A. W. H. Phillips

• The Bottom Line: A. W. H. Phillips was an economist who created the “Phillips Curve,” a famous (and often debated) model showing a trade-off between inflation and unemployment, which serves as a crucial reminder for value investors to focus on business resilience rather than trying to predict the economic big picture.
• Key Takeaways:
• What it is: A. W. H. Phillips (1914-1975) was a New Zealand economist best known for the Phillips Curve, which suggests that as unemployment falls, inflation tends to rise, and vice-versa.
• Why it matters: While value investors should never use this to time the market, understanding the concepts of inflation and unemployment helps us appreciate the economic environment a company operates in and reinforces the need to own businesses with pricing_power.
• How to use it: Use the economic climate described by the Phillips Curve not as a stock-picking tool, but as a backdrop to stress-test your investments and demand a larger margin_of_safety when economic uncertainty is high.

Imagine an Indiana Jones-style adventurer: a man who hunted crocodiles in Australia, managed a cinema in New Zealand, fled the Japanese invasion of China, and spent three and a half years as a prisoner of war after the fall of Java. Now, imagine that same man becoming one of the most influential economists of the 20th century. That man was Alban William Housego “Bill” Phillips. Phillips wasn't your typical tweed-jacketed academic. His practical, hands-on background as an electrical engineer led him to one of his first famous creations: the MONIAC (Monetary National Income Analogue Computer). It was a bizarre, room-sized contraption of tubes, tanks, and pumps that used colored water to physically model the flow of money through the British economy. It was a brilliant, tangible way to show how different economic variables interacted. This knack for seeing connections led to his landmark 1958 paper. By studying nearly a century of British economic data, Phillips noticed a remarkably consistent pattern. When unemployment was low, wages tended to rise quickly. When unemployment was high, wage growth slowed or even fell. This simple, inverse relationship—like two kids on a seesaw—became famously known as the Phillips Curve. In simple terms, the curve illustrates a trade-off that governments and central banks face:

• To lower unemployment, you might need to accept higher inflation.
• To fight inflation, you might need to accept higher unemployment.

For decades, this curve was a cornerstone of economic policy. However, the 1970s threw a massive wrench in the works with the arrival of “stagflation”—a nasty combination of high unemployment and high inflation, something the original Phillips Curve suggested shouldn't happen. This showed the relationship wasn't a permanent law of nature, but a historical correlation that could break down. For an investor, the story of Phillips and his curve is not a tool for predicting the future. Instead, it's a foundational lesson on the powerful forces of inflation and employment that shape the world in which our companies either thrive or struggle.

“The first rule of compounding: Never interrupt it unnecessarily.” - Charlie Munger. (This serves as a reminder to not let macroeconomic forecasts, like those derived from the Phillips Curve, jolt you out of a good long-term investment).

At first glance, a macroeconomic concept like the Phillips Curve seems like the exact opposite of what a value investor should focus on. Warren_Buffett and Benjamin_Graham taught us to be “business pickers,” not “economy forecasters.” They urged us to analyze individual companies—their balance sheets, their moats, their management—and largely ignore the noisy predictions of economists. So why should we care about A. W. H. Phillips? Because while we must never use his work to predict the market, we must use the concepts he studied to protect our portfolios. Understanding the relationship between inflation and unemployment is crucial for three reasons: 1. It Highlights the Ultimate Enemy: Inflation. The Phillips Curve puts a spotlight on inflation, the silent thief that erodes the real value of our returns. High inflation means the cost of raw materials for a company goes up, the wages it pays its employees go up, and the future cash it generates is worth less in today's dollars. A value investor’s calculation of a company’s intrinsic_value is meaningless without considering the impact of inflation. It forces us to ask the single most important question about a business in an inflationary environment: does it have pricing_power? Can it raise prices to offset rising costs without losing customers? A company like Coca-Cola can; a generic airline cannot. 2. It Informs Our Need for a Margin of Safety. The 1970s breakdown of the Phillips Curve into stagflation is a perfect lesson in humility. It proved that even the most accepted economic models can fail spectacularly. The future is uncertain. The economy can do strange things. This uncertainty is precisely why we demand a margin_of_safety. We buy a stock for $10 when we believe it's worth $20 not because we are certain the economy will be strong, but because we know it might be weak. A deep discount provides a cushion against macroeconomic surprises, whether it's a recession (high unemployment) or runaway inflation. 3. It Helps Us Ignore Mr. Market's Macro-Panic. The stock market, personified by Graham as the manic-depressive Mr._Market, is obsessed with Phillips Curve-related data. Every month, traders hold their breath for the latest inflation (CPI) and unemployment reports. They buy or sell in a frenzy based on tiny deviations from economists' forecasts. The value investor who understands the underlying concepts—but refuses to play the prediction game—can take advantage of this. When Mr. Market panics and sells off a wonderful business because of a scary inflation number, the prepared investor sees a buying opportunity, secure in the knowledge that the long-term value of the business is not determined by one month's data. In short, the Phillips Curve is not a map for telling us where the economy is going. For a value investor, it's a compass that constantly points us back to the timeless principles of buying resilient businesses, demanding a margin of safety, and keeping a level head.

A value investor does not “apply” the Phillips Curve to forecast or time the market. That is a speculator's game. Instead, we apply the insights from the economic forces it describes to make our investment analysis more robust and reality-based.

1. Step 1: Acknowledge the Prevailing Economic Climate. Are we in a period of low unemployment and rising wage pressures (the classic Phillips Curve scenario)? Or are we in a period of high unemployment and low inflation (a recessionary environment)? Or something else entirely? You don't need to predict the next move; just observe the current reality. Check the latest reports on the Consumer Price Index (CPI) for inflation and the national unemployment rate.
2. Step 2: Stress-Test Your Valuation. Your analysis of a company's intrinsic value should not assume a perfect economic future. Use the current climate as a basis for a “what if” analysis.
   • If inflation is rising: Ask yourself, “What happens to this company's profits if its input costs rise by 8% for the next two years? Can it pass those costs on to its customers? How does this affect my discounted_cash_flow calculation?”
   • If unemployment is rising: Ask yourself, “This company sells luxury boats. What happens to its sales if 1 million more people lose their jobs? Is its balance sheet strong enough to survive a deep recession?”
3. Step 3: Prioritize Business Quality Over Economic Forecasts. The most important application is to relentlessly filter for quality. The economic environment is a test that separates great businesses from mediocre ones.
   • In an inflationary world (low unemployment), look for:
     • Strong brands with loyal customers (pricing_power).
     • Low capital requirements (don't have to keep replacing expensive machinery at inflated prices).
     • Healthy profit margins that can absorb some cost increases.
   • In a recessionary world (high unemployment), look for:
     • Rock-solid balance sheets with little debt.
     • Products or services that are non-discretionary (people buy them even in tough times, like toothpaste or electricity).
     • Competent management with a track record of allocating capital wisely during downturns.
4. Step 4: Use Macro News as a Source of Opportunity, Not Fear. When the market sells off indiscriminately due to a bad inflation report, your watchlist of high-quality companies should be ready. The panic of others becomes your opportunity to buy wonderful businesses at fair prices. You are acting based on the durable value of the business, not a fleeting economic statistic.

Let's consider how a value investor, aware of the forces described by the Phillips Curve, would analyze two hypothetical companies in an environment of rising inflation and low unemployment.

The Value Investor's Thought Process: The news is full of talk about inflation heating up. The Phillips Curve framework suggests that with a tight labor market, these price pressures might continue. How does this affect my view of these two companies?

• Trendy Gadgets Corp.: “I'm worried about Trendy Gadgets. Their costs are rising, but their ability to pass those costs on is weak. In an inflationary world, consumers' budgets get squeezed. A new $1,200 gadget is one of the first things they'll cut back on. If a recession follows the inflation (rising unemployment), their sales could plummet. The company's debt makes it even more vulnerable. The risk here is high, so my required margin_of_safety would have to be enormous.”
• Steady Edibles Inc.: “Steady Edibles is in a much better position. Their costs are also rising, but their pricing power is immense. Everyone needs to buy groceries. They can increase prices to protect their profit margins. Their products are non-discretionary, so even if the fight against inflation leads to higher unemployment and a recession, their sales will be relatively stable. Their strong balance sheet means they can weather any storm. This is the type of resilient, all-weather business that thrives precisely because it is not dependent on a perfect economic forecast.”

The investor isn't predicting inflation will be 7% or 3%. They are using the threat of inflation and potential recession to test the fundamental strength of each business. This leads them to favor the durable, simple business over the exciting but fragile one.

• Provides Essential Context: It helps you understand why the federal_reserve makes decisions about interest_rates and why the market reacts so strongly to economic data. It's like knowing the rules of the game, even if you don't play it.
• Highlights the Importance of Pricing Power: It serves as a constant, powerful reminder that the single most important defense against inflation is a company's ability to raise its prices.
• Reinforces Anti-Speculative Discipline: Properly understood, it immunizes you against the temptation to time the market. You know the relationship is unstable and unpredictable, so you focus on what you can control: your analysis of individual businesses.

• The Trap of Prediction: The biggest pitfall is believing the Phillips Curve is a reliable forecasting tool. It is not. The stagflation of the 1970s and other periods have shown it can break down completely. Any investment strategy based on predicting its movements is pure speculation.
• Distraction from Bottom-Up Analysis: Spending too much time worrying about inflation and unemployment data can lead to “analysis paralysis” and distract you from the core value investor task of reading annual reports and understanding specific companies.
• It's an Oversimplification: The real economy is infinitely complex. The relationship between inflation and unemployment is influenced by globalization, technology, demographics, and government policy in ways Phillips could never have foreseen. Relying on this one trade-off is a dangerously simplistic view of the world.

• inflation
• interest_rates
• federal_reserve
• business_cycle
• pricing_power
• margin_of_safety
• mr_market
• intrinsic_value
• benjamin_graham