Finding Equilibrium

By: Erik Swarts | Tue, May 31, 2011
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William Phillips

William Phillips was many things before he became an economist.

The man behind the Phillips Curve was a dairy farmer, crocodile hunter, cinema manager, electrical engineer, member of the Royal Air Force and POW. By the end of WWII he had become so fascinated with sociology through his experiences in the war that he enrolled at the London School of Economics. He eventually was intrigued by the increasingly accepted Keynesian theory that he switched fields to economics.

Eleven years later he was a full professor at LSE.

Creative and pragmatic in a field typically steeped in academia and theoretical nuance - Phillips became famous for developing the MONIAC in 1949 while still a graduate student at LSE. The MONIAC (Monetary National Income Analogue Computer - later referred to as the Phillips Machine) was created using fluidic logic to model the workings of the UK economy at that time. Using his practical experience in engineering, he recreated monetary and fiscal practices in the tangible and manipulative medium of water.

He saw that money stocks could be represented as tanks of water, and monetary flows by water circulating round plastic tubes.

With a grant of £100 (obtained with Newlyn's help) he spent the summer of 1949 in a garage in Croydon 'living on air' as James Meade was later to put it, working on a hydraulic representation of the Keynesian model.

In the machine he constructed, the circular flow of income was represented by water being pumped round a series of clear plastic tubes, with outflows representing savings, taxes and imports, and inflows representing investment, government spending and exports. The model had three tanks representing the stock of money, one for transaction balances and one for foreign-held sterling balances. The whole system determined the level of income, the rate of interest, imports, exports and the exchange to an accuracy (astonishing at the time) of +two per cent. The time path of income and the other variables was traced out by plotter pens making it possible to analyse the quantitative effects of economic policy.

The machine, in the jargon, was a hydraulic representation of an open economy IS-LM model with an explicit underlying dynamic structure. It was this very Heath Robinson prototype which, with the enthusiastic support of James Meade (then Professor of Commerce at the School), Phillips demonstrated to Lionel Robbins' seminar in November 1949. Those attending gazed in wonder at this large (7ft high x 5ft wide x 3ft deep) 'thing' in the middle of the room. Phillips, chain smoking, paced back and forth explaining it in a heavy New Zealand drawl, in the process giving one of the best lectures on Keynes that anyone in the audience had ever heard. Then he switched the machine on. And it worked! According to Lord Robbins' recollections, "there was income dividing itself into consumption and saving...Keynes and Robertson need never have quarrelled if they had had the Phillips Machine before them" The Phillips Machine Project


Even for a professional trader it's easy to get distracted by the market's manifold of moving parts. You could say it's another example of a Rube Goldberg Machine.

Over engineered, inefficient - yet functional.

On occasion, components within the apparatus become excessively inefficient and full of friction. The machine goes on functioning for a time, until either the inefficiencies are corrected in-situ or the system breaks down all together.

Today, Europe is the zone of friction within the apparatus. The various participants keep coming back to address the audible rattles - but the problem is much greater than the occasional lubrication of liquidity or jawboning from the ECB.

It is a design flaw inherent to the great asymmetries of the eurozone itself.

Ironically, I'm sure if Milton Friedman and William Phillips were alive today - they would be in agreement to that line of reasoning. Perhaps from different perspectives, but if a Chicago school economist and a Keynesian economist would both agree that the Euro was doomed from the outset - what's left to debate?

Video & Audio: The Phillips Machine Demonstrated by Alan McRobie


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Erik Swarts

Author: Erik Swarts

Erik Swarts
Market Anthropology

Although I am an active trader, I have always taken a broad perspective when approaching the markets. I respect the Big Picture and attempt to place each piece of information within its appropriate context and timeframe. I have found that without this approach, there is very little understanding of ones expectations in the market and an endless potential for risk.

I am not a stock picker - but trade the broader market itself in varying timeframes. I want to know which way the prevailing wind is blowing, where the doldrums can be expected and where the shoals will likely rise. I will not claim to know which vessel is the fastest or most comfortable for passage - but I can read the charts and know the risks.

I am not a salesperson for the market and its many wares. I observe it, contextualize its moving parts - both visible and discrete - and interpret.

I practice Market Anthropology - Welcome to my notes.

Erik Swarts is not a registered investment advisor. Under no circumstances should any content be used or interpreted as a recommendation for any investment, trade or approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This is strictly for educational and informational purposes only. All opinions expressed by Mr. Swarts are subject to change without notice, and the reader should always obtain current information and perform their own due diligence before making any investment or trading decision.

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