The Cantillon Effect: The Fiat Faucet
This edition aims to answer these four questions:
- What is fiat?
- Who gets to issue it?
- Who is it issued to?
- What implications does this have?
Let It Be Done
The word fiat, taken from Latin, translates to 'let it be done’.
In the context of money, it refers to an authority (in this case a sovereign government) issuing a currency that is not directly backed by, or redeemable for, a fixed quantity of some asset.
Without this constraint on the production of new monetary units, it becomes possible for a sovereign government to fund their vision by simply creating new fiat money (and borrowing from the future through bond issuances), rather than by earning approval from citizens and collecting taxes.
The utility of fiat is often enforced by legal tender laws which require it be universally accepted by merchants. Additionally it may also be the only currency accepted by the government for settling tax debts.
“Had government money been a superior unit of account and store of value, it would not need government legal tender laws to enforce it." -Saifedean Ammous
First to Receive
In a fiat economy with an expanding money supply, those first to receive the newly created units have the advantage of spending or investing before the inflationary effects of this increase in money supply have materialized.
Hence, those closest to the fiat faucet enjoy higher standards of living at the expense of later recipients, as they create relative inflation based on their unique spending preferences. This disproportionately impacts the prices of goods and services in an economy.
So it's not just the increase in new monetary units that distorts an economy, but the path that this new money travels. As rational individuals are likely to choose the path which best protects their future purchasing power.
It should now be apparent that any government program, funded via money printing, cannot possibly predict all of the second-order effects on the relative prices of goods and services in a complex adaptive system such as a national economy.
“good intentions tell you nothing about the actual consequences.” -Thomas Sowell
Richard Cantillon
Cantillon's 1755 Essai, although written in the context of hard money, holds even greater relevance in a fiat era. In it he posits that an increase in the supply of monetary metals from increased mining activity, or supply injected from abroad, would have repercussions to the prices of goods and labor in the order they're consumed.
Mo' Money Mo' Problems
Due to the varying ways in which additional monetary units enter and travel through an economy, nobody can predict exactly how this will impact the prices of various things because nobody can predict how individuals will choose to act.
Though we look at the incentives of the current environment (exponential M2 growth + near-zero interest rates) and see why scarce assets may attract a disproportionate amount of every new fiat unit.
Further Reading
The Cantillon Effect: Why Wall Street Gets a Bailout and You Don't
Today I’m going to try and explain why the Fed and Congress, while attempting to throw money at everyone, disproportionately tends to aid certain narrow financial actors.
