The Cantillon Effect: How the Rich Get Richer

Welcome to the 1,236 new members of the curiosity tribe who have joined us since Friday. Join the 46,076 others who are receiving high-signal, curiosity-inducing content every single week.Today’s newsletter is brought to you by Eight Sleep!The Eight Sleep Pod Pro has legitimately changed my life.Sleep is the secret of the world’s top performers. Thousands of the world’s greatest CEOs, investors, and operators—and this humble newsletter writer—rely on the Eight Sleep Pod Pro to power their performance. It has patented technology to help you sleep at the perfect temperature all night, which research has shown can make you fall asleep faster and sleep deeper—so you can wake up energized to attack the day.Special Offer: For a limited time, Curiosity Chronicle subscribers can use the special link below to get $250 off on their first Eight Sleep purchase!Today at a Glance:The Cantillon Effect is an economic concept on the distributional consequences of new money creation created by Irish-French economist and philosopher Richard Cantillon in a 1755 paper.In simple terms, the Cantillon Effect says that the flow path of new money matters—those closest to the source and entry point of the new money benefit first and most handsomely.The robust monetary and fiscal response to COVID-19—and a surging wealth inequality problem—has re-ignited the discussion over the distributional consequences of the crisis response and thrown the Cantillon Effect back into the mainstream lexicon.The Cantillon Effect: How the Rich Get RicherThe Cantillon Effect is the most important economic concept you’ve likely never heard of. In today’s newsletter, I’d like to fix that.Here’s a simple breakdown of the Cantillon Effect—what it is, how it works, and why you should care.BackgroundRichard Cantillon was an Irish-French economist and philosopher born in the 1680s.He is something of a mystery man—not much is known about his life. Early in his career, he achieved material success as a banker and merchant—success that historians have attributed to the formidable political and business connections Cantillon made through his family and employer.This fact would prove relevant to his work later in life. At a young age, he had learned of the impact and importance of proximity to power...In the early 1700s, Cantillon is believed to have accumulated significant wealth through speculation in a variety of ventures, including John Law’s infamous Mississippi Company (which would collapse spectacularly, see this thread for more).Around 1730, influenced by his experience to date, Cantillon wrote a paper—Essai Sur La Nature Du Commerce En Général (translation: Essay on the Nature of Commerce in General)—today considered a foundational work in the study of the political economy. It is a broad, overarching paper with significant contributions to the study of economics.While it achieved wide circulation in manuscript form, it was not published until 1755, well after his death in a house fire in 1734.The Cantillon EffectWhile recognized for a variety of insights and contributions, Essai is most well known for its discussion of the distributional consequences of new money creation and the concept of relative inflation.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.In other words, the "flow path" of the new money through a system matters.In 18th century terms, Cantillon effectively observed that those closest to the king—the source of money and power of the era—benefitted first when new money entered the economy. In the 18th century, proximity to money and power really mattered.Broadly speaking, Cantillon noted that new money creates disproportionate effects based on where it enters the system.The Cantillon Effect was born...A Simple IllustrationTo bring this theory to life, let's walk through a (very) 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 small package on your doorstep. You open it up and gasp—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, and a bunch of land.But now, the other island inhabitants start to see and feel this new money flowing through the system. Prices begin to rise as demand surges but supply has yet to "catch up" to the new consumption. It takes time for supply to ramp.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.The workers who produced the goods—who earned wages from the sellers—similarly fa...