Understanding the Cantillon Effect
Many people think that economic inequality is a by-product of capitalism. Wrong. Inequality is driven more by our fiat currency system than capitalism itself. Capitalism rewards hard work, innovation, and risk-taking. Capitalism does not create inequality; the guilty party is the fiat currency system, which took a firm grip after the U.S. left the gold standard in 1971.
The Cantillon Effect explains how this happens. It's named for the 18th century Irish-French economist, Richard Cantillon.
If you want to understand the hidden forces that drive economic inequality, the Cantillon Effect is crucial. It describes how the first recipients of newly created money, often those closest to the money supply (like the financial sector) disproportionately benefit, thereby widening economic inequality. Put simply, the closer you are to the source of money creation, the more you benefit.
The Cantillon Effect works like this. When new money is introduced into an economy, it doesn't get distributed evenly. It goes first into sectors closest to the money supply — primarily the financial sector. The Cantillon Effect thus exacerbates economic inequality. Those closest to the money supply receive the new money first, which gives them more purchasing power, and gives them more leverage power - i.e. more power to borrow even more money. Meanwhile, average individuals are last in line, losing purchasing power as prices rise.
When central banks create new money and inject it into the economy (as happened in almost every country during the Covid-19 pandemic), that naturally raises the price of goods and assets. It created the recent inflationary surge.
The Cantillon Effect states that the first recipient of the new supply of money has an arbitrage opportunity; they can spend money before prices go up. The new fiat money is created at almost zero cost and given to specific parties, usually banks. These "first receivers" have an opportunity to spend this money on goods and assets whose price has not yet reflected the increase in money supply. Banks and their biggest customers can thus buy goods at a discounted rate or use the newly created money to invest. As the new money flows from central banks to private banks to investors to ordinary citizens, prices gradually begin to reflect the increase in the money supply. By the time ordinary citizens experience the increased money supply, they have to buy the goods at higher prices. The flow of new money through the economy is beneficial to parties that receive the funds first, and less beneficial to those that receive it later on. The individuals and institutions closest to the central bank – banks and asset owners – are granted financial advantages at the cost of those least connected to the financial system.
Why stay vulnerable to a flawed system? Gold doesn't lose its value over time, offering a protective shield from the effects of the Cantillon Effect. The Cantillon Effect plays a significant role in economic inequality. But you can insulate yourself by switching to a personal gold standard with Glint, where your assets have their own defence.
Here's a guide to some further reading to understand the Cantillon Effect.
Ludwig von Mises' 1912 book "The Theory of Money and Credit" is an excellent study of money - you can download a free copy from the Mises Institute, at mises.org.
Richard Cantillon's 1755 essay "Essay on the Nature of Trade in General" first described the uneven effects of new money on an economy.
Mark Thornton's 2004 essay "Cantillon on the Cause of the Business Cycle" gives a modern analysis.
At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.