The Cantillon Effect
The Cantillon Effect was a theory put forward by Richard Cantillon in the 18th Century. Cantillon argued that those who received the newly created money first would benefit the most, while those who received it last, would benefit least.
For example, imagine the government creates a large amount of new money and provides this to large institutions. These institutions can use this money for investments in various assets. They would benefit from buying the assets at the current market price, whilst simultaneously driving up the price of those assets. By the time this new money flows through to smaller businesses and individuals, they will now be on the receiving end of these higher asset prices, without having benefited from the new money itself. Hume noted himself that “some time is required before the money circulates through the whole state, and makes its effect be felt on all ranks of people.”
The Pros and Cons Of Money Creation
Some economists suggest that new money creation is vital in order to stimulate economic growth. This is true in a debt-based system. Without the creation of new money, governments would not be able to service their mandatory costs (let alone their other costs) using tax revenue alone (James Lavish has some great insights on this – check out his podcast interviews!). To get around this, they create new money, inflate prices, and pay the debt back with “cheaper money”….sounds a lot like a Ponzi scheme, you may be thinking?
New money creation and the current system have undoubtedly led to prosperous times (for some, anyway), and led to technical innovations that most are now benefiting from. However, because this system requires the constant creation of new money to pay off old debts, at some point the debt and interest payments can grow at an exponentially faster rate than the revenue and money creation.…like we are all witnessing at the moment. This is where modern monetary theory breaks down – in good times you repaid your dues, in the bad times you used stimulus to encourage economic stability. Now it’s just a free for all with lack of accountability.
Of course, the drawbacks of this approach are that whilst it enables the governments to continue “functioning”, it leads to asset price increases and inequality in wealth distribution, because those who are further down the socio-economic ladder will find they can never catch up with the rising costs, due to stagnant wage growth not keeping up with these assets rising in price, as well as not owning the assets that go up in price.
Why is it fair that the government can finance its obligations through money creation, which benefits the already wealthy at the expense of the middle class and below? It isn’t. Financial irresponsibility is leading to a chasm in the wealth divide, but it’s not necessarily the wealth divide that’s the problem, it’s the fact that the wealthy are able to play by a different set of rules to the rest of us. And you may be shouting at your screen, “so just invest in assets then”…..what if you can’t, or you don’t know the root of your problems – you aren’t aware the system is designed to steal your energy? What if you’re not in the USA, but in a country that doesn’t have access to investing in the S&P500?
Who Does It Benefit?
Typically, new money creation benefits those who receive it first, including; banks, financial institutions, and wealthy individuals. These groups of people are able to use the new money to buy assets before prices have gone up, and when the prices do go up, they profit substantially at the expense of those who didn’t have new money to invest.
New money supply can also lead to interest rates falling, so those able to buy at lower rates, such as institutions, not only benefit from the use of the new money creation, but also the lower interest rates as an effect of that.
Who Does It Affect Negatively?
Whilst it’s been shown that new money creation can benefit a select cohort, it can have disastrous effects on other cohorts. It has been suggested that this financial system privatises gains and socialises losses.
People who are on low/fixed incomes and may not necessarily be able to afford/have access to assets will be hit the hardest. They don’t see the effects of new money supply until later in the process, and by the time they do, they have already lived through rising prices caused by the new money creation. Furthermore, wages don’t track asset price increases, which puts further pressure on the already struggling cohort of low-income people. As if this wasn’t enough, to add salt to the wound, because they would also be seen as a higher risk to default on a loan, they would also suffer the penalty of paying higher interest rates to offset this risk with the banks. They don’t get the new money supply; suffer from price inflation; pay higher interest rates – any wonder why there is increasing societal dysfunction?
As I have already stated, this isn’t just about an ever-increasing wealth divide. It’s about this system taking energy and basic rights from the middle and lower class, and making them more reliant upon the wealthy. We are pushing people down the hierarchy of needs by removing things that would be classed as human rights: sovereignty of one’s property, access to housing, protection of purchasing power……
The wealthy get to benefit from inflated asset prices, whilst the rest of us pay the price of inflated asset prices. One might conclude that this is not a very fair game.
As a real-life example of this, in the 1970s, the USA Federal Reserve created a large amount of new money in an attempt to stimulate the economy. The stock market and real estate prices skyrocketed, while wages remained stagnant. This led to a situation where the rich got richer and the poor got poorer. The poorest Americans saw their incomes decline by as much as 20% in real terms.
Another example is Zimbabwe in the 2000s. The government printed a large amount of money in an attempt to finance its spending, but this led to hyperinflation. The value of the Zimbabwean dollar collapsed, and prices rose at an astronomical rate. This made it difficult for ordinary Zimbabweans to buy food and other necessities. Many people were forced to live in poverty.
Would Bitcoin Help To Neutralise This Imbalance?
Bitcoin could help reduce the negative impacts of the Cantillon Effect by bringing financial responsibility back to the system, by introducing a foundational trust layer to society. If the USD was backed by Bitcoin, and it was agreed that a certain ratio had to be maintained, then the government’s ability to create new money would be reduced. If Bitcoin became the new financial system, it is impossible to create new Bitcoin, and therefore the Cantillon Effect would not occur.
Yes, there would still be a wealth divide between the early adopters and the laggards, but, the crucial difference is, Bitcoin is a fully auditable system that cannot be changed or manipulated to benefit one cohort, and negatively affect another. It introduces a foundational layer of trust, and everyone is able to play the same game as everyone else, just at different magnitudes. The wealth divide isn’t the problem, it’s the creation of wealth at the expense of others that is.
Summary
In summary, it’s hard to deny that the Cantillon Effect is real, and it’s only becoming more and more evident as the debt to GDP ratio grows wider, and more money creation is required to pay off old debts…..and likely to only keep growing. A “D-E-B-T spiral” as Greg Foss puts it. Will a Bitcoin Foundational Layer solve this, and allow us to level up as a society? I would argue yes, it would. Let’s return assets to their utility value and allow people to play on a level playing field again. Let’s restore trust to society and collectively climb the hierarchy of needs.
