Where money ends up

New money does not spread evenly and stop. It pools in assets, because assets are what credit is secured against and what surplus money buys. This is why asset prices and wages have come apart.

Part three of how money actually flows.

If money were created evenly and spent evenly, prices would rise roughly together and nothing much would change in real terms. That is the mental model behind “inflation makes everything more expensive,” and it is close enough for a shopping basket.

It is badly wrong for assets.

Why assets behave differently

Consider what happens to a marginal pound or dollar in two different hands.

Someone spending most of their income on necessities receives extra money and spends it. It enters the consumption economy and shows up, eventually, in consumer prices.

Someone whose needs are already met receives extra money and buys an asset — property, shares, a business. Assets differ from groceries in one decisive way: the supply cannot expand quickly. You can bake more bread this week. You cannot build meaningfully more housing stock this week, and you cannot create more shares in an existing company at all without diluting it.

So money directed at consumption meets supply that can respond, and money directed at assets meets supply that mostly cannot. The same amount of new money produces mild price rises in one and sharp ones in the other.

Then add the mechanism from part one: most new money is created by lending, and lending is mostly secured against assets. Credit expansion does not merely allow asset purchases — it is structurally biased toward them, because an asset is what makes a loan safe to write.

This is a reinforcing loop, and it is worth stating explicitly:

1. Credit expands, secured against assets
2. That credit is used to buy assets
3. Asset prices rise
4. The collateral is now worth more
5. Which supports more credit

Nothing in that loop is irrational at any individual step. Every participant is behaving sensibly. The loop still runs.

Cantillon, again

Richard Cantillon noticed in the 1730s that new money does not raise all prices at once. It enters at a point and spreads outward, and whoever is near the entry point spends it before prices have adjusted. Those far from it find that prices adjusted before their income did.

Three centuries later the entry points are bank lending and central bank asset purchases. The people nearest them are those who own assets and can borrow against them. The people furthest are those whose only channel is a wage.

That is the mechanism behind a fact most people experience without having a name for: an economy can post respectable growth, low unemployment, and modest consumer inflation, while housing becomes unattainable for people doing the same jobs their parents bought houses with. Nothing has gone wrong in the official numbers. The money went where it goes.

The visible consequence

The clearest way to see this is not in prices but in ratios: the price of an asset measured in the number of years of median wages needed to buy it.

House-price-to-income ratios in most developed economies are substantially higher than in the 1980s. The nominal price of a house rising is not interesting on its own — wages rose too. What matters is that the ratio moved, and it moved because the asset was bid on with credit while the wage was not.

Look up the current figure for your own city rather than taking a number from an essay. The ratio is what to look at, and the direction over forty years is not seriously disputed.

What this does not mean

It does not mean asset prices only rise. They fall, sometimes violently, and the same leverage that amplifies gains destroys people on the way down. Anyone concluding “buy assets with maximum borrowing” from this has read the loop and skipped step 4 running backwards.

It does not mean owning assets is a moral failing or a moral achievement. It is a position on a circuit.

It does not mean the loop runs forever. It runs while credit is expanding. When credit contracts, the same mechanism operates in reverse and does so faster, because collateral falling in value forces selling that lowers it further.

The honest summary

Money is created at the top of the system, secured against things that already exist, and used to buy more of the things that already exist. Consumption prices rise gently. Asset prices rise sharply. Wages rise somewhere in between.

If your income arrives entirely through the wage channel and you hold no assets, your position relative to asset owners deteriorates every year the loop runs — not because you are doing anything wrong, but because you are standing at the far end of the circuit from where the money enters.

That is the problem this site exists to think about clearly. It is not solved by working harder, because the mechanism has nothing to do with effort.

Next: what it costs to hold money →

Sources

• Richard Cantillon, Essai sur la Nature du Commerce en Général (c. 1730), for the original observation about where new money enters.
• OECD and national statistical agencies publish house-price-to-income series. Use your own country’s, and prefer the ratio to the price.
• Bank for International Settlements research on credit cycles and property prices, for the collateral loop described above.