The Cantillon Effect and Wealth Inequality Problem Explained

Money is  not as “neutral” as we think

The Cantillon Effect was first described by 18th-century Irish-French economist and philosopher Richard Cantillon in a book that he wrote called “Essai sur la Nature du Commerce en Général” (Essay on the Nature of Trade in General).

He noticed a phenomenon: The closer you are to the source of money, the more you benefited. The further you are, the more you are harmed. 

To bring this theory to life, let’s walk through a simple story to illustrate Cantillon’s point.

Imagine you live in a tiny, enclosed society where people use seashells as money. These are very rare and durable which makes them perfect as a currency. 

One morning, you wander down a path and stumble across a small package.

You open it up and gasp – it has 100 million seashells in it. What a great day that brings you such good fortune! But now what? 

No one else knows these new seashells exist yet! You now secretly have 100 million seashells. Naturally, you start spending or investing this money quickly when prices are still low. 

Your standard of living improves rapidly. You buy the nicest properties, the most expensive cars and a bunch of other assets. 

Then, the other inhabitants start to feel this new money flowing through the system and realise the seashell supply has been inflated. 

By this time, the value of seashells has significantly reduced. Prices begin to rise as demand surges but it would take a while for supply to catch up. 

The new money improved your life but didn’t benefit others in the same way. Everyone faces rising prices when they consume, from the business owners (who receive your seashells) to the wage earners (with stagnating incomes). 

This simple example implies that the flow path of new money matters. It points out just how easy it is for the early recipients of new money entering an economy to amass a whole lot of physical and financial assets before it trickles down to the hands of normal people in society. Until it does, people would have to pay higher prices because there would be inflation. 

This is known as the “Cantillon Effect”. It was highlighted almost 300 years ago but it’s still the dynamic we’re seeing today with money creation and how it travels. 

Who benefits from inflation?

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