The Cantillon Effect: Finance displaces Productive People
Updated: Oct 27, 2020
We have seen that the state protected banking system inflicts damaging boom and bust business cycles (see post on May 3rd).
We have seen that the state protected banking system inflicts damaging boom and bust business cycles (see post on May 3rd). It also levies an inflation tax on savers’ and workers’ purchasing power by driving up the cost of living (see post on April 25th). Is there anything else to add to the charge sheet of state sponsored fraudulent monetary arrangements?
Well yes there is the current difficulty in getting any income on savings due to rigged low interest rates. And there is the way that paper money exchange systems crushed our manufacturing base when North Sea Oil came on stream. Both will be subjects of later posts.
But today’s topic is the Cantillon Effect. Richard Cantillon was a Franco-Irish economist and speculator who identified the effect named after him. He lived at the time of two massive contemporary financial bubbles in England and France in the early 18th Century – The South Sea Bubble in Britain and Law’s Mississippi Scheme in France.
These followed the borrowing binges which had funded the recently concluded War of Spanish Succession. They both involved the creation of paper money substitutes linked to the alleged value of largely bogus trading opportunities in the Americas. The result was the inflation of a bubble of speculative mania and the total collapse in the value of South Seas shares and French paper livres convertible into shares in Law’s scheme. Many were ruined.
Cantillon managed to prosper through all this chaos. By good fortune or use of unusual intelligence he made and kept a fortune. He also managed to die in bed. But not in a good sense, because he ended up being murdered as he slept by a disgruntled former servant.
Let us assume that ‘inflation’, that is the creation of new money out of thin air by the state protected banking system, raises wages and prices for everyone equally. Perhaps we could imagine that both are raised to twice their earlier level. Clearly this is very bad news for savers and creditors, who have been robbed at the behest of the state of half their worth. However, putting savers aside for today, one might think everybody would just be in the same relative position – say earning twice the previous money wages and paying twice the previous money consumer prices as before. And in real (inflation adjusted) terms everybody would seem to be no worse off. So that’s OK then?
Not so fast. Enter Richard Cantillon’s ghost to explain that increases in prices caused by ‘money printing’ creates unfair winners and losers. This is because the newly created money gets into the hands of those closest, institutionally and geographically, to the monetary pump. These people are disproportionately individuals in state, banking and crony corporatist circles, and live in the capital city or principal regional centres. They get to spend new money before prices have had time to rise, and before the provincials and less elevated but productive members of society realise what is happening. So the unproductive profit.
People away from the capital and outside of the financial sector and other State protected circles experience rising asset and consumer prices before their incomes reflect the newly created money. So they lose out.
And so to yet another Thought Experiment. On our far away imaginary water planet there is yet another pair of islands. We’ll call them ‘The City’ and ‘The County’. A simple example of a Cantillon Effect may help here. Imagine a very simple economy in the County comprising 10 houses each worth £1m. Each of their ten owners are happily leading productive existences in a prosperous and hopefully reasonably contented society.
One day a handsome dapper man from The City arrives on the boat. He is that most valuable person, a favoured bank customer. He has inside information that prices on the island are about to go up a lot. Nobody else realises this. Does he possess some extraordinary foresight to add to his presumed acumen? He does not. What he has is an agreement from the banking system in The City to create as much money out of nothing as he may wish to borrow. It will fund him to set up as a real estate speculator.
It’s not complicated. Our man approaches the owner of Number 1 Privet Drive, our first lucky home owner. He offers £1.1m for his house. The offer is accepted with delight. At last the vendor can buy a new car and travel round the world and come back to acquire another house at the normal £1m price, or so he thinks. After all the vendor does not know that prices are going up. The speculator meanwhile manages to get Number 2 for £1.3m from the next equally delighted homeowner. By the time the new cash works its magic our developer has bought 5 of the houses – the last a bit below the new prevailing market price of £2m.
He then rests from his rather undemanding labours. What has happened in reality? The real winner is our fortunate speculator backed by bankers on the island of The City. He appears on the front page of Fortune Magazine, or the equivalent, as a genius. But he was just the man next to the money pump at the bank. He knew that there would be inflation because he helped bring it about. Anyway, the upshot is that his vehicle Spiv Property Company now owns five houses. They are wholly unimproved. But at the new prevailing market price of £2m per house his company’s gross assets are worth £10m.
Against these assets the company owes the bank £7.5m (i.e. the total cost of his five house purchases). His company’s net worth has therefore gone from nothing to £2.5m (£10m - £7.5m).
Has he in fact created any value whatsoever? None at all. Nor has his bank which has made commission and interest income on money they fraudulently (in libertarian terms I mean, none of this is illegal now) created. Similarly, none was really created by the highly skilled and very hard-working professionals on The City island who have worked so hard putting together the deals. Nevertheless, in the absence of any sign of actual useful output, all these people have profited from the inflation.
Who has lost out? Five people are now occupying the same houses but they are supposed to be worth twice as much. Not that that is much use to them since all other houses have gone up in price too. But five former homeowners are in a bad way because they can’t afford to buy a house anymore. Prices have risen against them. They will have to rent from the developer at a high rent reflecting – of course - new higher house prices. Welcome to the ranks of those who lose as a result of the Cantillon Effect.
A housing market most people are priced out of is something that we all can recognise. But the same game is played by borrowing to buy up previously independent businesses in all sectors. We have often seen badly managed conglomerates built up by people whose only credentials were in accounting and ‘financial engineering.’ Sooner or later many of these heavily promoted titans of industry bite the dust. The outcome is often the destruction of once thriving businesses. If you want to know why our high streets feature shops belonging to the same few chains, perhaps you should take a leaf out of Richard Cantillon’s book.
And another thing, if you wonder whether the Cantillon Effect is alive and well in Britain and elsewhere consider the pattern of voting in England in the 2016 Brexit referendum. Beneficiaries of the Cantillon Effect are of course generally beneficiaries of other state rackets too. But it was noticeable that Remain won in exactly those areas and sectors which gain from the Cantillon Effect - London, regional government and financial centres, and universities, concentrations of official, legal, financial and crony corporate employees (including their dormitory towns). And Leave won everywhere else.