In 1949, the economist Bill Phillips created something called the Monetary National Income Analogue Computer. The MONIAC was an incredible invention. There’s one at the Science Museum in London. It’s a hydromechanical model where water represents the flow of money when macroeconomic variables such as spending, investment, interest rates, saving, imports and exports are changed. As a whole, the MONIAC models an Economy. The MONIAC can be used to simulate the impact of changing monetary policy on a firm’s investment and on GDP, amongst other things.
The MONIAC helped progress economic forecasting, but it also showed how interconnected our economy is. I studied economics at university and came of age during the Great Recession of 2007 and 2008. Fun times. As a teenager studying my A-Levels, I was struck by how interconnected everything is. It still strikes me now.
However, we still separate our world into different parts. You’ve got “The City” in London, which I imagine is an impenetrable phrase for those who don’t live in the UK. You’ve got Wall Street in New York and Silicon Valley on the west coast. You had Motor City in Detroit. Then you’ve got the oil rich Gulf states. Korea is the world’s shipyard. The splintering makes sense, they are areas with high economic output. But it’s the system that matters. Maybe we should update Clinton’s famous quote - no, not that one - to “It's the system, stupid.”
That’s why Jerome Powell, the current Chairman of the Federal Reserve is one of the world’s most important people. The decision of the Fed affects everyone: obviously, anyone dabbling in the stock market or those who manage money market funds are very interested in what the Fed does. So is any homeowner or renter. But the Fed’s decisions affect people far and wide: the cattle farmer in Australia, the captain of a small cargo ship in the South China Sea, and a young student in Buenos Aires. It’s a system where everything affects everything else. The phrase “when America sneezes, the rest of the world catches the cold”, coined after a Wall Street crash, has never been truer.
It’s also common to divide the economy into the financial economy and the real economy. It’s a false differentiation. We should have learnt that from the Global Financial Crisis. The financial economy was completely intertwined like an annoying shoelace knot with the real economy. The world was only hours away from cash not coming out of the cash machines, money market funds drying up and companies being unable to make payroll. You don’t need to be an economist to know that would be, uh, problematic. That’s not a “have a nice cold pint and wait for all this to blow over” type of problem.
In the 21st century, if a bank run happens, it kills everything, but it’s not only the financial sector - the shortage of chips impacts supply chains and delivery of goods everywhere. There are spillovers between countries and spillovers between industries.
Economic interconnectedness is the double edged sword. It is the rocket fuel that powers growth when times are good, but it is the apex predator of the economic cycle when times are bad. Like an economic virus, interconnectedness means economic distress is contagious and is rarely contained within one industry.
First-order effects, second-order effects, third-order effects, fourth-order effects …. you get the idea. I guess that’s what makes economic forecasting so hard and studying economics so fun. It’s also what makes eminent economists look pretty foolish when their predictions are wrong. In 1998, Paul Krugman, a Nobel prize winner no less, said: “By 2005 or so, it will become clear that the Internet's impact on the economy has been no greater than the fax machine's.” Boy, that’s a doozy for wrongness.
When the Bank of England raises interest rates to 4.50% to help reduce the rate of inflation, borrowing becomes more expensive. It depresses business investments and changes capital allocation as investment moves into safer assets. It becomes more expensive to pay off a mortgage and suppresses demand in the housing market. Higher mortgage payments mean that households reduce spending on discretionary goods and sales decline. This has an impact all along the supply chain. You’ll buy less from Amazon and Alibaba, and so there is less demand for shipping, and our friend, the boat captain in the South China Sea will be less busy. If it gets really bad, he’ll have to let employees go, and that’ll be sad. He’ll reduce investment, and the shipyards of South Korea might be a little bit quieter. The decision of the Fed in Washington impacts the worker in Ulsan.
It’s not just the human factors too, the pesky weather often throws economic curveballs. Take the banana. Trusty Ecuador accounts for 28% of the world’s $12.3 billion worth of banana exports. That’s higher than anywhere else, by far. If there’s bad weather in Ecuador, that will hit the supply of bananas. Our old friend, supply and demand means that the price will rise. But demand for food doesn’t reduce - you still need to eat; instead, you’ll substitute demand for that banana for something else. A Wetherspoons fry up, perhaps? No, just me? One loss of revenue can be made up by increasing revenue elsewhere. It’s enough to make the Del Monte man choke on his banana.
Well, what are we to do with all this interconnectedness? I see only one way forward - embrace it, and grow the wealth of the system as a whole. Former US president William Taft said: “I am in favour of helping the prosperity of all countries because, when we are all prosperous, the trade with each becomes more valuable to the other.” Wise words.
He said this over 110 years ago, and since then interconnectedness has only increased. World trade volume is 45 times greater in 2022 than in 1950.
82% of FTSE 100 revenue originates outside of the UK, a figure that has been steadily climbing. For the S&P 500, the figure is 40%. The value of total exports as a share of GDP has shot up sharply in my lifetime, from around 15% of global GDP in the early 1990s, to 25% now.
Perhaps there’s no better measure of interconnectedness than how we live alongside one another: the number of foreign nationals in the UK has been growing over time.
So, with the MONIAC, a spectacular bit of engineering, Bill Phillips was onto something, but really we need another 196 MONIACs, one for each country. Call it a super-MONIAC. Spend your life perfecting the understanding of the economic machine and how all the different bits fit together, and you’ll have a superpower understanding of economics.
