The Cantillon Effect

How and why the rich keep getting richer
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The Cantillon effect is also called the non-neutrality of money. Newly created currency is not distributed evenly in an economy. It benefits the first recipients of the currency before inflation occurs. Those that are last in line to receive the currency will do so after that spike in inflation. This creates the gap between rich and poor.

The inflation that is produced by money printing acts as a hidden tax imposed on the population. As a result the population is disadvantaged as they are at the end of the chain. Inflation siphons out additional wealth and punishes savers, especially when inflation increases.

Who Benefits from the Cantillon Effect

The first recipients of the currency have an increase in purchasing power before the currency moves on to others in the rest of the economy. Subsequently the rich benefit the most from this effect.

Here is a list in the order of who benefits the most before it moves on to others within the economy:

  1. Banks
  2. Other financial institutions
  3. The State
  4. State companies
  5. Private companies
  6. Government contractors

How the Cantillon Effect is Created

This happens when economies are built on easy money or unsound money. Easy money is money that can easily be increased in its supply by money printing done by central banks. This is because the currency is not tied to any physical aspect like for example gold.

The entire system is covered very well in the documentary, The Paradigm of Money.

How Long has this Been Happening?

In 1971 the Cantillon effect started when president Nixon took the US dollar off the gold standard. Since all other world currencies were tied to the dollar all currencies then became fiat currencies and able to support the Cantillon effect at the expense of the population.

Below is a chart from the centre of budget and policy priorities which shows one of the charts that can be used as an example that shows the rich have gotten richer since the 70s.

Chart sourced from Centre on Budget and Policy Priorities

There are moments in times when more money printing is done by central banks like for example in 2008. This was when the world economy was in crisis and going to come to a stand-still. Central banks leaped into action and printed money and distributed it to large corporations and banks to stimulate the economies.

Since then central banks kept printing much more money since 2008. The crisis was never really over and the economies never truly recovered. The central banks called the money printing Quantitative Easing or QE for short.

In 2020 almost a fifth of all US dollars were created provoking concerns about inflation.  In the December 2020 report of the Centre of Financial Stability the broad measure of money which measures inflation called Divisia M4 “grew by 28.9% in December 2020, on a year-over-year basis.”

How is the Cantillon Effect Maintained?

The last decade has seen central banks using or mentioning some new tools that have or will increase the Cantillon effect. They are:

1. ZIRP (zero interest rate policy) or NIRP (negative interest rate policy)

These are policies implemented by central banks keeping interest rates artificially low where there is no price discovery to the true rate. Unfortunately these extremely low interest rates are only available to the rich and not for the rest of society. ZIRP is short for zero interest rate policy while NIRP is short for negative interest rate policy.

2. Yield curve control

This was mentioned as an additional tool to keep interest rates suppressed.

What is a yield curve? A yield curve is the value of the interest rate or yield on debt on bonds of different time spans; the 2 year, 5 year, 10 year etc. The interest rate for shorter term debt would be lower because it is less risky than lending for 30 years.

So all this means is central banks will keep the interest rates for shorter time frame bonds at ZIRP or NIRP.

The way central banks keep interest rates low is by buying government bonds. This effectively creates an artificial form of demand for government bonds which suppresses the interest rate.

The Rich Keep Getting Richer

When the financial crisis happened and the central banks printed money to inject it in the economy they thought the money was going to prop up companies. Which it did, but it did not create any new investment to enable the economies to grow.

Unfortunately the newly created currency which is meant to stimulate the economies is going towards asset purchases. The low interest rates are making the situation worse by propping up and increasing asset prices. These assets are largely held by the rich giving their net worth a grand boost.

Some of the money goes into share buybacks which is the purchase of shares of a company’s own stock. This props up prices of the company stock giving the illusion that the company is growing when in fact this is not genuine market interest and accounting trickery.

The Creation of Zombie Companies

Some companies have become what is known as zombie companies. These are companies that only survive from bailouts from central banks. This of course means that the companies are not healthy as companies are run by making profits. If this is not the case these companies would otherwise go bankrupt.

As of January 2021 zombie companies in the US alone are now $2.6 trillion in Debt. There are over 600 of these zombie companies in the US alone and they are by no means small business. They include the likes of Delta and United airlines, Exxon Mobil and Marriott international. 

The federal reserve which is the central bank of America is merely propping up failing companies. Letting companies fail will result in a lot of pain that is felt throughout society, but it is necessary. These companies will fail in the long run, propping them up is just delaying the inevitable at the cost of the tax payers. It makes the problem infinitely worse. Letting companies go bankrupt is not a bad thing as they need to make way for others that work better and will grow the economy. The new companies will create more stable job opportunities and wealth.

Who Coined the Term Cantillon Effect?

The Cantillon effect was observed by the Irish-French economist Richard Cantillon. He wrote the ‘Essai sur la nature du commerce en general’ (Essay on the Nature of Commerce in General) between 1730-1734.

In 1734 Cantillon was murdered and then his house was set ablaze with him inside. His essay was the only document that survived the fire and was published in 1755, 21 years after his death.

Cantillon’s essay contained a number of observations including the Cantillon effect. The document influenced other prominent economists like Adam Smith and others that went to base some other their works and theories on his work.

Getting Rid of the Cantillon Effect

There are ways of knocking off the restraints of the Cantillon effect. Mainly it’s if you can’t beat them join them. The more people that know about this the better it is for them and removing the advantage of the rich.

How can this be done? A quick disclaimer; before you consider any of these investments or options do your own research and consult a financial adviser.

Gold

If the economy was based on a hard money system where central banks were not able to print money this would not happen. In the past this was done by a gold standard. If you purchase gold it could still act as a hedge against inflation.

Bitcoin

The last couple of years it seems like Bitcoin might be taking over the role of being a hedge against inflation from gold to some extent. Bitcoin has been labelled as ‘the fastest horse’ by famous fund manager Paul Tudor Jones.

Become an entrepreneur

Richard Cantillon himself suggested that becoming an entrepreneur will help those that succeed in business to overcome the Cantillon effect. Entrepreneurs are drivers of the economy that risk it all to earn profits. If you get to the stage where you are classified as a large business you could qualify for low interest rates.

Hard money

The options above are for individuals, however the system at large could benefit by removing the Cantillon effect altogether.

This can be done by getting the economy based on a sound or hard money financial system. This would entail government to accept this which will be hard for politicians to do as they like to have control of the money.

Governments may end up being forced to do this in the end by going on a gold standard. A gold standard could still be prone to being manipulated so a Bitcoin standard could be proposed instead. The distinguished economist Saifedean Ammous has proposed this in his book the Bitcoin Standard. You can buy The Bitcoin Standard from Amazon.

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