The Cantillon Effect: Who Gets the Money First?
How Money Is Created
When central banks engage in quantitative easing or lower reserve requirements, they essentially create new money digitally. Commercial banks do this too when they issue loans - they don't need to have all the money on hand; they create it as a digital entry. This is how most money in our economy actually comes into existence.
The Cantillon Insight
The Cantillon Effect, named after 18th-century economist Richard Cantillon, describes the crucial insight that new money doesn't spread evenly through the economy like water finding its level. Instead, it has specific entry points.
First in Line, Best Prices
Those closest to these entry points - typically financial institutions, governments through bond purchases, and large corporations with easy credit access - get to spend this new money before prices adjust upward. They're essentially shopping with tomorrow's money at today's prices.
Think of it like being first in line at a sample sale - you get the best deals before the crowd arrives and prices adjust to demand. By the time this money reaches ordinary workers through wages, or small businesses through consumer spending, prices have already risen to reflect the increased money supply.
The Inflation Sequence
The inflation sequence follows a predictable pattern. Asset prices (stocks, real estate, bonds) inflate first because that's where the recipients of new money typically park it. This is why we've seen housing prices and stock markets surge even during periods when regular consumer inflation seemed tame. Eventually, this asset inflation bleeds into the real economy through wealth effects, higher rents from expensive properties, and increased costs of doing business.
The fundamental relationship the passage highlights is between money supply growth and real economic growth. If the money supply grows at 10% but the actual production of goods and services only grows at 2%, that extra 8% has to go somewhere - and it goes into higher prices. The timing and distribution just depend on who gets the new money first.
This mechanism helps explain why wealth inequality tends to widen during periods of aggressive monetary expansion - those with assets see their wealth inflate, while those living paycheck to paycheck face rising costs without corresponding wage increases.
Deflation: The Fiat Nightmare vs. Bitcoin's Promise
The current system needs inflation, while Bitcoin flips that paradigm completely. Let's explore why deflation is considered dangerous in the existing system, and why it could actually be beneficial in a Bitcoin standard.
Why Deflation Is "Bad" for the Existing Fiat System
Because of that, it only really works smoothly if prices and incomes drift up over time (inflation). Here's why deflation (falling prices) is dangerous for this particular setup.
a) Debt is Fixed, But Incomes and Prices Fall
Simple Example:
- You have a €300,000 mortgage. That number is fixed in nominal terms.
- Suppose prices and wages fall by 20% (broad deflation).
- Your salary is lower (or your job is shaky).
- The house price might fall too.
- But your debt is still €300k, not €240k.
So in real terms, the burden of the debt got heavier.
Now scale that to:
- Households (mortgages, car loans, credit cards)
- Companies (corporate bonds, bank loans)
- Governments (sovereign bonds)
If prices and incomes fall but debts stay the same, you get:
More and more of everyone's income has to go to servicing old debt.
Less income is left to spend into the real economy.
The Debt-Deflation Spiral
(Irving Fisher style)
- Prices fall →
- Real debt burden rises →
- People & firms cut spending →
- Defaults rise →
- Banks pull back lending →
- Money/credit shrinks further →
- Prices fall more → repeat
Inflation (a bit of it) actually helps erode the real value of debt over time.
Deflation does the opposite: it weaponises the debt against the debtor.
b) Collateral and Asset Prices Implode
Remember the Cantillon / asset-inflation story:
- New money flows into assets first (houses, stocks, bonds, etc.).
- These assets are then used as collateral for even more borrowing.
If you get deflation + falling asset prices:
- House prices fall → mortgages are suddenly a bigger % of house value.
- Stock prices fall → collateral for loans disappears.
- Bond prices fall (or yields spike) → funding costs jump.
That triggers:
Because the whole thing is leveraged on top of inflated collateral, a serious deflationary episode makes it all wobble.
c) Why Central Banks Are Terrified of Deflation
Mild Inflation
- Makes debts easier to service over time.
- Keeps asset prices supported.
- Encourages borrowing and spending (higher time preference).
Deflation
- Exposes how over-levered everyone is.
- Risks a cascade of defaults and a banking crisis.
- Freezes spending ("I'll wait, things will be cheaper later").
So they target ~2% inflation as "grease for the system" – it keeps the debt tower from collapsing and slowly transfers value from savers to borrowers (especially to big, highly indebted players: governments, large corporates, financial system).
Deflation isn't "bad" in some cosmic moral sense – it's bad for this particular over-indebted fiat, Cantillon-structured system.
Why Bitcoin Can Make Deflation "Good" Instead
Bitcoin flips a few crucial things:
- Money is not created as someone's debt
- Supply is capped / predictable
- Deflation (in prices) comes mostly from productivity, not from a collapsing credit bubble
a) No One's Debt = No Need to Inflate It Away
In Fiat:
- New money = mostly new debt.
- System quietly needs inflation to prevent the real debt load from crushing people and states.
In Bitcoin:
- New coins are created by the protocol, not by someone borrowing them into existence.
- After ~2140, supply is essentially fixed at 21 million (ignoring tiny fees & lost coins).
- So there's no political or systemic need to erode the currency to save debtors.
If you build your economy on equity and savings, not constant leverage, you don't need a permanent inflation tax to keep the game going.
b) Natural/"Good" Deflation from Progress
In a Bitcoin world, you'd roughly get:
Money supply: flat / predictable
Real output & tech: going up
→ Prices (in sats) drifting down over time
Example:
- Year 1: 1 BTC buys you a basic car.
- Year 10: tech got better, factories more efficient, supply chains smoother.
- Same 1 BTC might now buy you a much better car, or two decent ones.
That's deflation in prices driven by productivity, not a shrinking money supply.
"We must inflate to stop the system collapsing"
"We let prices fall as we get better at making stuff. Holding sound money lets you share in that productivity gain."
In that world:
- Savers are rewarded: holding BTC preserves and increases purchasing power over time.
- Workers benefit: their accumulated savings buy more every year.
- Entrepreneurs still invest:
- You invest if your project can beat the deflation rate.
- If prices fall ~3% a year, you fund projects you expect to return >3% real.
- That filters out wasteful, marginal projects that only survive on cheap credit and "money printer go brrr."
c) Why "People Will Never Spend If Money Goes Up" Is Overblown
Fiat defenders often say:
"If money gains value over time, no one will spend or invest."
But in real life people:
- Still buy phones, laptops, cars even though tech gets rapidly cheaper/better.
- Still invest in businesses when the expected real return is positive.
- Still need housing, food, experiences now, not just "later".
A Bitcoin standard just means:
- You don't have a gun to your head saying "spend or be inflated away".
- You can choose more rationally:
- Spend on what you value now.
- Save for what you value later, knowing your savings aren't being quietly drained.
It lowers time preference: people can think longer-term.
d) The Contrast in One Sentence
Fiat + Cantillon World
You need constant inflation to keep a debt-and-asset bubble from imploding, so prices "must" go up and those closest to the money tap win.
Bitcoin World
You can let prices fall as technology and productivity improve, because money isn't someone's debt and doesn't need to be devalued to save the system – ordinary people share in progress just by saving.
The Choice Is Clear
A system that rewards saving and productivity over leverage and manipulation.