What Is the Cantillon Effect?

In the summer of 1719, a narrow street in Paris called the rue Quincampoix was packed from dawn to dark. Servants, nobles, and shopkeepers pushed through the crowd to buy shares in the Mississippi Company, the grand project of a Scottish financier named John Law. Law's royal bank was printing paper money on a scale France had never seen, and much of it flowed straight into those shares. Fortunes were made in weeks.

One of the men making them was an Irish-born banker named Richard Cantillon. He bought shares early and sold them at much higher prices, even though, by his biographers' account, he believed the scheme was unsound and bound to fail.¹ Before the end of 1719 he had left Paris for Amsterdam. When the bubble burst in 1720, many who had bought late lost nearly everything. Cantillon kept his fortune.

He had stood closer to a flood of new money than almost anyone alive, and he had watched where it went first. About ten years later he wrote down what he had learned.

The Question Locke Skipped

Cantillon's book, the Essay on the Nature of Trade in General, was written around 1730 and passed around in manuscript for a generation before it was printed in 1755.¹ In it he took on the most respected thinker of his day. John Locke had taught that more money means higher prices. Cantillon agreed, and then pointed at what Locke had left out.

"He has clearly seen that the abundance of money makes everything dear, but he has not considered how it does so. The great difficulty of this question consists in knowing in what way and in what proportion the increase of money raises prices."

Richard Cantillon, Essay on the Nature of Trade in General, Part II, Chapter 6²

His answer was a story. Suppose, he wrote, a country discovers a rich silver mine. The owners of the mine and the men who work it are the first to hold the new silver, and they "will not fail to increase their expenses." They buy more meat and wine, finer clothes, better furniture. The craftsmen they hire earn more and spend more too. All that new demand pushes up the price of meat, wine, and wool, and the farmers who sell those things profit as well.²

Then he named who pays for it.

"Those then who will suffer from this dearness and increased consumption will be first of all the Landowners, during the term of their Leases, then their Domestic Servants and all the Workmen or fixed Wage-earners who support their families on their wages."

Richard Cantillon, Essay, Part II, Chapter 6²

Some of them, he added, would be forced to leave the country to find a living. That is the Cantillon Effect: new money changes prices in a sequence, and where you stand in that sequence decides whether the new money helps you or costs you.

First in Line

The idea is simple once you see it. A newly created dollar is spent for the first time at today's prices, because the rest of the economy has not yet noticed it exists. Whoever spends it first gets full value. As it changes hands, it bids prices up. By the time it reaches the people at the end of the line, as wages or as interest on savings, prices have already risen, and the dollar they finally receive buys less than it did when it started out.

Think of it as a raise that arrives after the rent goes up. If your landlord raises the rent in January and your employer raises your pay in December, you spend eleven months paying the new price on the old wage. Nobody stole anything from you in the usual sense. The loss came from the order in which things happened. Multiply that across every price in an economy and every year of a working life, and the order starts to matter a great deal.

Cantillon's list of losers is worth reading again with that in mind. It was not simply "the poor." It was anyone whose income was fixed while prices moved: landlords locked into long leases, servants, and wage earners. In his example the gainers were not only the rich, either. The miners and the farmers did well. What separated the two groups was not wealth but timing.

Where New Money Enters Today

There are no silver mines in a modern money system. New dollars are created when the Federal Reserve buys bonds from banks and large financial firms, crediting them with new reserves, and when governments spend borrowed money. Those are the doors new money comes through, and the people standing next to them are the first to hold it.

In 2020 those doors opened wider than ever before. On March 4, 2020, the Federal Reserve held about $4.24 trillion in assets. By April 13, 2022, it held about $8.97 trillion.³ In about two years it added more than it had accumulated in the century and more since it opened in 1914.

That episode is a useful test of Cantillon's idea, because some of the new money took an unusual path. Congress also sent relief checks straight to households, and over the same stretch the Fed's own data shows the share of the nation's wealth held by the bottom half of households rising from 1.9 percent in early 2020 to 2.4 percent in late 2021.⁴ Other forces were at work too, rising home values among them. But when some of the new money arrived at the front door instead of the bank's, people further down the ladder were, for once, near the front of the line. Cantillon would not have been surprised. His whole point was that the channel decides who benefits.

Then prices caught up. In the twelve months ending June 2022, consumer prices rose 9.1 percent, the largest increase in more than forty years.⁵ Paychecks rose too, but not as fast. Over the same twelve months, the average hourly wage, measured in what it could actually buy, fell 3.6 percent.⁶ For a worker earning $25 an hour, that is like quietly losing 90 cents of every hour's pay while the number on the pay stub went up. Savers holding cash, and retirees on pensions with no cost-of-living increase, had no raise at all to soften it. They were exactly the people Cantillon described in 1730: those who "support their families on their wages," last in line.

Two Ways to See It

Economists do not agree on how much this matters, and both sides are worth hearing.

The mainstream view, put plainly by former Fed chairman Ben Bernanke, is that the effects of monetary policy on inequality "are almost certainly modest and transient."⁷ In this view, the Fed's bond buying lifted asset prices, which helps people who own assets, but it also kept businesses open and people employed, which helps everyone else. Inflation also shrinks the real value of debts, and borrowers tend to be less wealthy than lenders. On balance, the argument goes, the transfers wash out, and the cost of doing nothing in a crisis would have been far greater.

Economists in the Austrian tradition, who count Cantillon as one of their earliest influences, see it differently. To them, new money is never neutral on the way in. It changes which prices rise first, which businesses look profitable, and who can afford to buy assets before they become expensive. Even if the effect is hard to measure precisely, they argue, a system that regularly creates money through banks and bond markets will regularly reward the people closest to them, and the bill will regularly land on wage earners and savers.

You do not have to pick a side to take away the central point. The same new dollar is worth more to the first person who spends it than to the last person who receives it. That is not a theory about anyone's motives. It is arithmetic about time.

Paid Before Sundown

"You shall not oppress your neighbor or rob him. The wages of a hired worker shall not remain with you all night until the morning."

Leviticus 19:13

The law of Moses paid unusual attention to timing. A day laborer was to be paid the same day, because a worker who has to wait for his wages carries a cost that the one holding them does not. Delay itself can be a kind of taking. The Cantillon Effect is a question of timing too, played out across a whole economy: some people are paid in new money at old prices, and others are paid later, after the prices have moved. It is fair to ask which of the two a money system is built to favor.

A Schedule Anyone Can Read

Bitcoin has first recipients as well. Every new bitcoin goes to a miner, the person or company that does the work of securing the network. What differs is how that issuance is decided. The schedule was fixed in the software in 2009, it is public, and it shrinks by half about every four years. Since April 2024 it has been about 450 new bitcoin a day, which works out to less than 1 percent a year, and it will keep falling until the 21 million limit is reached. No bank, government, or crisis committee can issue more on its own say-so, for itself or for anyone it wants to rescue; changing the schedule would take the agreement of the people who run the network, and it has never been changed.

That does not make bitcoin's price stable; measured in dollars, it is famously volatile. But it does mean the question Cantillon asked, who gets the new money first, has a fixed and published answer that does not change depending on who is asking.

The free first lesson of the course follows the same question through the history of the dollar, from 1913 to the present day, and shows what it has cost the people at the back of the line.