Money Matters: The Cantillon Effect

Welcome to Financial Fluency - a newsletter designed to boost your understanding of financial terms and provide you with investment ideas for long-term financial success.

In today’s newsletter:

• A Look at the Markets: NVIDIA

• Money Matters: The Cantillon Effect

• Quote of the Day: Warren Buffett

• What I’m Reading & Watching: Broken Money by Lyn Alden

• Word of the Day: Surge

• Whenever you are ready, here is how I can help you

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A Look at the Markets: NVIDIA

US Tech Stocks Sell Off After Chinese AI Breakthrough

There was a major sell-off in US technology stocks on Monday (27th January 2025), with Nvidia dropping 17%.

What caused the sell-off?

Over the weekend, a Chinese company, DeepSeek, released a new AI model that claims to match - or even surpass - the performance of US models like OpenAI's ChatGPT.

Why did this shock the markets?

US companies such as OpenAI have spent billions training their AI models, yet DeepSeek claims to have achieved similar results for around $5.6 million. If true, this could disrupt the AI industry, particularly for leading US AI firms.

Interestingly, the US had restricted the export of high-performance chips to China. While intended to limit China's AI development, this may have actually spurred Chinese companies to innovate with fewer resources, ultimately making their models more cost-efficient.

What does this mean for the future?

Greater competition could benefit the AI industry, pushing US companies to rethink their approach to training AI models.

What about Nvidia?

Nvidia was hit hardest because investors feared that fewer of their leading high-capacity chips would be needed in the future. However, the stock has since started to recover.

How did this affect the S&P 500?

The S&P 500 is heavily weighted toward the top seven technology stocks, so any significant drop in their value impacts the entire index. However, by the close on Monday, the S&P 500 was only 1.5% down compared to Friday’s close.

The Vanguard FTSE All-World ETF

One of the advantages of investing in an all-world index for the long term is that you do not have to worry about short-term price action. However, I have posted the chart below.

Although the Vanguard FTSE All-World ETF dropped a similar amount to the S&P 500 it has already rebounded to a level above last Friday’s close. The chart is still close to all-time highs.

Money Matters: The Cantillon Effect

Why Money Creation Isn't Neutral

Last week, we explored the crucial distinction between currency debasement and inflation. This week, we'll delve deeper into a fascinating economic principle that helps explain why money creation affects different groups in society differently: the Cantillon Effect.

Understanding the Cantillon Effect

Named after 18th-century economist Richard Cantillon, this effect describes how changes in the money supply don't affect all economic participants equally. Instead, the benefits of new money creation flow to those closest to the source - typically financial institutions and wealthy individuals - before gradually spreading to the broader economy.

How It Works: A Modern Perspective

Imagine a company giving annual bonuses to its employees. However, not everyone receives their bonus at the same time—first the directors, then the managers, and finally the workers.

The directors, receiving their bonuses first, rush to the car dealerships and buy up the available stock at current prices. By the time the managers get their bonuses and head to the dealerships, they're told there are no cars left in stock. Due to the surge in demand, they can place an order, but the prices have gone up.

Finally, when the workers receive their bonuses, they find an even longer waiting list and prices so high that buying a new car is no longer affordable for them.

Similarly, when central banks create new money:

1. Financial institutions receive it first through various monetary operations

2. These institutions can invest in assets before prices adjust

3. By the time this money reaches the broader economy, asset prices have often already risen

4. Regular wage earners face higher asset prices without having benefited from the initial money creation

Real-World Impact on Your Finances

The Cantillon Effect explains why stock markets rose during the 2020 Coronavirus crisis, even as much of the world was in shutdown. Injecting money into the economy fueled a rise in asset prices, disproportionately benefiting investors who already held assets - primarily the wealthy.

In other words, this effect helps explain:

• Why asset prices often rise faster than wages

• How wealth inequality can widen during periods of monetary expansion

• Why financial markets sometimes seem disconnected from the "real" economy

Investment Implications

Understanding the Cantillon Effect can reshape your investment strategy. Most importantly, it explains why you should consider protecting your money by investing. Consider positioning your portfolio to benefit from, rather than be victim to, this economic reality:

• Maintain exposure to assets that benefit from monetary expansion

• Focus on investments that have historically preserved purchasing power

• Consider allocation to sectors that typically receive new money early in the cycle

Next week we will look at some assets that historically benefit during periods of monetary expansion.

Business English Vocabulary Focus

Broader Economy The complete economic ecosystem beyond financial markets.

Monetary Expansion When central banks increase money supply through methods like lowering rates or buying securities.

Purchasing Power Your currency's real-world value - what it can actually buy. When purchasing power falls, you need more currency for the same goods.

New Money Fresh currency entering the system through central banks and financial institutions.

Quote of the Day: Warren Buffett

The volatility in the market this week means that it is a good time to remember this quote from Warren Buffett’s:

By ‘trouble’, he means big financial events such as Black Monday (1987), the Gulf War (1990 - 1991), the financial crisis (2007 - 2009) and Brexit (2016). This week’s DeepSeek is another example of ‘trouble’ for the technology sector.

When I read this quote, I remember the importance of mentally preparing for increased volatility in the markets and potential large price corrections.

However, Warren Buffett may have had another meaning. ‘Trouble’, for Warren Buffett, meant buying opportunities.

What I’m Reading & Watching: Broken Money by Lyn Alden

Although it was only released in 2023, I am now reading this book for the second time.

In Broken Money, Lyn Alden explores the evolution of money, why the financial system has lagged behind technological advancements, and how cryptocurrencies could reshape it. While not a Bitcoin book, it covers digital assets in the final sections. She also examines the Cantillon effect, which we discussed earlier.

I recommend this book for Advanced and Proficiency English students interested in financial markets. For economists, it’s a must-read.

Broken Money on YouTube

Lyn has posted a useful animated video of the book on YouTube. This gives a nice preview of the book and I would watch this before you decide whether to buy the book.

Word of the Day: Surge

Surge - noun - countable - a sudden and great increase or upward movement

Business Context: 

When prices surge in financial markets, it means there's a sudden and significant increase in value.

Example Sentences:

• Bitcoin surged to new highs following increased institutional investment.

• The company's stock price surged after announcing record profits.

• A surge in demand led to supply chain bottlenecks.

Word Family:

• Verb: to surge

• Noun: surge

• Adjective: surging

• Past tense: surged

Common Business Collocations:

• price surge

• demand surge

Whenever you are ready, here is how I can help you:

We provide Business English lessons and Cambridge and IELTS preparation courses. You can book an online lesson over Zoom here:

You can book a free 20-minute consultation with Iain over Zoom here:

Why not subscribe to our sister Business Fluency newsletter for English students interested in understanding essential business terms and concepts and providing you with practical strategies to boost your business and career prospects?

Disclaimer:

This newsletter is for informational and educational purposes only and should not be construed as financial advice. The information contained herein is generic and does not take into account your individual financial circumstances. You should always consult with a qualified financial professional before making any investment or financial decisions.

Additionally, the authors and/or publishers of this newsletter may hold investments in securities or other financial instruments mentioned herein. These are included for illustrative purposes only and should not be taken as a recommendation to buy or sell such securities or financial instruments.