We do not see things discussed within the framework of this theory too often. However, it is very applicable to what is taking place. When we look at the distribution mechanism of money today, we see there is a major problem. The situation over the last 20 months with regards to government action pertaining to the stimulus magnifies the problem.
We all know the saying "the rich get richer". But why is this? How come it exists and is there a way to alter it? In fact, can cryptocurrency be the solution to the problem?
In this article we will explore this idea.
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The Cantillon Effect
This was an observation made in the 18th century by a French economist named Richard Cantillon. He was looking at the relative prices to new money along with how the distribution of said funds impacted people in society.
One of the most potent aspects to the Cantillon Effect was how new money favored the early recipients as opposed to those who received it via "trickle down". Keep in mind, this was the observation a few hundred years ago, a situation that still appears to hold true today.
The response to the COVID lockdowns was for governments to engage in a lot of stimulus. Here we possibly saw the Cantillon Effect in action. While countries like the United States did some direct stimulus (perhaps $400B), the overwhelming majority when to the banking and financial system (a couple trillion).
We saw this play out on a public stage. The net worth of the wealthiest people skyrocketed. Essentially, the richest people in the United States (and many other countries) saw their worth jump by trillions of dollars.
Contrast this with the average person. In the U.S., there were a couple thousand dollars distributed in stimulus along with things such as extended unemployment benefits. That is what the masses received. Naturally, there was a lot of blowback about people getting $1,200 a month in extended unemployment. Few focused upon the trillions that went to the upper end.
The only hope, which is more like a prayer, is that some of this money will make it down to the general public. History shows this is not the case. In fact, Cantillon's work highlights how this will not occur. The tickle down effect, if there is any, is of minimal impact.
How New Money Is Created
We live in a system that is credit based. New money is created by the commercial banking system. When banks lend, the number of USD, as an example, expands. Thus, those who are deemed credit worthy end up with access to the resources.
Over the last few years, we saw the lending to small businesses collapse. This is no surprise considering they have the least amount of assets to post as collateral. At the same time, individual entrepreneurs and innovators are shut out. Unless one is able to capture the attention of some Venture Capitalist, the idea will be shelved.
Those who are extended credit are able to leverage their ability to produce. It is an advantage that many can take advantage of. When we look at the actions of major corporations, they often take utilize low interest rates by borrowing, even when they have the cash on hand. This enables them, at a minimum, to make a greater return on their cash holdings as compared to what they are paying on the loan. Often, they are able to also generate a greater return on the money loaned, thus compounding the impact when coupled with the increase in value of their original cash position.
To give an example, let's say a company is looking to invest $100 million. The company has the cash on head yet takes out a loan for 3%. With the cash, they are able to generate a 5% return, putting them 2% ahead.
However, there is still the $100 million that was loaned out. If that project yields another 5%, this means the total impact is a 7% return (10%-3%).
We can see how this is a different situation that most deal with. Individuals, if they get any credit, it might be for a home or car loan. The later is nothing more than a payment system on a depreciating asset. While the former can result in appreciation, when market fluctuations along with maintenance costs are tallied up, few end up making much money at all.
Going back to the example, if this $100 million investment was made by a private company, the financial benefits goes to one or two individuals. The owners of the entity find the results in their wallets.
Now the question is how much of that money finds it way into the hands of average individuals? Once again, history shows very little. People at the upper spent less of a percentage of their income as compared to the lower classes on necessities. Hence, in addition to luxuries, they also have more for investing.
And thus we see the effect Cantillon focused upon.
Does Cryptocurrency Fix This?
Cryptocurrency offers the opportunity to change many different aspects of our financial and economic world. One of the major shifts is the fact we have a completely new distribution system.
New money is not created by a bank. Instead, it is coded into a blockchain and issued as per the rules for the system. In the Proof-of-Work model, it goes to the miners who are validating the blocks.
Of course, we know there is more than one model. At the same time, contained in each are a multitude of blockchains and projects. We see tokens appearing everywhere.
This shows us how there are two forms of "new money".
First, we have the individual tokens that are minted by the system. This is new in that they did not exist before. They are distributed directly to a wallet that is owned by an individual or entity. No bank is involved in the process at all.
The second way we see this process play out is with the development of new projects or blockchains. Each time something new is formed, there is a genesis block where the first token is distributed.
Think back to Cantillon of how new money favored the early recipients. Here we have two ways where new money is ending up in the hands of individuals. Throughout the entire cryptocurrency realm, we are seeing this happening on a daily basis.
Cryptocurrency is not looking to alter the Cantillon Effect. In fact, it is embracing it as a valid concept. Instead, we are seeing the formation of new money on a regular basis being passed out to individuals.
Ultimately, this will generate more wealth since those who get the new money are impacted to a greater degree as compared to those on the trickle down basis. Since we have the opportunity to do this with billions of people, spread over hundreds of thousands of tokens, we can see how a new system is emerging.
Thus, it appears cryptocurrency does not solve the Cantillon Effect but is simply more inclusive.
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Distribution of (free) money will hardly make people rich. Rich keep becoming more richer because they already discovered the recipe to create wealth but it do not stop poor to become rich if they discovered the same recipe.
This truth is that bitcoin might not be able to solve this effect but bitcoin at the long run will eradicate poverty, you might not be wealthy but it will sustain you and create equal opportunities for us all as time goes on
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I would say that is the case with cryptocurrency. I am not sure we get that from Bitcoin since it is fixed money.
Those who own it now should do very well. That is going to be a great asset, in my view, to hold. However, when it comes to global economics, I think there are challenges with Bitcoin.
By the way, good to see you using the Leofinance Mobile App. How are you liking it?
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I like it, simple and user friendly.
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Interesting post I had never heard of the cantillon effect but I have heard a lot of "the rich get richer and richer".
Despite the great inclusion or diversification that cryptocurrencies have, there is still that effect in them because the person with great capital, financial education and interest in this crypto world, will have the possibility to invest in more projects and therefore receive better returns than an average person.
Even in the case of blockchain that new money is still favoring early recipients right? It's just not as much of it is staying with them?
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I would have to agree with this comment. The early adopters always earn more because they are risking the most as well.
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I totally agree with you..but catching up might not be so difficult
You are right. With the right investment in the right projects it could be very easy to catch up!
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New money is freshly minted.
A bitcoin that is paid to a miner today is still new money. That means the particular miner will benefit more from the money today as compared to someone who get a hold of that Bitcoin two years from now.
It is not a comparison to the price of the token. Remember, with currency, that was not often the consideration. It is in crypto because we look at this stuff like stocks.
So the HIVE you got today is new money. So is the next project you get in on Hive Engine 6 months from now.
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I think the only difference is the transparency between this and fiat. Obviously nobody knows where money ends up and we don't want people having the ability to shut people out of the system. In a way I think blockchain does better in those regards.
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A large part of the Cantillon effect is only applicable in a fractional reserve lending model.
If you cannot make money out of thin air, the borrowing on your money to get more money doesn't work. For that, we need an expanding money supply.
If banks suddenly had to use bitcoin, very few would make loans.
The savings and loans may come back (as a dao or a smart contract) where savers, en mass, make loans.
But the concept that a bank, after being given your house, suddenly has a million dollars to lend to you will be gone.
The thing i still base my hopes on is that bitcoin is not inflationary (well, not in the 10x that banks currently operate) and thus, a bitcoin saved is a bitcoin earned.
My fear is that there may come a time when bitcoin is completely saved, and none of it moves.
I would saw that history is on the side of this fear coming true. It is the tendency for fixed money throughout history.
Plus there is the added problem that, when the economy needs the money the most, during economic downturn, those with the money are more likely to take the conservative approach and stand on the sidelines.
Holding Bitcoin, on a personal level, will likely provide people with a means of collateralization that will allow them to utilize other mechanisms to get "loans". That is where I see the SoV for Bitcoin really helping out.
In fact, if we spread it out further, this is the problem with state of the present system. Everyone focuses upon the money but few talk about the fact much of the collateral out there is junk.
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Crypto currency will solve most of the problems of the financial system.
I just thought of how we keep money in the bank and I am paid 0.1% per annum.
Does it mean that they earn 0.1%?
Of course not. They earn way more than at least 10% and what gets to the masses is .1%
Defi has started making the possibility of people getting what they truly deserve attainable by excluding the middle men.
Although Defi is new and open to a lot of mishaps, I believe that with time, there will be more developments than what the centralized system is offering.
Even at this stage, defi is currently providing more than what centralized system is doing in my opinion despite the rise and falls.
I think the cantillon effect is a legit theory.
That is true of most technologies. They are quirky in the early days. Over time, things get better. Look at the idea of the Hive Authentication Services. That is going to revolutionize key management and increase the security greatly.
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Learned something new today.
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