On Cantillon

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The Crafts which require the most Time in training or most Ingenuity and Industry must necessarily be the best paid. - Richard Cantillon

Monetary policy and everything concerning it has to be one of the most interesting topics out there. With monetary economics, there are quite a few interesting concepts which come with it. One is the so-called Cantillon effect.

The Cantillon Effect is the most important economic concept one has never heard of. Richard Cantillon was an Irish-French economist and philosopher born in the 1680s.
He achieved success as a banker, which he attributed to the formidable connections made through his family and employer.

At a young age, he had learned of the impact of proximity to power and money. Around 1730, Cantillon wrote a paper—Essay on the Nature of Commerce in General—which is considered a foundational work in the study of the political economy.

It was widely circulated in manuscript form, though it was not published until 1755, well after his death. In the paper, Cantillon posited that the early recipients of new money entering an economy will benefit more significantly than those it trickles down to.

No society can surely be flourishing and happy of which by far the greater part of the numbers are poor and miserable. - Adam Smith

The Cantillon effect describes the uneven expansion of the amount of money. If a central bank pumps more money into the economy, the resulting increase in prices does not happen evenly. The Austrian economist Friedrich August von Hayek compared this monetary expansion with honey. If you pour honey into a cup, it won’t spread out evenly. It will clump in the middle of the cup first before spreading out.


In other words, the path of the new money matters. In 18th century terms, those closest to the King—the source of money/power—benefitted first when new money entered the economy. Broadly, Cantillon observed that new money creates distributional effects based on where it enters the system.

The Cantillon Effect was born. Here is a simple story to illustrate Cantillon's central point: Imagine you live in a tiny, enclosed island society. One morning, you wake up to find a package on your doorstep. You open it up and see that it has $1 million in it.

Great! But now what?

No one else knows you received this package. You now secretly have $1 million new dollars. Naturally, you start spending it (and maybe investing it) quickly. Prices are still low, because no one knows these new dollars exist yet. Your standard of living improves rapidly. You buy yourself the nicest house, the most beautiful clothes, a bunch of land—and still have some money left over. But, people see and feel this new money flowing through the system. Prices begin to rise as supply has yet to "catch up" to the new demand. It takes time.

In economics things take longer to happen than you think they will, and then they happen faster than you thought they could. - Rudiger Dornbusch

Better to front run the crowd than be left behind. So, while the money improved your life, it didn’t benefit others in the same way. The sellers of the goods—who received your cash—now face rising prices when they consume. Same with the workers who produced the goods.

If the increase of hard money comes from gold and silver mines within the state, the owner of these mines, the entrepreneurs, the smelters, refiners, and all the other workers will increase their expenses in proportion to their profits. Their households will consume more meat, wine, or beer than before. They will become accustomed to wearing better clothes, having finer linens, and to having more ornate houses and other desirable goods. Consequently, they will give employment to several artisans who did not have that much work before and who, for the same reason, will increase their expenditures. All this increased expenditures on meat, wine, wool, etc., necessarily reduces the share of the other inhabitants in the state who do not participate at first in the wealth of the mines in question. The bargaining process of the market, with the demand for meat, wine, wool, etc., being stronger than usual, will not fail to increase their prices. These high prices will encourage farmers to employ more land to produce the following year, and these same farmers will profit from the increased prices and will increase their expenditure on their families like the others. - Cantillon


There were distributional effects—the path mattered. This is—quite obviously—a simplified example, but it gets at the essence of the problem that Cantillon highlighted.

Proximity to the source of new money is relevant—the entry point and path have distributional consequences. So, why should you care today? Well, with the "money printing" activity of central banks globally and an expanding wealth inequality problem, mentions of the Cantillon Effect have accelerated.

It's a useful lens through which to evaluate the monetary and fiscal response to pandemics and wars—and its potential impact. The Federal Reserve's escalating asset purchases have an injection point at the top. Direct stimulus checks—on the other hand—have an injection point at the bottom. The former was much larger $$$ than the latter. The asset purchases—and rock-bottom interest rates, among other things—generally benefit asset owners.

If socialists understood economics they wouldn't be socialists. - Friedrich Hayek


Those with a significant portion of their net worth in equities, crypto, real estate, or similar assets have benefitted significantly over the last 18 months. Wage earners—who received some degree of support but did not benefit in the same way from the asset appreciation—are getting the short end of the stick.

Inflation—particularly across food and energy prices—will have a disproportionate impact on their standard of living.

By now, everyone has heard that inflation is running hot in the U.S. but, perhaps more importantly, it's also running disproportionately hot—as exhibited in this chart from Business this week.

What is most troublesome is that central banks cause an enormous amount of redistribution from the poor to the rich on the one hand, but on the other hand the some blame capitalism and demand higher taxes for the rich. Since nobody really thinks about the effects of central banks and takes them as a given, certain groups thus are thought of as “social,” and “thinking about the poor.” However, their demands are the root of these problems. They try to balance out their regressive tax caused by the central banks with a progressive one. Of course, the Cantillon Effect is not the only problem, but it is a problem which should not be ignored entirely.

All in all, this effect causes other problems which probably wouldn’t exist without central banks. And as usual, government causes problems which wouldn’t happen without its interference.

I hope this short note provides you with a solid foundation of understanding on the topic. This should not be a political debate. It should be a grounded discussion we all have when we consider the impact of various monetary and fiscal policies proposed by our leaders.