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Unformatted text preview: uantitative link between layers of qualitatively differentiated assets. At any
moment in time, markets makers are straddling two layers of the system, with one leg in one
layer and the other in another. More accurately, the two legs are the two sides of the marketmaker’s balance sheet. Simple Hierarchy of Market Makers Mehrling 9/14/2009 Asset 7 Market Maker Price Central Bank Exchange Rate Banking System Par Security Dealers Interest Rate Gold
Securities If the market makers do their job well, we will observe continuous markets at the various prices
of money. In other words, the qualitatively differentiated hierarchy will appear as merely a
quantitative difference between various financial assets. It is this transformation from quality to
quantity that makes it possible to construct theories of economics and finance that abstract from
the hierarchical character of the system (as most do). But the hierarchical character remains, and
shows itself from time to time, especially when the market makers are not doing their job well,
such as during periods of financial crisis or under the extreme stress of war finance.
Even in less extreme times, fluctuation in the natural hierarchy shows up as strain on the market
making institutions. A narrowing of the hierarchy means an increased qualitative differentiation
between credit and money, and in the course of that differentiation there is bound to be pressure
on the quantitative price of credit in terms of money. Just so, interest rates can and do change to
reflect that stress, but that quantitative change is not necessarily equilibrating, and might just
make the strain worse. Further, the whole point of par is that it is a price that does not change,
and under a fixed exchange rate system the same is true internationally. The banking system
thus comes under stress as the natural hierarchy fluctuates because it is bound to defend the fixed
price between different layers of the hierarchy. Reserves are the first line of defens...
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This document was uploaded on 02/16/2014.
- Fall '14