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. The Cantillon Effect (#GotBitcoin)
Three weeks ago, the government passed a giant multi-trillion dollar bailout. Supposedly, it was money for a host of stakeholders, including hospitals, states, Wall Street banks, big business, the unemployed, and small businesses. Today the Federal Reserve built on top of Congress’s framework, announcing yet another multi-trillion dollar set of facilities, on top of what it already put out, to help cities, states, small businesses, main street businesses, and so on and so forth.
So what has happened so far? This is today’s change in stock price of a real estate venture run by one of largest private equity funds in the world.
A thirty five percent jump in a day is… a lot. The reason the stock skyrocketed is because investors believe the new measures from the Federal Reserve will bailout the debt of this private equity fund. There’s a ‘monetary bazooka’ aimed at the economy. And yet there’s a puzzle. If there’s money for the entire economy, why is that normal people and small businesses can’t access unemployment insurance and lending programs? To put it another way, why is the money meant for everyone only showing up in the stock market?
The reason is because money has to travel through institutions, and right now, the institutions for the powerful function well, and those for the rest of us are rickety and broken. So money gets to the rich first. Eventually, some money will get to the rest of us, but in the interim period before that money fully circulates, the wealthy can use their access to money to buy up physical or financial assets.
An 18th century French banker and philosopher named Richard Cantillon noticed an early version of this phenomenon in a book he wrote called ‘An Essay on Economic Theory.’ His basic theory was that who benefits when the state prints a bunch of money is based on the institutional setup of that state. In the 18th century, this meant that the closer you were to the king and the wealthy, the more you benefitted, and the further away you were, the more you were harmed. Money, in other words, is not neutral. This general observation, that money printing has distributional consequences that operate through the price system, is known as the “Cantillon Effect.”
In Cantillon’s day, the basis of money was gold, so he wrote about what happened when a nation-state discovered a gold mine in its territory. Increasing the amount of gold in the realm would not just increase price levels, he observed, but would change who had wealth and he didn’t. As he put it, “doubling the quantity of money in a state, the prices of products and merchandise are not always doubled. The river, which runs and winds about in its bed, will not flow with double the speed when the amount of water is doubled.”
Cantillon went on to discuss how money would flow, basically noting that rich people near the mine would spend it on 18th century luxuries like servants and meat pies, prompting a general rise in prices. Eventually the money would get out to the populace, but until it did, working people would have to pay higher prices without access to the new money that mine owners had. So there would be inflation, with uneven distribution of purchasing power.
There’s also a China angle. Cantillon noted that a kingdom discovering gold would in the long-run erode its own manufacturing base, that the non-neutrality of money also had geopolitical consequences.
Here’s How He Put It:
When the overabundance of money from the mines has diminished the number of inhabitants in a state, accustomed those who remain to excessive expenditures, raised the prices of farm products and the wages for labor to high levels, and ruined the manufactures of the state by the purchase of foreign products by property owners and mine workers, the money produced by the mines will necessarily go abroad to pay for the imports. This will gradually impoverish the state and make it, in a way, dependent on foreigners to whom it is obliged to send money every year as it is extracted from the mines. The great circulation of money, which was widespread in the beginning, ceases; poverty and misery follow and the exploitation of the mines appears to be only advantageous to those employed in them and to the foreigners who profit thereby
This is approximately what has happened to Spain since the discovery of the Indies. As for the Portuguese, since the discovery of gold mines in Brazil, they have nearly always used foreign articles and manufactured goods; and it seems that they worked the mines only for the account and advantage of foreigners. All the gold and silver that these two states extract from the mines does not supply them with more precious metal in circulation than others. England and France usually have even more.
This dynamic is exactly what happened with the United States since the 1960s, if you replace the idea of gold mines with the ability to print dollars. In 1971, Keynesian economist Nicholas Kaldor said that dollar hegemony would turn “a nation of creative producers into a community of rentiers increasingly living on others, seeking gratification in ever more useless consumption, with all the debilitating effects of the bread and circuses of imperial Rome.”
Today what Cantillon observed is far more extreme than it was in the 1960s; it is hedge funds, private equity, and bankers who have benefitted from the money printing, and the foreigners who benefit from our money printing are increasingly Chinese and foreign manufacturers.
This theory doesn’t imply that money creation is always biased towards the powerful, only that how money travels matter. There is no inherent money neutrality, such neutrality must be constructed by institutional arrangements. Much of the New Deal in the 1930s and 1940s was designed to build alternative channels for lending so that small business, industry and individuals could have access to money as quickly as big banks.
The Reconstruction Finance Corporation, government procurement, the Federal Housing Administration, the Federal Reserve, agricultural credit supports, Federal Home Loan Banks, credit unions, and regulations like Regulation Q were all mechanisms to insure the flow of money would be neutral. The International Monetary Fund was originally created to ensure money neutrality on a global basis.
So we can now see that the hollowing out or subversion of these institutions since the 1980s is designed to ensure they would be non-neutral, and tilted towards the powerful. Since 1981, increasingly the only channels that work to move money creation are the Federal Reserve to Wall Street, as well as the backstop to mortgages, who could get money to new homebuyers through mortgage lenders. Housing has been a key driver in both recessions and recoveries for a lot of reasons, but also for a simple one. It’s one of the few ways to get money into the hands of normal people in America at scale.
The Federal Reserve has usually seen its role as printing money and distributing it to the economy, largely by moving money to big banks and assuming they will in turn increase the amount of money available to everyone else equally. The 2008 crisis jarred this vision of neutral and frictionless money movement, because it became obvious that institutions matter.
In 2016, Federal Reserve Chair Janet Yellen gave an important speech on this topic. It turns out, she said, that who the Fed deals with matters. To paraphrase her speech, the bigger and powerful get money first, and the small and weak get money last. That’s the dynamic we’re seeing in this bailout, with small businesses and the unemployed having trouble accessing funds and the big guys getting what they need when they need it. If you want the boring version of the speech, here’s a paragraph of Yellen explaining that the Fed economists were stupid and intellectually corrupt, but doing it so that anyone listening would fall asleep rather than get outraged.
Economists’ understanding of how changes in fiscal and monetary policy affect the economy might also benefit from the recognition that households and firms are heterogeneous. For example, in simple textbook models of the monetary transmission mechanism, central banks operate largely through the effect of real interest rates on consumption and investment. Once heterogeneity is taken into account, other important channels emerge. For example, spending by many households and firms appears to be quite sensitive to changes in labor income, business sales, or the value of collateral that in turn affects their access to credit–conditions that monetary policy affects only indirectly. Studying monetary models with heterogeneous agents more closely could help us shed new light on these aspects of the monetary transmission mechanism.
Saying ‘heterogeneous’ just means that the powerful and the powerless get and use money differently. In other words, Yellen was observing, in part, the Cantillon Effect.
And this brings us to today’s bailout and the meaning of institutions. Large banks, private equity corporations, and foreign central banks get dollars through the capital markets, by trading bonds and stocks. It turns out that the Federal Reserve is very good at working in these markets, and can move trillions of dollars relatively quickly. So that’s why the real estate arms of the largest private equity funds in the world are skyrocketing today. They know that the Fed turned the spigot on, and that spigot is instant and functional.
However, the Small Business Administration, unlike institutions in the 1930s and 1940s, does not have the workforce or ability to make direct loans to businesses. They have to guarantee loans made by banks, who in turn are supposed to make loans. Or that’s the theory, but in America, commercial lending institutions have hollowed out dramatically. Neither the banks nor SBA nor anyone else have the people to originate loans. We can’t do it. And our unemployment offices aren’t much better. The only functional bureaucracy that touches business and people is the IRS.
There are a bunch of aspects of the Cantillon effect that I don’t know how to translate. This is not an inflationary moment, the money printing is happening in a moment of severe deflation. So the issue is not that prices will rise, though of course they could. And we do see shortages in certain products, which is a form of inflation. I suspect purchasing power will matter more in who can afford to hold financial assets, not who can afford meat pies and servants. But the basic outline of the Cantillon Effect, that some people have more purchasing power and others have less in the same economy, if the channels of money creation make it so, is still operative.
And that’s the lesson we’re learning in this bailout. If we want to be able to expand and reduce the money supply in a way that doesn’t benefit the already powerful and hurt everyone else, we have to have institutions to do so. There are many policies designed to fix this, including getting every American a debit card as Rep. Rashida Tlaib suggests, or using the IRS as a mechanism to extend payroll support to businesses, as Senator Josh Hawley seeks. With the technology we have today, moving money neutrally in an industrialized economy like ours should be a pretty simple undertaking. Our policymakers just have to decide to do it.
Updated: 7-23-2021
Banks Are Giving the Ultra-Rich Cheap Loans To Fund Their Lifestyle
Billionaire hedge fund manager Alan Howard paid $59 million for a Manhattan townhouse in March. Just two months later he obtained a $30 million mortgage from Citigroup Inc.
Denis Sverdlov, worth $6.1 billion thanks to his shares in electric-vehicle maker Arrival, recently pledged part of that stake for a line of credit from the same bank. For Edgar and Clarissa Bronfman the loan collateral is paintings by Damien Hirst and Diego Rivera, among others. Philippe Laffont, meanwhile, pledged stakes in a dozen funds at his Coatue Management for a credit line at JPMorgan Chase & Co.
In the realm of personal finance, debt is largely viewed as a necessary evil, one that should be kept to a minimum. But with interest rates at record lows and many assets appreciating in value, it’s one of the most important pieces of the billionaire toolkit — and one of the hottest parts of private banking.
Thanks to the Bronfmans, Howards and Sverdlovs of the world, the biggest U.S. investment banks reported a sizable jump in the value of loans they’ve extended to their richest clients, driven mainly by demand for asset-backed debt.
Morgan Stanley’s tailored and securities-based lending portfolio approached $76 billion last quarter, a 43% increase from a year earlier. Bank of America Corp. reported a $67 billion balance of such loans, up more than 20% year-over-year, while loans at Citigroup’s private bank — including but not limited to securities-backed loans — rose 17%.
Appetite for such credit was the primary driver of the 21% bump in average loans at JPMorgan’s asset- and wealth-management division. And at UBS Group AG, U.S. securities-based lending rose by $4 billion.
Borrowing Binge
“It’s a real business winner for the banks,” said Robert Weeber, chief executive officer of wealth-management firm Tiedemann Constantia, adding his clients have recently been offered the opportunity to borrow against real estate, security portfolios and even single-stock holdings.
Spokespeople for Howard, Arrival and Laffont declined to comment, while the Bronfmans didn’t respond to a request for comment.
Rock-bottom interest rates have fueled the biggest borrowing binge on record and even billionaires with enough cash to fill a swimming pool are loathe to sit it out.
And for good reason. With assets both public and private at historically lofty valuations, shareholders are hesitant to cash out and miss higher heights. Appian Corp. co-founder Matthew Calkins has pledged a chunk of his roughly $3.5 billion stake in the software company — whose shares have risen about 145% in the past year — for a loan.
“Families with wealth of $100 million or more can borrow at less than 1%,” said Dan Gimbel, principal at NEPC Private Wealth. “For their lifestyle, there may be things they want to purchase — a car or a boat or even a small business — and they may turn to that line of credit for those types of things rather than take money from the portfolio as they want that to be fully invested.”
Yachts and private jets have been especially popular buys in the past year, according to wealth managers, one of whom described it as borrowing to buy social distance.
‘Significant Benefit’
Loans also allow the ultra-wealthy to avoid the hit of capital gains taxes at a time when valuations are high and rates are poised to increase, perhaps even almost double. Postponing tax is a “significant benefit” for portfolios concentrated and diversified alike, according to Michael Farrell, managing director for SEI Private Wealth Management.
Critics say such loans are just one more wedge in America’s ever-widening wealth gap. “Asset-backed loans are one of the principal tools that the ultra-wealthy are using to game their tax obligations down to zero,” said Chuck Collins, director of the Program on Inequality and the Common Good at the Institute for Policy Studies.
While using public equities as collateral is the most common tactic for banks loaning to the merely affluent, clients further up the wealth scale usually have a bevy of possessions they can feasibly pledge against, such as mansions, planes and even more esoteric collectibles, like watches and classic cars.
One big advantage for the wealthy borrowing now is the possibility that rates will ultimately rise and they can lock in low borrowing costs for decades. Some private banks offer mortgages on homes for as long as 20 years with fixed interest rates as low as 1% for the period.
The wealthy can also hedge against higher borrowing costs for a fraction of their pledged assets’ value, according to Ali Jamal, the founder of multifamily office Azura.
“With ultra-high-net worth clients, you’re often thinking about the next generation,” said Jamal, a former Julius Baer Group Ltd. managing director. “If you have a son or a daughter and you know they want to live one day in Milan, St. Moritz or Paris, you can now secure a future home for them and the bank is fixing your interest rate for as long as two decades.”
Risks Involved
Securities-based lending does comes with risks for the bank and the borrower. If asset values plunge, borrowers may have to cough up cash to meet margin calls. Banks prize their relationships with their richest clients, but foundered loans are both costly and humiliating.
Ask JPMorgan. The bank helped arrange a $500 million credit facility for WeWork founder Adam Neumann, pledged against the value of his stock, according to the Wall Street Journal. As the value of the co-working startup imploded, Softbank Group Corp. had to swoop in to help Neumann repay the loans and avert a significant loss for the bank.
A spokesperson for JPMorgan declined to comment.
Still, for the banks it’s a risk worth taking. Asked about securities-backed loans on last week’s earnings call, Morgan Stanley Chief Financial Officer Sharon Yeshaya said they’d “historically seen minimal losses.” Among the bank’s past clients is Elon Musk, who turned to them for $61 million in mortgages on five California properties in 2019, and who also has Tesla Inc. shares worth billions pledged to secure loans.
“As James [Gorman] has always said, it’s a product in which you lend wealthy clients their money back,” Yeshaya said, referring to Morgan Stanley’s chief executive officer. “And this is something that is resonating.”
Updated: 10-26-2021
How Superstar Firms Win Big From Low Interest Rates
A new paper from the National Bureau of Economic Research shows that low borrowing costs disproportionately aid the top 5% of companies within each industry.
Low real interest rates and the rise of so-called superstar firms are two of the most prominent features of the macroeconomy over the past decade. A new analysis suggests the two are intricately related, highlighting the interaction between monetary policy and the industrial organization of companies.
In 2015, Jason Furman and I highlighted a relatively new development: a dramatic increase in the dispersion of capital returns across companies, with industry leaders seemingly pulling away from others within the same sector.
Since then, a flurry of research has examined such superstar firms, with a vigorous debate occurring over the role of antitrust enforcement in facilitating their rise, whether their rise is more apparent than real, and to what extent they add to overall wage inequality. History will likely show that the pandemic reinforced the “Matthew effect” of leading companies becoming even more dominant.
Furman and I, however, paid little or no attention to the role of low interest rates in all this. An interesting new National Bureau of Economic Research working paper, “Falling Rates and Rising Superstars,” by Thomas Kroen, Ernest Liu and Atif Mian of Princeton University and Amir Sufi of the University of Chicago, does precisely that.
Kroen et al. examine data from 1980 to 2019 on a wide array of companies, and assess the effects of a change in interest rates on the top 5% of companies within each industry relative to others. (It is a purely econometric paper, with no individual companies named.)
The key finding is that “falling rates, especially as rates get close to zero, disproportionately benefit ‘superstar’ firms.” These findings hold regardless of whether the companies are ranked by market value, earnings or revenue.
More specifically, the market value of superstar firms rises, relative to other companies, when interest rates decline. The authors separately assess increases and decreases in interest rates and find largely symmetrical results: A decline in rates benefits the leading firms, and an increase in rates reduces their relative market values.
The effect, furthermore, “snowballs” in the sense that a given drop in rates has a larger impact on the superstars when the interest rate starts from a lower point — so a decline from 2% to 1.5% has a larger effect than a decline from 5% to 4.5%.
What causes this differential market response? Several factors appear to contribute. First, when interest rates fall, superstar firms experience a larger decline in borrowing costs. If the short-term interest rate is 2% and then falls 10 basis points (to 1.9%), the cost of borrowing for industry leaders declines by 15 basis points relative to other companies.
When the initial rate is closer to zero, a decline of 10 basis points produces an even larger relative change: Borrowing costs then drop by 24 basis points more for superstar companies than they do for others.
Second, the superstar firms respond to the relative decline in borrowing costs by issuing more debt, and once again the effect is larger if the initial interest rate is already low. When rates start out close to zero, a decline of 10 basis point in short-term rates is associated with a 5% increase in debt for the superstars relative to industry followers.
Finally, the leading companies use the additional debt not only to buy back more shares than others, but also to expand investment and mergers. When interest rates start near zero, a decline of 10 basis points is associated with a 0.4 percentage point increase in capital expenditures and a 1 percentage point increase in cash acquisitions relative to total assets for leading firms, compared with followers.
As The Authors Conclude:
A decline in the interest rate disproportionately lowers the cost of borrowing of industry leaders, who take advantage of the lower cost of borrowing to raise additional debt financing, increase leverage, repurchase shares, boost capital investment, and conduct acquisitions … the findings provide empirical support to the idea that extremely low interest rates may be a culprit in explaining the rise of superstar firms in the U.S. economy.
If the new findings are corroborated by other researchers, they will have three important ramifications. First, they directly link Federal Reserve policy to the competitive structure of industries, suggesting a closer connection between monetary policy and the superstar phenomenon than had been previously appreciated.
Second, they raise the question of whether similar effects are seen in other countries. The decline in interest rates, after all, has been global. Whether similar effects are seen elsewhere would contribute importantly to the ongoing debate over the role of different factors, including antitrust enforcement, in the rise of the superstars.
Finally, as Robert Rubin, Joseph Stiglitz and I emphasized earlier this year, despite the best efforts of policy makers and central banks, interest rates are fundamentally uncertain. Low rates seem to contribute to the disproportionate growth of superstar firms — for better or worse — but neither they nor the rest of us know how long the era of low rates will persist.
Updated: 1-30-2022
From Cash To Crypto: The Cantillon Effect Vs. The Nakamoto Effect
1. What Is The Nakamoto Effect?
Bitcoin introduces the world to the Cantillon effect 2.0, often known as the Nakamoto effect. Those who live closer to the truth can receive value creation benefits in a Bitcoin world, rather than being rewarded for privilege, status or geography.
The issue of why we need Bitcoin (BTC) is a prevalent one these days, but most people’s responses leave them shaking their heads and declaring it to be either a Ponzi scheme or money for criminals. This conclusion falls short of describing how Bitcoin has the potential to address the systemic inequity and corruption that plague our present monetary system.
Miners contributing to the Bitcoin network’s security are rewarded with new Bitcoin and fees based on how much protection they give, referred to as the Nakamoto effect. In contrast, the Cantillon effect, a long-forgotten classical theory on how the distribution of money impacts individual wealth, is one of the injustices in our current society.
Our modern monetary system, which is built on the generation of money primarily through bank-issued debt with interest, transfers wealth from the middle to the top, resulting in an unstable monetary system and a society in which the “future doesn’t matter.”
Between 1970 and 2010, the International Monetary Fund reported 425 systemic banking, monetary and debt crises, an average of 10 each year. Monopolistic state money is a fragile and unequal system, while countries with many currencies have historically experienced greater stability and equality.
The answer to many of these problems regarding state control of money can be solved with Bitcoin, a new non-state money. After the Great Financial Crisis of 2007–08, the first and most significant change was brought on with Bitcoin The system going online in January 2009.
2. What Are Cantillon Effects?
A change in relative prices resulting from a shift in money supply is known as the Cantillon effect.
Initially defined by 18th-century economist Richard Cantillon, the Cantillon effect is a shift in relative prices caused by a change in the money supply. Making a large amount of cheap money available through banks does not guarantee that the demand for everything will rise simultaneously. Instead, history demonstrates that certain assets outperform others, resulting in price increases in some sections of the economy while prices decline in others.
The Biflation effect is a form of the Cantillon effect. It occurs when the central bank pumps money into the economy to reinflate asset prices during a period of debt deflation (and subsequent recession). Despite the central bank’s efforts, beneficiaries of freshly produced money prefer to spend it on commodities and other associated assets rather than fighting the ongoing deflationary trend in debt markets.
The central bank’s attempt to stimulate the economy may not only fail but instead result in a spike in the cost of living as raw material and consumer basic prices rise, comparable to stagflation’s impacts.
The Cantillon effect is a method of levying an additional tax on anyone who earns a “sticky” wage or has a large portion of their wealth in dollars. This tax rewards people who invest in financial assets or work for the government as preferred contractors. Bitcoin as an investment separates the creation of new money from politics, which makes it far more equitable. But how does the Cantillon effect work?
According to the Cantillon effect, the first recipient of a new money supply has an arbitrage chance to spend money before prices rise. This is partly because new fiat money is created at near-zero cost and distributed to particular parties, most commonly banks. These banks can use this money to buy products and assets whose prices have not yet risen due to the increase in the money supply.
As a result, banks can purchase items at a reduced price. Therefore, individuals and institutions with the closest ties to the central bank — banks and asset owners — are given financial advantages at the expense of those with the fewest links to the financial system. Understanding the Cantillon effect provides that inflation can be viewed as a government-imposed non-legislative and regressive tax on citizens’ purchasing power.
3. How Does Bitcoin Fix The Cantillon Effect?
Unprecedented actions by the central banks and governments of the world’s major economic powers enrich the wealthy while further impoverishing the poor. The famed Cantillon effect lurks underneath this reality, and Bitcoin is the ultimate remedy.
To grasp how Bitcoin alleviates inequity, consider how fiat currencies such as the dollar are allocated now and how fresh Bitcoin is issued.
Almost all of the fiat currency currently issued goes to banks and the government first. This is the case because central banks like the Federal Reserve back big commercial banks like JP Morgan and Citi. Central banks have “printing presses,” that allow them to “print” (or digitally add) a limitless number of their own fiat currency into circulation.
They also impose rules on commercial banks to encourage them to lend more or less money, increasing or decreasing the total money supply. Because banks and the government are the first to get additional money, they determine who is second in line to profit from the Cantillon effect.
This is when lobbying and the influence of being well-connected to the financial elite come into play. Lobbyists ensure that their clients profit from the Cantillon effect, which allows the super-rich and corporations to obtain loans from banks at extremely cheap interest rates.
The Bitcoin system eliminates lobbyist influence and the benefits of knowing the right banker, putting everyone on an equal footing. Every 10 minutes, every miner on the Bitcoin network has an equal chance of winning a reward of newly produced BTC.
Anyone may become a miner by simply connecting a computer into a wall socket, which is significantly less time-consuming than petitioning elected officials for a government contract. Miners spend a lot of money on electricity to fight for the reward, and they provide the Bitcoin system with a much-needed service: security. The Bitcoin system would not work without miners.
Of course, policymakers may influence the Cantillon effect by altering how new money enters the system. However, this does not address the underlying issue: someone benefits at the expense of someone else. The Bitcoin system is significantly more equitable because it employs the Cantillon effect to appropriately reward people who perform a valuable service for everyone else: network security.
4. How To Protect Yourself From The Cantillon Effect?
The simplest method to safeguard yourself against the unequal distribution of new money is to leave the monetary system completely.
Only the oldest living generations can recall a time when money was more than a piece of paper backed by the government’s and military’s “full faith and credit.” We are conditioned to conceive of money as a product of our government, yet avoiding the Cantillon effect necessitates looking at money throughout history, even if it is only a century old.
Money used to be defined as gold, a resource that no government can magically produce more of and that needs a great deal of labor to locate and dig out of the ground. Bitcoin is analogous to gold in that no one can suddenly create more of it, and mining it is extremely difficult. On the other hand, Bitcoin travels at the speed of the internet, allowing worldwide commerce in ways that gold cannot.
Protecting yourself from the Cantillon effect necessitates avoiding the unfair fiat currency systems as much as possible by storing wealth in true money, such as gold or BTC. This is the most peaceful method to phase out the old system and replace it with a new, more equitable one.
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