Hi Money makers,
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In today’s article I’m going to be explaining what the Cantillon Effect is and how your proximity to money affects you in your daily life.
What is the Cantillon Effect?
Money needs to travel through certain institutions before it gets to us. In this process the elite get to directly benefit from the benefits of this new money entering into the system while the working class suffer the consequences.
Let me explain why:
‘An Essay on Economic Theory’ was a book written in the 18th century by Richard Cantillon. In his book he describes a phenomenon that we now know of today as the ‘Cantillon Effect’.
The theory was simple, those that benefit from money printing were directly tied to the institutions that were setup within the state (country). The closer you were to those institutions, the greater your economic benefits were.
From his (Richard Cantillon) general observation, he pointed out that money printing had distributional consequences that operate through the price system. Simply put, those that received the new money first could benefit from the stronger purchasing power of that money before prices in the local economy began to rise.
Think of a supersonic fighter jet, when you first see the plane you don’t hear anything right away. It’s only a few seconds after the plane has already passed you that you hear the sounds. (We know this as something that moves faster than the speed of sound). There is a lag between your sight and the sound.
In the case of the Cantillon effect, the lag is between the purchasing power of your money and the inflationary effects in the economy. Just as the plane comes first and then the sound follows, those at the top of institutions are able to buy more with this ‘new money’ entering the system before the effects of inflation follows through.
Diving into History
In an earlier time when this was first observed, the closer one was to the king and the wealthy, the more one would economically benefit.
Back in the 18th Century, the basis of money was not like it is today, money then was gold, today it is paper or credit. Gold had/has inherent inflation built into it, this is because the more you mined/mine, the more gold that came to market. (Increasing money supply).
Richard Cantillon noticed this phenomenon and the effects of increasing the money supply (bringing more gold to the market).
The increase of gold went to the rich first (mine owners). This increase in the money supply eventually changed who had wealth and who didn’t. The mine owners were able to spend this ‘new money’ first before it flowed to the general populace.
They would spend their money (gold) on servants and other luxury goods. It was only when the rich (mine owners) near these gold mines started spending this money into circulation that we started seeing the effects of rising prices.
For example:
I create an extra R100.00 and the 5 richest people get access to this money first. At this very moment, prices haven’t risen because there is no new supply circulating or entering into the system yet. The rich and the closest to them are the beneficiaries of this new money.
Once they start sending this new money it then creates more demand for these products they buy, so prices gradually rise as the money supply increases. It (money) then eventually finds its way to the rest of the populace as it changes hands from person to person. By the time it flows to the everyday person they have to pay higher prices for goods and services.
The working class don’t benefit from this new money at all because of their proximity to it, but they end up paying the price of higher prices (inflation). This uneven distribution of purchasing power transfers wealth from the working class to the rich.
Related back to South Africa
Cantillon states; “ Any kingdom that discovers gold would in the long-run destroy their own manufacturing base. When the overabundance of money from the mines has diminished the number of inhabitants in a state, accustomed those who remain to excessive expenditures, raised the prices of farm products and the wages for labor to high levels, and ruined the manufactures of the state by the purchase of foreign products by property owners and mine workers, the money produced by the mines will necessarily go abroad to pay for the imports”.
He goes onto say further;
“This will gradually impoverish the state and make it, in a way, dependent on foreigners to whom it is obliged to send money every year as it is extracted from the mines. The great circulation of money, which was widespread in the beginning, ceases; poverty and misery follow and the exploitation of the mines appears to be only advantageous to those employed in them and to the foreigners who profit thereby”
His observations in the 18th century would have applied to South Africa during the gold rush too. What he wrote in the 18th Century is scarily accurate as to how South Africa is now in the present moment. Our manufacturing base has been eroded and we’ve become more reliant on imports while ever dependent on the mining sector to fund those imports.
Gold vs Currency
As explained in my previous article, I highlighted the differences between money and currency. If you haven’t had a chance to read that yet, I suggest you do buy clicking here.
Gold had it’s shortcomings, but it limited the rate of inflation while allowing the money supply to still be elastic to accommodate for growth. So although the money supply grew, it was benign when compared to today.
Present Moment
I relate this back to the United States because they have the global reserve currency of the world, and whatever they decide to do would affect us all. So although we may be in Africa, Europe or Asia, whatever happens there has great consequences for the global economy at whole.
In 1971, President Nixon unpegged the dollar from gold and effectively moved away from the gold standard. This allowed governments to print their currencies with no more constraint.
This move has had drastic consequences on the global economy mainly because governments have been free to engage in expansionary policies, freely monetizing their debt (printing money) without offsetting the increase in money supply with productivity (economic growth).
Take a look at the FEDs balance sheet below:
This increase in the money supply has led to asset inflation and real inflation.
This ultimately creates a wealth illusion for those holding paper assets and makes the rest of us poorer who don’t own any assets. We pay the higher prices while the rich benefit from spending newly created money first. We see this in the cost of everything around us. Not only in the US, but in South Africa, too.
The USA has been able to create a hegemony, where the world has become reliant on deriving value from their currency - the Dollar. This benchmark has been used for international trade and has allowed the US to manipulate other nations for the benefit of themselves, thus enriching a few at the expense of the many.
This privilege they have had (global reserve status) has been abused and has created huge wealth discrepancies for their citizens and the global economy at large.
Over the last two years between 2020-2022, this Cantillon effect has been seen in full force. Asset prices have risen exponentially and inflation is starting to pick up.
We can see how everyday people are being priced out of the market while the rich who already own assets benefit more because of their proximity to this flow of newly created money.
How to protect yourself
We see now that Money flows from the top down, and those on top get all the economic benefits while the working class (us) at the bottom suffer. The working class continue to work just to survive, just to stay out of debt, and just to keep feeding this economic machine while the wealthy continue getting wealthier.
This system has gone from bad to worse, from slightly corrupt to brazenly corrupt. There is no limitation to what they can print, which means the erosion of our purchasing power will continue indefinitely.
What Cantillon observed in the 18th century is more true today than it was in the past, and there are only a few ways for us not to fall victim to these conniving bastards.
We need to:
Own hard money
Owning money or assets with a maximum fixed amount. This prevents governments or central banks from devaluing them. This could include precious metals like gold or possibly even bitcoin as it has a fixed supply.
Start businesses
Invest in the purchase of goods and materials with the incentive to sell them in the future. Look for gaps in the market or find inefficiencies where you can make things better.
By having your own business you won’t just be waiting for the newly printed money to get to you, you’ll be able to increase your prices to offset inflation.
Relying only on the income from employment at this stage is too risky.
Increase income
This is an underrated option. One could upskill themselves by learning a new in demand skill. There is no better way than protecting your income than by being sought out for a specific skill. It gives you the flexibility to be mobile in this chaotic world.
Another good way to grow your income is by growing your community and connecting with like-minded individuals. Tapping into the internet to make sales via distribution channels is also another way to secure extra income.
I wont get too much into the details here, but if you are interested in making money online, then I’d suggest you click here
Create your own money
If you can’t beat them join them. We know that money loses value over time, and in fact, governments like inflation they just don’t like telling you there is any.
The reason they like inflation is because it allows them to pay back their debt with money that is worth less in the future.
What do I mean by this?
It comes down to the future value of money (FV)
Money in the future is worth less than today.
If I borrow R10 000 today to buy a popcorn machine. I am buying an asset that generates cash flow, which I can use to service my debt.
I’m using money now that is worth more (purchasing power) and I’m paying back debt in the future with money that is worth less, because of inflation. This is how governments inflate their debt away.
Owning assets and equity in businesses is so important.
You can leverage financial institutions by taking loans and investing in financial assets. You would be able to invest alongside the rich who get the money first.
Take March 2020 for example, financial assets crashed and subsequently money printing pushed them back up again to all time highs.
The rich and whoever bought those assets at that time benefitted greatly from the rise in prices. (asset inflation). The return of those assets would have covered the cost of the loan, while simultaneously the value of the currency lost purchasing power over that time too.
This is of course is easier said than done, and it isn’t something I would recommend anyone doing until they understand the cycles an economy goes through. Because if you end up borrowing money to do this and interest rates increase and stocks fall, then the opposite of what was described above happens.
Closing Thoughts
Richard Cantillon’s theory doesn’t imply that money creation is always biased towards the powerful, only that how that money travels is what matters.
Unfortunately, the money travels skewedly in our financial system. Our financial system is akin to one big pyramid scheme, where the founders benefit and the later recruits get the scraps.
We are the recruits, and many of us still haven’t realized we are being swindled.
Stay safe, everyone
See you next week :)
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