the ocean. Wherever they strike, you fade away, flowing towards the point of least resistance.

Sun Tzu talks about this in terms of emptiness and fullness. Where they strike, you are empty. But, where you strike, there is fullness that “punches” through.

The psychological outcome of this flowing like water is a feeling momentum. When you flow like water, you are going where the momentum takes you and so you have the momentum behind you.

Having spent a decade advising and working with hundreds of companies across many different industries, I would say there is basically nothing more important to a company’s success than momentum.

When an army has the force of momentum, even the timid become brave; when it loses the force of momentum, even the brave become timid.

When a company has momentum, it seems like everyone is good at their job. Getting in a habit of winning consistently and following momentum is incredibly valuable. One way to lose momentum is to try and do too much. Often projects get scoped too big and drag on for too long, losing momentum.

When you do battle, even if you are winning, if you continue for a long time it will dull your forces and blunt your edge; if you besiege a citadel, your strength will be exhausted. If you keep your armies out in the field for a long time, your supplies will be insufficient.

Good managers and companies don't let projects drag on. They seize momentum and ship quickly.

Good companies also cut their losses quickly. If you start an initiative and it doesn't get momentum fast, get rid of it.

When your forces are dulled, your edge is blunted, your strength is exhausted, and your supplies are gone, then others will take advantage of your debility and rise up. Then even if you have wise advisers you cannot make things turn out well in the end.

Therefore I have heard of military operations that were clumsy but swift, but I have never seen one that was skillful and lasted a long time.

Speed and momentum are the killer forces in all competitive environments and the notion to “become like water” is about how to get those on your side.

In his 2016 letter to shareholders, Amazon CEO Jeff Bezos gave similar advice:

“Most decisions should probably be made with somewhere around 70% of the information you wish you had. If you wait for 90%, in most cases, you’re probably being slow. Plus, either way, you need to be good at quickly recognizing and correcting bad decisions. If you’re good at course correcting, being wrong may be less costly than you think, whereas being slow is going to be expensive for sure.”

In Sun Tzu’s terms, seizing the momentum is more important than being right. If you are wrong, you simply stop change and flow towards wherever the weakness is. Water doesn’t know the exact path it will take, it just worries about flowing downhill.

Boyd also focused on the idea of momentum, Getting inside your adversary’s OODA loop is done by executing what he called “fast transients,” WTF moments designed to make your adversary feel trapped in an unpredictable world of doubt, mistrust, confusion, disorder, fear, panic, and chaos.

The “transient” is the change between maneuvers. The ideal fast transient is an abrupt, unexpected, disorienting change that causes the other side to say “What the f**k!”

Boyd was a renowned dogfighter because he would create disorienting, WTF moments by engaging in an unexpected maneuver, and by the time the other pilot was able to re-orient, it was too late.

Similarly, good leaders seize momentum. When they see an unexpected source of momentum, they don’t think “that’s not in the plan,” they think “this is the new plan.”

One of the most useful questions I ask myself as part of my weekly review is “What were the 3 biggest wins or unexpected sources of momentum and how can I double down on them.” This is basically the idea of flowing to the point of least resistance, being like water.

This is particularly important because market structure is always changing. Tactics that work right now may not work next year and so it's important to seize the momentum today.

I think businesses can copy this idea of being like water by employing Boyd’s ideas of schwerpunkt, fingerspitzengefuhl, and einheit.

Indeed, these are the core jobs of a good leader. The leader looks for the most important focus for the company (schwerpunkt) using their intuitive feeling for the market (fingerspitzengefuhl) and then build a culture of mutual trust (einheit) that enables everyone to work in sync.

The leader also knows when to defer to the fingerspitzengefuhl of their team and let them be the ones that run with something when they have a better fingertip feeling rather than trying to micromanage.

Become like water my friend.

Money, Blockchains, and Social Scalability
Unenumerated

There are not a lot of blog posts worth reading multiple times, but this one from Nick Szabo is one I have revisited maybe a dozen times.

Nick was the creator of bitgold, a cybermoney that had many characteristics similar to bitcoin. He is arguably the most knowledgable person about cryptocurrency alive (enough that many people speculate he is Satoshi Nakamoto).

This blog post on social scalability lays the conceptual foundation for why Bitcoin is important and worth taking seriously and is the first place I tend to point people interested in learning more about bitcoin. I summarized Nick's piece here.

Kelly Versus Classical Portfolio Theory, And The Two Kinds Of Uncertainty Premium

Rob Carver

This post makes an important distinction between two different forms of uncertainty.

First, "risk" (which we can think of as known unknowns, or at least the amount of volatility expected from a risk & return model which is calibrated on past data) and "Uncertainty" (which we can think of as unknown unknowns, or to be more precise the unknowability of our risk & return model).

In my experience, people often conflate the two which leads to sub-par investment decision making.

Ages of Discord

Peter Turchin

I'm a sucker for the "grand theory of everything" book genre. The downside to the genre is that all the books in it are wrong. The upside is that some of them manage to be wrong in interesting and new ways which is a pretty impressive achievement in my mind.

Ages of Discord is one such book that seeks to explain why and how recurring periods of prosperity and distress arise focusing on structual-demographic variables.

To start with what I didn't like, I kept getting a sort of vague worry about scientism. Turchin spends a good amount of time talking about the equations he uses to try and model social trends, but he's dealing with such macro variables over such a long time frame that there's no way to get good data. (E.g. No one really knows what real wages were in 1810 America). I think Turchin operates in good faith in trying to piece together such big picture questions, but I think you ultimately can't "prove" anything on the scale at which Turchin is arguing in any meaningful way.

That being said, I think the "person sitting in armchair spit-balling on grand theories of everything" genre is underrated. Aristotle, Kant and Nietzche all fall in that camp and they had some pretty cool ideas so I'm along for that ride.

Read in that light, Turchin's theory is still very interesting. The core of the theory is that social conflict is the result of "elite overproduction." There are only so many senators, Fortune 500 CEOs and Big Law partners and as competition for those limited seats heats up, it causes society to fracture.

Turchin looks at the United States from founding to present, seeing two macrocycles. The first cycle ultimately resulted in a Civil War as Northern and Southern elites clashed over economic policies. Turchin believes the most recent cycle peaked around 1970 and we are headed towards a similar "disintegrative phase" (though not necessarily a Civil War).

Though I think the elite overproduction thesis is oversimplified, it is wrong in an interesting way as I do think that the story of the 1% vs. the 0.1% is perhaps more explanatory than the more popular 1% vs 99%.

I think Turchin is also correct in the important way that we tend to overemphasize legible factors, particularly figureheads (e.g. presidents) and overestimate how much power they actually have. His focus on structural factors and demographics like birth rates and immigration seems much better placed to me.

If you're interested, here's a good summary in Turchin's own words.

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