“the outstanding quantity of bank assets and liabilities is determined by
private supply and demand, and the same is true of the interest rate. In a
CAPM world, monetary policy determines neither the quantity of money nor the
price of money. Both are endogenous variables determined by private borrowing
and lending behavior.” 169


“Fisher's brilliant innovation was to realize that the market for securities
is a current market with current prices where claims for future consumption
are exchanged.” 167


“I believe that in a country like the US, with a smoothly working financial
system, the government does not, cannot, and should not control the money
stock in any significant way. The government does, can only, and should
simply respond passively to shifts in the private sector's demand for money.
Monetary policy is passive, can only be passive, and should be passive. The
pronouncements and actions of the Federal Reserve Board on monetary policy
are a charade. The Board's monetary actions have almost no effect on output,
employment, or inflation.” 164


"Fischer Black in his 1976 manifesto "What a Nonmonetarist Thinks":


“Most of the history of monetary thought is about the conversation between the
money view, which emerges organically from experience with the monetary
system, and the economics view in the academy. But the last few decades have
been an exception.” 164


“Cash flows emerging from past production meet cash commitments engaged with
an eye on future production, and the balance or imbalance between the two
poses the problem that is solved every day by the monetary apparatus.” 164


"In the money view, we are looking at a world where "the present determines
the present". […] In the economics view, by contrast, we are typically looking
at a world where "the past determines the present" in the sense that the
current flow of goods being produced is the consequence of capital investments
made over many generations in the past. […] In finance, "the future determines
the present" in the sense that current capital values are a consequence of
ideas about future income flows, which we discount back to the present."
(Mehrling 2016:163f)


“Paulson, the hedge fund manager, paid Goldman to help him bet against
subprime, and the way he did it was by establishing a so-called "synthetic
CDO". (The very first CDS was established in this way for JP Morgan to hedge
tail risk its portfolio of corporate loans. […] Abacus is a synthetic CDO, not
a cash CDO, because its exposure to credit risk comes from its CDS position,
not from any actual holdings of RMBS (residential mortgage backed securities).
It sells that exposure to IKB in the form of bonds (CDO tranche), and invests
the proceeds in Treasury bills. […] So long as the RMBS was not in default,
Paulsen paid a regular premium to Abacus, which added that premium to the
Tbill return to pay interest to IKB on its bond holding. Once the RMBS was in
default, however, Abacus paid Paulsen by delivering its holding of Treasury
bills, while Paulsen delivered the underlying RMBS which he bought at
liquidation value. The difference between face value and liquidation value is
absorbed in the value of the CDO tranche bonds owned by IKB. […] the falling
value of the referenced securities merely caused a transfer of the collateral,
already collected, from Abacus to Paulsen.” 149


“Goldman Sachs was in effect acting as a CDS dealer, selling protection to
clients but buying protection from AIG. AIG was a naked seller of protection.
When the referenced risky asset started to fall in price, the value of the
insurance rose. This is a liability of AIG, so it cut into their capital
buffer (AIG had no dedicated reserves against these CDS because it thought
they were essentially riskfree). Not only that, but AIG had agreed to post
collateral, and mark the CDS to market, so these losses were not just book
losses but involved payments into a segregated account that Goldman Sachs
controlled, about 30 billion at the time AIG failed. AIG failed because it was
no longer able to meet these collateral calls; instead the government took
over, lending 85 billion. There has been a lot of loose talk about how the
government paid off Goldman at par instead of forcing Goldman to take a loss.
This is not exactly what happened. Rather, because the CDS was marked to
market, Goldman already had possession of the collateral, it had already been
paid. The government money was used to acquire the referenced securities at
liquidation value in order to end the swap.” 148


“UBS was doing something it called a Negative Basis Trade in which it paid AIG
11 bp for 100% credit protection on a supersenior CDO tranche, and financed
its holding of that tranche in the wholesale money market. In its report to
shareholders 2 , to explain why it lost so much of their money, it states that
this trade netted an apparently riskfree arbitrage profit of 20 bp. Because it
was apparently riskfree, they did massive amounts of it. The risk turned out
to be liquidity risk, when money market funding dried up and they could not
sell their AAA tranche. Their CDS hedge did them no good since they could not
use it to raise funding. (To make matters worse, the CDS hedge was typically
only against the first 2% loss, leaving UBS exposed for everything more than
that.)” 147


“The effect of the swap market is to spread stresses in one place and at one
time, across the system and across time, and to unite the individual markets
into one big market. In this way, any imperfections in the markets caused by
regulation or intervention can be evaded. If central banks raise short rates
in one area, making it unattractive for short term lending, then borrowing can
happen elsewhere and swap into the desired currency.” 142


“US interest rate swaps have their origin in 1981, in the midst of the Volcker
tight money period, when some lesser credits would have been locked out of
certain markets completely.” 139


“we see the swap as similar to a repo. The difference is that with swaps we
are dealing with corporate liabilities not governments, and also with much
longer maturities both of the bond (say five years rather than 3 month Tbill)
and of the financing (say 6 month LIBOR rather than overnight repo).” 138


“If the forward imbalance is large, then the current price distortion will be
large, and that means that the expected profit from an unhedged forward
exposure will be large. This expected profit can be expected to attract
speculators in the larger economy, outside the banking system, to hold the
exposure that the banks cannot or are unwilling to bear. Conceptually we will
think of the futures market as the place where the banking system sells off
its excess forward exposure to speculators in the outside economy.” 131


“Banking as Advance Clearing […] is the way that emerging imbalances in the
future show up as cash flow imbalances in the present, again with the money
rate of interest serving as a symptom, and discipline.” 129


“In the United States, politics has resulted in a division of the spoils of
this cheap source of funds during peacetime. Until recently, the central bank
has invested almost entirely in government debt. Commercial banks historically
specialize in making commercial and industrial loans, though they do other
things as well. Savings and loans historically specialize in mortgage lending
and they issue "shares" which have come to look more and more like deposits.”
127


“Because bank deposits are substitutes for currency, and because currency
typically pays no interest, deposits typically pay zero or low interest as
well. This makes it profitable for banks to make loans at relatively
attractive rates. Not surprising, there is considerable competition to get
access to this cheap money. Historically, the biggest player in this
competition is the government. In times of war, we always see bank balance
sheets fill up with loans to the government or to government-favored
enterprises. Similarly, for countries trying to jumpstart a development
process, it is very tempting to begin by trying to mobilize idle balances on
the balance sheets of domestic banks.” 127


“You might think that the liquidity of bank liabilities requires liquidity of
their assets, but this is true only at the margin. To achieve liquidity on the
margin, it is sufficient that the banking system hold some cash reserves, and
have the ability to replenish those reserves. For this latter purpose,
individual banks depend on access to the FF market and discount loans at the
Fed, and on holding of some easily sold "secondary reserve" assets.” 126


“individual households and firms in the economy not only want to make payments
(flow), they also want to hold means of payment (stock). This makes room for
the banking system as a whole to issue a permanent short position in cash. The
role of banks as intermediaries comes from their use of this short position to
fund long positions in non-cash assets.” 126


“Basically bond funds have replaced the saving component of whole life
insurance policies, and also bank time deposits, as fixed income saving
instruments. And stock funds have replaced defined benefit plans as retirement
income savings instruments. This change reduces the degree of transformation
in financial intermediation. Nowadays, mismatch between the preferences of
borrowers and the preferences of lenders is increasingly resolved by price
changes rather than by traditional intermediation.” 126


“Modern finance, by contrast, emphasizes that no risk is eliminated in the
process of intermediation, only transferred, and sometimes quite opaquely.
Thus it is by changes in price that capital markets equilibrate. Attempts to
avoid this by indirect finance only create arbitrage opportunities that over
time have transformed the system.” 125


“an intermediary […] is a financial institution that mediates between the
primary borrower and primary lender of funds, holding as assets the
liabilities that the borrower issues, and issuing as its own liabilities the
assets that the creditor holds. […] such indirect finance by contrast with
direct finance in which borrower and lender meet directly, as by the direct
issue and holding of stocks and bonds.” 124


“think of the primary borrower as a corporation borrowing in order to purchase
some physical capital asset such as a machine or a building. This involves the
corporation in current expenditures far in excess of current receipts, and it
is only over the long lifetime of the capital asset that the corporation
expects to reverse that imbalance. Society's problem thus is to find someone
to hold that illiquid asset over its entire productive lifetime. […] the issue
is the distinction between payment versus funding.” 123


“The key is the use of banking to mobilize unused resources. If entrepreneurs
use their new deposits to buy things that otherwise would have been unsold,
they don't raise prices, they increase economic activity. Schumpeter
emphasized technological change. Others have emphasized other margins of
mobilization—see Lewis model on economic development and the role of banks in
mobilizing underemployed labor, moving it from the traditional subsistence
sector to modern manufacturing sector.” 123


“Adam Smith, back in 1776, urged the adoption of a paper money system as a way
of economizing on the use of gold. We could trade the gold for real capital
assets, which is a trade of a sterile commodity for a productive resource. In
a way that is what we have been doing ever since, moving toward a pure credit
economy.” 122


“We've got to be careful here. It is very easy to go astray, and most of those
you will find posing as monetary alchemists are in fact monetary cranks. The
ability to create money from nothing is not the same as the ability to create
bread from nothing.” 122


“One person who did understand the importance of banking for development
finance was Schumpeter, whose experience was with the Continental banking
system, not the British. As early as his PhD thesis he insisted on the
importance of bank deposit creation as a mechanism for development finance, a
way of giving purchasing power to entrepreneurs who do not have it, without
requiring any individual saver to cough up saved funds.” 122


“One way of understanding the banking collapse of the 1930s is that it was a
run on the shadow banking system of the time, namely this system of private
funding liquidity using repo on nonTreasury security. The Fed refused to
support it, so it collapsed. The consequence was that the government had to
take on responsibility for long term lending itself through various
mechanisms, most famously the Reconstruction Finance Corporation. This mistake
was not, thankfully, repeated in 2007-8!” 122


“In the American system, liquidity was all about "shiftability", meaning
salability. The word was first used by Harold Moulton (JPE 1918), who was
worrying that the new Fed discounting policy might interfere with capital
accumulation. Shiftability means market liquidity, the ability to buy and
sell. The net effect of this system was to mobilize bank deposits as a source
of funding for long term capital finance, by using the repo market, not the
real bills discount mechanism, as a source of liquidity. However the founders
of the Fed saw this shiftability system as a source of instability and tried
to replace it with proper real bills discount banking.” 121


“in the U.S., which was a developing country compared to Britain, the pressing
need for long term finance caused the banking system regularly to hold long
term bonds, and even some of the purported short term loans were really long
term, since they were intended simply to roll over at maturity. As a
consequence, banks did not have regular cash inflows to provide liquidity and
they had to devise another means. (They also did not have a central bank to
provide rediscount, and so they had to devise other means for that as well.)
Instead of self-liquidating short term assets, they held substantial cash
reserves, including correspondent balances, and devised elaborate mechanisms
of secured interbank borrowing using their bond holdings as collateral. […]
this explains why the US was the first to have bond rating services.” 121


“Economic historians argue whether British excellence in money markets held
back the capital development of the nation by emphasizing short term finance
at the expense of long term finance.” 120


“In Bagehot's day, arguably, the two were much more separate than now.
Banking, as we have seen, was about discounting of short term bills that
financed goods on their way toward sale. Bank liquidity was assured by
creating a portfolio of bills maturing at different times in the future, so
that you always have cash inflow to meet possible cash outflow, either from
deposit withdrawal or from new discounts. On the other hand, there was a
capital market, for government and corporate bonds, and also equities. […] or
the most part banks did not buy bonds or equities; they were thought to be
inappropriate assets for banks because they were not "self-liquidating".” 120


“It is common practice to treat capital markets in finance courses, and money
markets in banking courses. But in the real world the two markets are quite
completely integrated, most obviously in the shadow banking system, which I
define as money market funding of capital market lending. Thus the
intellectual habit to treat them separately is outdated, but also more than a
little misleading and even dangerous” 120


“As of October 2013, the Fed has signed permanent and unlimited swap lines
with five major central banks: ECB, Bank of England, Bank of Japan, Bank of
Canada, Swiss National Bank. So now this emergency backstop is present all the
time. So far it has not been needed, but that's mainly because private markets
are more willing to do the job, knowing that the backstop is in place.” 107


“the MMMF lends to Treasury, which lends to Fed, which lends to ECB, which
lends to the Shadow Bank. That was how we managed lender of last resort
internationally in the heat of the crisis. In the aftermath, all this
temporary construction got dismantled, essentially by taking MBS back to the
US where it was easier to cobble together dollar funding directly. It is no
accident that there is now over a trillion MBS on the balance sheet of the
Fed.” 107


“During the financial crisis, one of the big problems was a shortage of dollar
funding for dollar assets held outside the US. […] When the crisis happened,
the Money Market funding all dried up as MMMF refused to roll their loans to
the shadow banks, and demanded instead high quality money market assets such
as Treasury bills. In the aftermath of Lehman and AIG, the funding problem was
fixed temporarily by means of a liquidity swap between central banks: the Fed
lent dollars to foreign central banks, which then lent them on to the shadow
banks located in their countries. Thus the central bank network substituted
for the collapsing money markets.” 106


“Some economists (most notably Milton Friedman) persuaded themselves that
flexible rates would actually work better, on the grounds that market prices
tend to work better than administered prices. 4 Perhaps he thought that price
stability domestically would inevitably result in exchange rate stability
internationally, through the mechanism of Purchasing Power Parity. The result
however did not bear out these hopes. The result was inflation and stagnation
simultaneously until the 1980s when we began to get some discipline into the
system again, and ordering around a few key currencies. The discipline came
from commitment by central banks to a regime of inflation targeting
domestically, even absent any international disciplining device (such as gold
convertibility). Such regimes were very successful in producing price
stability. But internal price stability did not translate into international
exchange stability, not at all. Volatility of major rates—dollar, euro,
yen—continued even after reduced inflation in each area. One important legacy
of the period of disorder was the rise of currency futures markets for hedging
exchange rate risk, and these markets remain to this day extremely important.”
105


“When the US unilaterally broke the connection with gold, even the weak
discipline of the gold anchor was lost. The rationale for other currencies to
peg to the dollar was therefore lost, and they broke away. Instead of a
hierarchical system, we got a system of national currencies and floating
exchange rates. A system of national currencies is typical in war time, when
commerce is typically severely restricted, but quite anomalous in peace time.”
105


“One way we might have fixed the problem would have been to revalue gold;
Mundell says that Arthur Burns was trying to get Nixon to do that. Another way
was to increase the supply of gold, or rather of SDR (Special Drawing Rights)
fiduciary issue of "paper gold" by the IMF. This was attempted in 1967 but it
was too little too late. Mundell suggests that if more had been issued, so
that central banks could have substituted SDRs for gold reserves, that would
have reduced worldwide demand for gold, so lowering its price relative to the
dollar, and taking the pressure off. Instead, the pressure continued and in
1971 the US simply went off gold.” 105


“an expansion of dollar reserves for the rest of the world that does NOT
require the US to be running a trade deficit. Instead they are just the
liability counterparts of gross capital outflows to finance the redevelopment
of the rest of the world. So long as the rest of the world accepts dollar
deposits as if they were gold, the system works fine. But it comes under
unsustainable pressure if gold comes to be undervalued, so that holders of
dollars ask for the promised convertibility. Over time, in the 1960s, this
started to happen with increased frequency.” 104


“Add to this structural deflationary tendency some mismanagement by the Fed,
and you got the ingredients for a real disaster. Mundell identifies the key
mistake in 1931: "Instead of pumping liquidity into the system, it chose to
defend the gold standard" (p. 330) by raising the rediscount rate from 1 ½ to
3 ½ percent. Thus the Fed compounded the secular deflationary tendency with
explicitly deflationary policy. In terms of our hierarchy, we can think of the
Fed as defending the position of the dollar relative to the purportedly better
international money gold. This was the wrong thing to do on two accounts.
First, the whole point of raising the rediscount rate was to attract gold, but
that just increased the upward pressure on the price of gold, which means the
downward pressure on prices generally, and on other currencies. In the event
the pressure was too much for the weaker currencies to stand, and they simply
abandoned gold, as did the United States itself eventually, and the end result
was the collapse of the international monetary system, and along with it much
of international commerce. Second, by defending the dollar against gold, the
Fed was in effect leaving domestic banks on their own to defend the par value
of bank deposits against the national dollar. Falling agricultural prices
meant widespread loan default, and tight central bank policy added liquidity
pressure. The result was widespread domestic bank failure, which added a
further impulse to domestic deflation. 1 On both accounts, Mundell suggests
that the right policy would have been instead to engineer a worldwide
revaluation of gold, which means a worldwide depreciation of currencies
against gold. "Had the price of gold been raised in the late 1920s, or,
alternatively, had the major central banks pursued policies of price stability
instead of adhering to the gold standard, there would have been no Great
Depression, no Nazi revolution, and no World War II."” 103


“The Federal Reserve System was established in 1913 on the eve of WWI. Only
the US remained on gold during the war, but that was no great feat because
throughout the war gold flowed in to pay for war material. At the end of the
war, most of the world's gold was in the US, and the international monetary
system was comprised of national currencies, none of which was properly
convertible into a higher level international money. Nevertheless, the
decision was made to move in the direction of a return to the international
gold standard which had been the system before the war. The problem was that
almost no one realized, and certainly no one prepared for, the deflationary
consequences of doing so without revaluing gold. Over the next decade, the
value of gold would increase each time another country that returned to gold,
simply because of the increased monetary demand for gold, and the consequence
would be downward pressure on other prices (quoted in gold) throughout the
world. (France was a partial exception because France devalued its own
currency against gold, and so got a fresh start.)” 102


“the discipline that is imposed by the gold standard is a payments discipline;
countries settle payments ultimately in gold […] The problem is that
individual states, and their central banks, may not be willing to submit to
the discipline. If they could coordinate with other states, either to revalue
gold (increase its price) or to create accepted substitutes for gold (such as
the SDR), they could relax the discipline somewhat (more gold in circulation
relative to a given quantity of credit). But in practice they have not been
able to coordinate because individual states, and their central banks, are
also generally not satisfied with the place assigned to them in the system,
and so always looking to improve their position. As a consequence, the 20 th
century monetary experience has had not much to do with gold and much more to
do with the behavior of the dominant nation (the US) and its central bank (the
Fed.)” 102


“The establishment of the Federal Reserve system in 1913 switched that
hierarchy, putting public money on top in the domestic banking system. That
proved enormously useful for the war finance that followed, but it stored up
problems once the war was over because the Federal Reserve System left private
money on top in the international gold standard banking system. This was a
contradiction that would take another hundred years to work out, and it is not
completely worked out even today.” 101


“Now consider what happens when the government repays the loan in currency and
bills (not repayment really, just refinancing), holding onto gold as the
international reserves but requiring banks to use its own currency as domestic
reserves. […] The effect is to put the government bank at the top of the
hierarchy, while lower down the private bankers gain the right to issue forms
of money that compete with the king's money. It is a win-win. The hybrid
structure brings more credit to the king for war, and then more credit to the
economy for peacetime expansion.” 100


“neither of these traditions seems to be very well lined up with the current
facts […] The modern system is not a parallel money system but rather a hybrid
or integrated system. […] Historically, wars have provided the opportunity for
kings to discover the usefulness of the private money system. During wars,
governments face a dire need for funds, and typically the kind of funds they
need are metallic not fiat, in order to pay for crucial war materials. The
private metallic system can provide gold since it runs on metallic reserves.
Suppose, as was usually the case, there is a banker's bank separate from the
government bank, and suppose such a bank issues deposits against a 100% gold
reserve. (Think of a clearinghouse, which we have already seen is a kind of
primitive central bank.)” 99


“price levels move very slowly but exchange rates and monetary quantities
fluctuate rapidly. Advocates of the chartalist theoretical tradition therefore
argue that the theory is about the long run tendency of the system. But in the
long run doubts arise about the direction of causation. Money and prices move
together, to be sure, but maybe prices drive money rather than vice versa,
especially under modern conditions where most money is actually credit? And
maybe exchange rate movements drive domestic prices, rather than vice versa?”
97


“Within nations, the hand-to-hand currency used by the common people was the
king's money (and its credit derivatives); the chartalist tradition grew up to
explain how that money worked. Between nations, the money used to facilitate
international wholesale trade between businesses was a metallic currency (and
its credit derivatives); the metallist tradition grew up to explain how that
money worked.” 95


“Of the $4 trillion a day of FX trades, $1.5 trillion are spot transactions
while $1.8 trillion are FX swaps, and the remainder are outright forwards ($.5
trillion), options and exotics ($.2 trillion), and currency swaps ($43
billion). The overwhelming majority of the market is short term; the FX market
is fundamentally a money market, not a capital market.” 95


“fully 84.9 percent of trading volume has the dollar as one leg of the trade.
[…] it is important to appreciate that the dollar in question is substantially
the international private dollar, which is to say bank money not state money.”
94


“Gold is the ultimate international money, an asset that is no one's
liability. Under a gold standard, each currency has its own mint par, and the
exchange rate is determined by the ratio of mint pars. In this view of the
world, the multiple national (state) systems relate to one another not
directly (money to money) but only indirectly (credit to credit) through the
international (private) system. […] This mint par ratio idea does not work
exactly in practice because of the cost of shipping gold around” 93


“The domestic story caused the Fed to liquidate about half of its holdings of
Treasury bills. The international story caused the Fed to expand both sides of
its balance sheet. You might ask why the Fed got involved in supporting
foreign banks. One reason is that they wanted to stop foreign banks from
liquidating their holdings of RMBS, hence driving down the price and adding to
the liquidity spiral. Another reason was the pressure that foreign banks were
putting on domestic banks through the correspondent banking system. That
pressure showed up in the spread between the Eurodollar rate and the term Fed
Funds rate” 91


“The Fed did not involve its own balance sheet, but it did try to encourage
banks to involve their own balance sheets, by cutting the Fed Funds rate from
5% to 2%. But it wasn't enough. The banks and more generally the dealer
system, having taken on responsibility for financing the shadow banks, now
began to run into problems themselves, and that required more serious Fed
intervention. The cornerstone of the domestic intervention was various forms
of term lending to banks and dealers. The cornerstone of international
intervention was liquidity swaps with foreign central banks that then made
term loans to their own banking system.” 91


“One of the first things that happened is that MMMFs refused to roll over
ABCP— essentially they wanted to convert their money market assets into cash.
In the first stage of the crisis (Fall 2007), this was handled by replacing
ABCP with RP, still secured funding but now shorter term. In the second stage
of the crisis (Bear, March 2008), RP became suspect as well, haircuts were
increased, so forcing shift to unsecured Eurodollar and Financial CP funding.
In the third stage of the crisis (Lehman), these also became suspect. In each
crisis trouble shows up as upward pressure on money market funding. We need to
understand these pressures as coming ultimately from the need to maintain par.
Banks that had backup lines of liquidity to the shadow banking system had
themselves to step up to the plate in many instances” 90


“if the Fed always meets the demand for liquidity, then it allows people to
delay adjusting their balance sheets to their changed circumstances, so the
discipline never comes and the imbalance continues. If the imbalance is
prevented from showing up in a liquidity crisis, it will show up somewhere
else, as for example in inflation (or exchange crisis).” 90


“the crisis is typically a symptom of some underlying deeper problem. What the
Fed wants to do is to buy time for adjustment, but not so much time that
people lose the incentive to make an adjustment. Then the problem of the Fed
is to ensure enough price movement to put pressure on the system but not so
much as to make the problem worse.” 89


“In effect a liquidity crisis in any market tends eventually to get funneled
into a demand for bank lending, and if that demand is high enough banks will
eventually try to meet it by dumping their holdings of securities. Note well
that the securities banks hold are overwhelmingly government securities. What
this means is that, if the Fed does not help, there is always danger that
liquidity problems in any market get translated into liquidity problems in the
government securities market--and that cannot be tolerated. Government
securities trade at a premium not only because they are default free, but also
because of the liquidity of the markets. A Fed that failed to maintain the
market for government debt would be a Fed soon under direct Congressional
control. A Fed that ensures liquid markets for government debt in effect
ensures liquid markets for other debts as well.” 88


“Central banks typically follow some version of the so-called Taylor Rule,
which I'll write as follows: R = ρ + π e + α(π e -π*) + β(Y - Y F ) The first
three terms of this equation express the idea of the Fisher Effect, which says
that the private negotiations between borrowers and lenders tend to produce a
nominal rate of interest that takes account of the expected rate of inflation
(so R = ρ + π e where ρ is the real rate of interest and π is the rate of
inflation). This is what the private markets tend to do on their own. Fisher
himself thought that private markets tend to have "money illusion", so they
systematically underestimate future inflation, and hence mistake merely
nominal interest rate changes for real interest rate fluctuations. In his
view, monetary policy was mainly about correcting for these systematic
mistakes. In modern treatments, we tend to assume "rational expectations"
which means that the private forecast is as good as can be achieved from
available information. In modern treatments, the problem is not that people
make mistakes, but that their adjustments of the nominal rate to expected
inflation do nothing to bring inflation under control—they merely accommodate
it. The role of the central bank is to do more than that, by raising interest
rates even more when inflation exceeds the target, and lowering even more when
inflation falls below the target. (That means that α>1.) Translated into our
language, the central bank imposes discipline when prices are rising too fast,
and tries to instill some additional elasticity when prices are not rising
fast enough. In the current crisis, this "inflation targeting" framework has
come under some question. Many people think that the central bank played a
role in causing the credit bubble by keeping interest rates too low for too
long, and that it did so because it was watching inflation not asset prices
(housing prices). So expect to see some evolution in thinking about money
management […] Maybe we will be seeing a return to Hawtrey, with his emphasis
on the inherent instability of credit, operating through the effect of lending
on collateral valuation.” 85


“Once the central bank took responsibility for crisis management, it was
inevitable that it would take responsibility also for trying to prevent crisis
by intervening well before any actual trouble. […] Today we reverse the order,
taking monetary management first, and crisis management second. […] We can
think of Fed interventions in both ways. First, the Fed is using its control
of money (at the top of the hierarchy) to try to influence the expansion of
credit (at the bottom of the hierarchy). Second, the Fed is using its control
of the money rate of interest (at the short end of the term structure maturity
spectrum) to try to influence the bond rate of interest (at the long end). In
both cases, it is actually the private credit market that will determine
quantities and prices, but the Fed is an important player in that market and
can influence it.” 82


“In normal times, the Fed targets overnight rates, leaving term rates to be
determined in the market. But during the crisis the Fed did a lot of
intervention in term markets, which broke down, mainly lending. And now the
Fed is experimenting with intervention on the other side of the market, by
issuing term deposits of its own, first time Sept 10, 2012.” 81


“how do banks manage to make markets in currency and deposits at a zero bid-
ask spread and a price that is fixed at par, and how do they make profit doing
so? The answer is that they are also in a complementary business, the business
of bearing liquidity risk by issuing demand liabilities and investing the
funds at term, and this business is highly profitable. They cannot change the
price of deposits in terms of currency, but they can expand and contract the
quantity of deposits because deposits are their own liability, and they can
expand and contract the quantity of currency because of their access to the
discount window at the fed. Security dealers are stuck with the quantity of
securities out there, and stuck also with the quantity of cash out there.
Banks are not stuck with the quantity of deposits or currency, so although
they have less flexibility on price, they have more flexibility on quantity.”
81


“At the moment the effective funds rate is actually below IOER rate (16 bp vs.
25 bp), but that is because there are some lenders in the market who are not
eligible to receive interest on reserves, and there are lots of excess
reserves, so they have to take what they can get. In a way, we should think of
the effective FF rate as 25, not 16, and that helps us a bit to understand why
repo rates are higher than FF. A lot of distortion in the system right now.”
80


“The shadow banking system faces the same problems of liquidity and solvency
risk that the traditional banking system faced, but without the government
backstops (mainly Fed LOLR and FDIC deposit insurance). Instead the shadow
banking system relies on the market for both, the wholesale money market and
the CDS market mainly. […] The lender of last resort to the shadow banking
system is the traditional banking system, operating through various lines of
credit and liquidity support commitment.” 79


“In the last ten years or so we have seen a further development of this
parallel banking system, into what now people call the shadow banking system.
Essentially we seem to be moving from a system of bank credit to a system of
capital market credit. Corporations pioneered in this shift, but the latest
development has notoriously been more about household credit, namely mortgage
credit.” 79


“banks were losing their core business, but at the same time being prevented
from going into any others. The Securities Industry Association (SIA) resists
bank attempts to get into underwriting non-exempt securities. The Fed imposes
capital adequacy regulations on banks that are not imposed on others. This
accelerates the tendency to strip the balance sheet, to go for off-balance
sheet exposure, substituting FRA for deposits, futures for actuals, etc....
This apparent discrimination against the banks was also in part motivated by
concerns about safety and soundness of the payment system. Also the fact that
banks, unlike their competitors, have privileged access to the Fed, and the
Fed wants to keep use of that access to a minimum.” 79


“This traditional view sees banks as intermediaries between savers (household
depositors) and investors (corporations). […] This is a pretty good picture of
what things looked like in the fifties. One thing it leaves out is that
government securities were a large portion of bank portfolios, so that much
expansion of lending was replacing government securities with private loans.
[…] Things have however changed. […] the "Death of loans"--top corporate
customers have access to open market credit, particularly commercial paper,
where they can borrow more cheaply than banks. Banks have adjusted to the loss
of this business by instead providing backup lines of credit to commercial
paper issues. The second big change I would call the "Death of deposits". Reg
Q worked to provide banks with low cost funds by limiting interest payment on
deposits, but this eroded over time. Rise of money market mutual funds as
competitors. So-called "disintermediation" as ultimate borrowers and lenders
began to take interest rate risk, without the bank standing between them.” 78


“Overnight repo is analogous to a demand deposit account, and term repo is
analogous to a short term loan.” 77


“The real profit in the business comes from trading on the information one
gets from knowing the state of the market better than anyone else, and from
having privileged access to both money and securities in the repo and reverse
markets which means the ability to put on a position more cheaply than anyone
else. Dealers take "positions", which means they speculate on how prices will
change in the future. They deliberately mismatch their book in the direction
they think will be profitable.” 73


“Competition among dealers forces them to offer a very tight "inside spread",
so the profit on any one trade is very small. They compensate for this with
leverage. One step toward greater leverage is to reduce cash inventories to a
bare minimum and rely instead on borrowing […] The dealer accesses the
inventory of securities using reverse and the inventory of cash using repo. We
can think of the repo as borrowing money to finance the dealer's long security
positions, and reverse as lending money (borrowing collateral) to finance the
dealer's short positions. […] In effect, dealers operate a just-in-time
inventory system. […] Ultimately access to cash comes from higher up in the
hierarchy, from banks, and access to securities comes from lower down in the
hierarchy, from security holders.” 72


“We can think of the dealer as supplying liquidity because he is offering the
option to trade. If you want to trade he is willing to trade at the quoted
prices, either way, but if you don't want to trade that's okay too.” 71


“the fundamental value of securities can and does change over time, and this
is the major source of risk in the dealing business: "inventory risk". Also
there is the risk that a customer might know more than the dealer, so the
dealer will be buying at too high a price and selling at too low a price:
"adverse selection risk". The Bid-ask spread compensates somewhat for this
risk, and in times of high volatility (and for securities that have especially
high volatility) we see dealers widen the bid-ask spread. Equally important,
however, is the dealer's ability to change the price as inventories change.”
70


“One way to appreciate what dealers do is to think about what would happen
without them. Imbalances in supply and demand would cause prices to jump
around, or force ultimate suppliers and demanders to wait for the opposite
side. The security market would be like the housing market in which individual
buyers have to find individual sellers and negotiate individual deals.
Instead, in the securities market, buyers and sellers only have to find a
dealer, and the dealer takes the opposite side of their trade. The dealer
makes liquid markets by buying when there is excess selling pressure, and
selling when there is excess buying pressure. […] Dealers thus operate to
smooth prices as well as to make continuous markets out of discontinuous order
flow.” 70


“The continuity of the market price for a particular good thus seems to depend
on a hierarchical structure of inventories. Even so-called "just-in-time"
production is best viewed as a very careful adjustment of the flow of ultimate
supply to ultimate demand in order to minimize inventories.” 69


“A liquid market is "one in which an individual transaction does not disrupt
the continuity of the market". More specifically, it is a market in which you
can buy and sell (1) quickly, (2) in volume, (3) without moving the price
much.” 68


“the clearinghouse was presumed to receive no interest on its assets (gold)
and pay none on its standing liabilities (CH certificates). In times of
crisis, the clearinghouse was presumed to charge an exceptionally high rate of
interest (6%) on loans to members, and to pass that high rate of interest on
to members who were willing to hold clearinghouse loan certificates. We see
here a primitive kind of lender of last resort function emerging organically
from business practice. […] banks are a kind of security dealer, a market
maker in money.” 61


“par, which is the price of deposit money in terms of currency (or reserve
money). […] the interest rate as the price of delaying settlement” 61


“We see the tension also in institutions like continuous real time gross
settlement and control over daylight overdrafts on Fedwire, limits on
overdrafts and daily net settlement on CHIPS, combined with looser limits in
the repo and Eurodollar markets. The effect is to protect the core of the
payments system from potential credit problems (excess elasticity), and to
protect the core of the credit system from potential money shortage problems
(excess discipline).” 61


“the difference between money and credit is all about time. […] the
hierarchical system […] is why the next higher level can operate as a backstop
for credit markets at every level. The availability of that backstop is the
place where the balance between elasticity and discipline is managed. Smooth
operation of the payments system requires elasticity, so that shortage of
means of payment does not get in the way of mutually beneficial trade. But it
also requires discipline, so final settlement is only postponed, not put off
forever.” 61


“Because foreign banks do not have access to the Fed discount window, they
have evolved different ways of making sure that cash inflows match cash
outflows, mainly by matching the two in advance using Forward Rate Agreements,
and then relying on the overnight Eurodollar market to handle any remaining
mismatch. In a similar way, foreign banks have developed mechanisms for
matching up inflows and outflows in every currency in which they deal, mainly
by using forward currency markets and currency swaps.” 60


“The fundamental reason for the Eurodollar market seems to be that foreign
banks have customers who wish to hold dollar balances or take out dollar loans
from them. This customer-led demand causes some of the banks to have a natural
surplus position (more dollar deposits than loans) and other banks to have a
natural deficit position (more dollar loans than deposits). They could each
resolve the imbalance by doing business with some US bank, but it seems easier
all around for them to do business with each other, with the surplus banks
lending to the deficit banks. That's what is happening in the interbank
market, and the London Interbank Offer Rate, or LIBOR, is the rate of interest
charged in that market. […] the special vulnerability of the Eurodollar market
to liquidity problems because of its lack of access to the Fed's balance
sheet.” 54


“Historically there were capital controls that got in the way of free movement
of dollars in and out of the country, and there were regulatory controls (such
as reserve requirements and FICA premiums for deposit insurance) on dollars
held inside the country. The Eurodollar market sprang up to provide a
necessary service outside the control of US authorities. Most of those
barriers have by now been lifted, but the market survives as a separate
entity. But the Eurodollar market is more than a dollar payment system; it is
also the world funding market. Wherever you may be in the world, if you need
to raise money for some domestic project that you are unable to finance
domestically, you are going to be borrowing in dollars. […] the overnight
Eurodollar market has recently been larger in volume than the overnight Fed
Funds market.” 53


“Eurodollars are dollar balances held by banks or bank branches outside the
country, which banks hold no reserves at the Fed and consequently have no
direct access to settlement through Fedwire. Instead, Eurodollar balances
settle on the private CHIPS network. The center of the world Eurodollar market
is London, not New York.” 52


“In effect the market rate of interest is the repo rate, and the official rate
is the Fed Funds rate. The Fed is trying to set up incentives for banks to
borrow at the Fed Funds rate and lend at the repo rate, so supporting short
term credit markets more generally. The fact that the gap stands now at 15
basis points suggests that this strategy is not working very well—that is a
large gap in money market terms, even if it seems small to us.” 51


“The Fed […] does repo (buys Tbills for resale, lends money) like everyone
else when it wants to temporarily increase reserves. But when it want to
decrease reserves, it does MSP (matched sale purchase). […] foreign central
banks get interest at the repo rate on their balances at the Fed, whereas
normal reserve balances pay no interest.” 49


"in general security dealers borrow more than they lend in the overnight
market (repos>reverses), but lend more than they borrow in the term market
(repos < reverses). Like banks, dealers seem to be in the business of
borrowing short term to lend long term, but unlike banks dealers are
specialists in the very short end of the money market term structure. […]
Security dealers have 2.5 trillion dollars of overnight borrowing, which we
can consider analogous to bank deposits. You can't spend an RP, but you can
certainly spend the next day proceeds, and corporate treasurers use that
feature heavily. […] security dealers borrow short and lend long, providing
liquidity to the market in much the same way that banks do." (Mehrling
2016:48f)


“the repo market does much the same thing as the Fed Funds market but for a
much wider class of economic agents, a class that includes just about anybody
that owns eligible collateral. Repo can be thus be understood as inter-
corporate borrowing […] Whereas the Fed Funds market is largely a direct or
brokered market, the repo market is largely a dealer market, and the most
important dealers are the primary security dealers whose balance sheets are
monitored by the Fed. […] By serving as the counterparty for most RP
transactions, they serve to make a unified and relatively homogeneous market
out of what would otherwise be extremely fragmented and heterogeneous (various
counterparties, various collaterals, various maturities.) Like Fed Funds
dealers, RP dealers can be thought of as market makers. […] the price of a
security that is used as repo collateral is less than its market price by an
amount called the "haircut".” 47


“A repurchase agreement is a collateralized overnight loan, legally
constructed as two security transactions one day apart. Keeping our eye on the
loan interpretation, we can call the agent who "repos securities" (sells
securities for repurchase) the borrower of money, and the agent who "reverses
in securities" (buys securities for resale) the lender of money. (To make
things confusing, it is the latter person who is said to "do repo," meaning to
invest in overnight loans.) […] corporations and pension funds invest in repo
(make overnight secured loans to security dealers) as a way of earning
interest on their money balances, and banks repo their security holdings
because it is often the cheapest way to finance them.” 46


“Fedwire is a Real Time Gross Settlement system where a payment from bank A to
bank B is immediately good funds that bank B can use to make a payment of its
own. The problem is that banks were making more payments than they had
reserves during the day, with the plan that they would be receiving more
payments at the end of the day. So there was in effect an intraday expansion
of reserves that was not under the control of the Fed. The Fed got concerned
about the apparent credit element entering here, partly because it put them in
the position of lending without control, partly also because they think of
reserves as money and they want the credit element to happen somewhere else in
the system. They clamped down initially by establishing credit limits,
tailored to individual bank needs. Then in 1994 they started charging interest
on average daily overdrafts (now 36 basis points). This has not been that
effective in reducing overdrafts, and not effective at all in reducing peak
aggregate overdrafts (which come late in the day and are driven by security
transactions). One thought is that maybe the price is not high enough? Maybe
so, but be careful. The relevant alternative to overdrafts on Fedwire are
overdrafts on other payments systems, which typically cost less, even zero.
(Here again we hear echoes of the Strong Rule: use the amount of credit on the
Fed balance sheet to monitor and control credit more generally.) For example,
CHIPs is an alternative payment system with an even stronger credit element
because payments are not good funds until net settlement at the end of the
day. One way to think about what happens is that banks do business on CHIPS,
taking great care to keep track of their net position and to accumulate what
FF they need to clear that position at the end of the day. Note that Oct 1,
1981 Fed required that CHIPs go to same-day settlement, which in effect
tightened up on the credit element here as well. And there has been periodic
tightening of the collateral requirements for overdrafts on CHIPs. The idea
has been to push the credit element out of the payments system into the repo
market” 45


“Fed Funds are (usually overnight) loans from one bank to another, payable in
deposits at the Fed. Call these loans credit. Until recently, the underlying
deposits paid no interest, but the interbank loan does, and that interest rate
is the Fed Funds rate. […] Fed Funds are a credit element that lends
elasticity to the payment system. But Fed Funds are overnight credit not
daylight credit, and they are interbank credit not Fed credit. […] a Fed Funds
transaction involves an immediate flow of reserves between the banks. There is
no waiting for the end of the day, no netting of inflows and outflows, like at
a clearinghouse. […] money center banks trade Fed Funds among themselves as a
way of managing intraday cash flow fluctuations” 40


“today when all banks have massive excess reserves so that the legal reserve
requirement does not bind. […] The survival constraint says that cash inflows
must be at least as large as cash outflows. The precise institutional
mechanism that embodies that constraint for banks is the requirement to end
the day with a non-negative balance in their reserve account at the Fed. To
appreciate the importance of this constraint at the end of the day, it is
useful to appreciate the way that banks are allowed to relax the survival
constraint during the day. Indeed that violation is essential for the smooth
working of the payments system because it allows banks to be the "first
mover", to make payments before they receive payments. The institutional form
that violation takes is the "daylight overdraft". If Bank A sends over Fedwire
an order to pay $10 to Bank B, but has insufficient funds to cover that
payment, the Fed does not "bounce the check" but rather covers it temporarily.
The effect is a temporary expansion of reserves in the system […] these
daylight temporary reserves, not the overnight required reserves, are the
actual ultimate means of payment. […] The survival constraint kicks in at the
end of the day, when they must bring their accounts back to zero” 39


“Clearinghouses can be broken by any individual member who insists on
redeeming clearinghouse notes for gold. Central banks by contrast cannot be
broken by internal forces because their own liabilities are the member banks'
reserves. In effect, the central bank makes the system of banks operate as
though it were a single bank because they all have clearing accounts at a
single bank. All payments from someone within the system to someone else
within the system net out. There is however still the problem of managing
payments to and from agents outside the system and this problem is the origin
of the "Art of Central Banking" Two kinds of problem arise. It may be that the
bank customers demand payment, so reserves flow out of the banking system into
circulation as customers demand currency. This is called an internal drain and
central bank balance sheet expansion can satisfy it. A more difficult problem
is an external drain, where foreigners demand payment in gold. For this, a
higher bank rate of interest can satisfy demand by discouraging discounts.” 37


“Central banking can be understood as nothing more than one step beyond the
clearinghouse, a kind of regularization and strengthening of the clearinghouse
system that goes the extra step of obliterating the difference between
clearinghouse certificates and clearinghouse loan certificates.” 37


“Typically these member loans are highly over-collateralized, and pay interest
of 6%. Similarly the CH loan certificates pay interest of 6%. The loan
certificates are not gold, and so are not strictly speaking legal reserves,
but in a crisis they come to be treated as similar to the clearinghouse
certificates which are gold and are legal reserves. After the crisis they are
liquidated.” 37


“what happens in a financial crisis, when all member banks find themselves
short of gold, because of outflows into circulation or abroad. Then there is
no chance of solving the problem by arranging for weak banks to borrow
temporarily from strong banks. Instead, weak banks borrow from the
clearinghouse, which creates additional reserves from thin air simply
expanding both sides of the balance sheet.” 36


“problems of mismatch between cash flows and cash commitments show up as
upward pressure on the short term money market rate of interest.” 30


“the enormous amount of action "below the line" that is necessary in order to
make goods and services transactions "above the line" possible.” 27


“To analyze how financial commitments affect the economy it is necessary to
look at economic units in terms of their cash flows. The cash-flow approach
looks at all units—be they households, corporations, state and municipal
governments, or even national governments—as if they were banks. (Minsky 1986,
p. 198)” 25


“at every moment in time there is a balance between discipline (which comes
from the scarcity of money) and elasticity (which comes from the availability
of credit). […] the discipline comes from the credit limit and terms imposed
by the bank on each borrower, and the elasticity comes from the willingness of
the bank to swap its own IOU (which is money) for IOUs farther down the
hierarchy (which are credit).” 24


“the quantity of bank money fluctuates over time, as bank credit expands and
contracts in order to facilitate the time pattern of trade. It is of course
this third system that most resembles the institutions of the modern developed
economy.” 24


“Suppose neither of us trusts one another sufficiently to extend bilateral
credit, so the bilateral credit limit is zero. But we both trust some third
party, and that third party also trusts each one of us. In this case we can
organize our exchange by issuing IOUs to and accepting IOUs from the third
party. It seems reasonable to call these third party IOUs "money", and to call
the third party a "bank".” 24


“this pure credit payment system is more flexible than the pure money payment
system, since we are not limited by the total money supply, only by mutually
agreed credit limits. Observe that in this system, unlike the money system,
the quantity of outstanding IOUs fluctuates over time.” 23


“The monetary system is a hybrid system, comprised of both private money (bank
deposits) and public money (currency). The central bank is also a hybrid
entity, both bankers' bank and government bank. It is possible in principle to
build a monetary theory around either one of these dimensions, focusing on
either the private dimension or the state dimension, and treating the other as
subsidiary. But any such theory is only partial since it misses the true
hybrid character of the system. The story of American monetary history is a
story of getting the public/private balance right. It took a while, and indeed
is still ongoing.” 22


“The key to all this was supposed to be the discount mechanism, and hence also
the discount rate. The idea was that member banks could always get whatever
reserves they needed simply by presenting one of their eligible loans to the
local FRB for discount. In turn the FRB could itself always rediscount for
Federal Reserve notes. If the amount of new discounts exceeded the repayment
of existing discounts, then total reserves would expand. If repayment exceeded
new discounts, then reserves could shrink. No longer would the system spend
half the time with too much reserve (fuelling speculation) and half the time
with too little (risking financial crisis). […] But WWI intervened. Instead of
real bills, the central bank got stuffed with government paper.” 21


“After the crisis of 1907, the Aldrich Vreeland Act of 1908 created the legal
basis for these ad hoc measures, but more was needed. The Federal Reserve
system routinized the private solution to both problems. Under the national
banking system, the quantity of cash was fixed. Under the Federal Reserve
System it became elastic. The way it was supposed to work was that banks could
take certain kinds of loans (so-called real bills) to their local Federal
Reserve bank and "discount" them for Federal Reserve bank notes that could be
used in circulation. The various reserve banks could also discount at the Fed
itself to get Federal Reserve notes which were legal as well as economic
reserve. Shifts in demand as between deposits and cash could thus raise no
problems; also cash drains into circulation would raise no problems; and total
reserves could also fluctuate elastically.” 21


“How to make reserves elastic? The answer was to make reserves a form of
credit. […] What the banking system needed in times of tight money was a
temporary increase in reserves (for the farm banks) and a temporary increase
in cash (for circulation purposes).” 21


“At harvest time there is a cash drain from the system, and that means a cash
drain from New York, which New York see ks to remedy by calling in loans and
raising reserves from abroad. Thus the cash drain spread into the stock
market, causing selling by those who were using call loans to finance their
speculative positions. And it spread to the international money market,
pulling in gold from London. The consequence was a very definite seasonal
pattern in interest rates […] The result was not only a seasonal interest rate
but also periodic financial crises, caused whenever banks had to make cash
payments but lacked the cash to do so. Young makes the correct point that the
problem was the inelasticity of reserves.” 20


“a very inelastic money issue because the collection of bonds that could be
used to back notes was not increased except by special measure. There was also
very inelastic reserves, indeed perversely elastic because of the reserve
requirements, 25% for central city all in cash, 25% for middling cities partly
in central city reserves, and 15% for country partly in central city reserves.
Already in 1873 the country experienced the first of a series of financial
crises, all of which followed a similar pattern. In slack times the farm banks
would find themselves with excess funds for which they could find no local
outlet. They might use them to buy a security (bond) but they had always to
keep in mind that they would need the funds come fall. So they tended to
deposit the funds in New York where they could earn interest. New York banks
would therefore find themselves with excess funds, which they also knew were
only seasonal, so they wanted a short term investment. They would buy liquid
securities or make short term loans.” 20


“This third strategy for government purchase of war goods is financed by an
expansion of private money (the bank notes), which are promises to pay the new
standard money (legal tenders) not gold.” 20


“The National Banking System was established in 1863 during the Civil War as
another of Chase's attempts to secure wartime finance. The overriding idea was
to strengthen the market for government bonds. But the lasting effect was to
fix the money supply. Chase's idea was to issue a special class of bonds that
could be used to back the bank note issue, while at the same time putting in
place measures (taxes) that eliminated other potentially competitive note
issues. […] imposing a tax on all note issues that were backed by anything
other than these special 2% bonds.” 20


“Once the banking system has no more gold, its promises to pay gold (its
deposits) lose their credibility, and banks accordingly "suspend
convertibility". […] bank deposits become promises to pay government issued
legal tender. In 1862, because of the weak market for government bonds (on
account of risk, possibly overestimated, but then the banks had been burned
once already), the government decided not to try to issue marketable bonds but
rather to rely on legal tender note issues. […] insert legal tenders between
gold and bank deposits in the hierarchy of money. At the same time it broke
the connection between the dollar and gold, since the legal tenders were not a
promise to pay any specific quantity of gold.” 18


“When the banking system swaps IOUs with the government, it expands both sides
of its balance sheet, so total deposit liabilities increase. The story of
Civil War finance begins with just such an operation. […] the entire banking
system broke free of gold and only returned 17 years later in 1878. […] Salmon
P. Chase, Secretary of the Treasury […] in August 1861, he took out a big bank
loan and then withdrew the proceeds, hence gaining control of the banking
system's gold for his own war purposes […] This allowed the North to buy
needed material from abroad, while the South was forced to rely on barter for
cotton exports. But it also forced suspension of specie payments
domestically.” 17


“Deposits are similarly an asset of the government or private sector and a
liability of the banking sector, so payment for the bonds enters as a
reduction in both private sector assets and banking sector liabilities, and as
an increase in both government assets and banking sector liabilities.” 17


“a story of war finance in the Civil War, when the North fought the South, as
well as lots of political constraints given American antipathy for central
banking. Note that before the Fed there was no official central bank, but
there was a collection of New York banks that operated informally as such for
their members. Behind the scenes are Big Finance and Big Government, the two
big bogeymen of American monetary experience, and the populist agitation for
easy money for themselves, not for Wall Street and not for Washington.” 16


“the attempt to use monetary policy for non-monetary purposes can put strain
on both par and the exchange rate, and more generally on the institutions
charged with maintaining quantitative equivalence between qualitatively
different levels of the hierarchy. Standard analytical frameworks in
macroeconomics (such as IS-LM) tend to abstract from such strains, and hence
from the limits of monetary policy” 15


“Modern central banks have larger ambitions. They are typically concerned with
"managing the economy." But their actions still have their impact only to the
extent that they succeed in influencing the natural hierarchy.” 15


“If ordinary banks were having difficulty defending par, the central bank
could help them out by providing additional reserves—this is the essence of
the classic "lender of last resort" function. On the other hand, if the
central bank itself was having difficulty defending the exchange rate, it
could raise the interest rate in order to attract international reserves
(gold).” 15


“The whole idea of monetary policy however is to intervene actively with some
objective in mind other than profit maximization. We can understand monetary
policy as an attempt to manage the natural fluctuation of the system for the
general good, rather than for the profit of the central bank.” 14


“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.
[…] 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.” 14


“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 asset prices. 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.” 14


“A security dealer stands ready to buy or sell a security at a given price
(actually two prices, the buy-sell spread) in terms of money. He does this by
holding an inventory of both securities and money (actually an inventory of
credit instruments that provide access to inventories of securities and
deposits held elsewhere, i.e. repos and reverse repos). I propose to think of
banks as a special kind of security dealer that stands ready to buy or sell a
deposit at a given price (now only one price) in terms of currency. And I
propose to extend the idea also to the central bank which, under a gold
standard, stands ready to buy or sell currency in terms of gold. Both banks
and central banks are thus like specialized types of security dealers.” 13


“the hierarchy is not something imposed from the top down, e.g. by the
government or the central bank. Monetary systems are naturally hierarchical,
from the ground up […] I do not mean to suggest that the monetary system is
self-organizing in the sense meant by some Austrian thinkers, as Menger […]
Rather I think of the institutional organization of the monetary system as
inherently involving a system of market makers at different levels of the
natural hierarchy.” 13


“The natural scarcity comes from the fact that agents at any particular level
in the hierarchy cannot by their own actions increase the quantity of the
forms of money at a higher level than themselves. Just so, governments cannot
increase the quantity of gold, and banks cannot increase the quantity of
government currency. The availability of money thus serves as a constraint
that holds the system back in its attempts to expand. The natural elasticity
comes from the fact that agents at any particular level in the hierarchy can,
by their own actions, increase the quantity of forms of credit at their own
level, and possibly also below them. If you and I want to make a trade and you
are willing to accept an IOU from me, then we can trade and what makes the
trade possible is an expansion of credit. The elasticity of credit thus serves
as an element of freedom that facilitates breaking loose from any constraint
that may be standing in the way of expansion.” 12


“The history of monetary theory is to a large extent comprised of a dialogue
between two points of view, often distinguished as the Currency School versus
the Banking School, which emphasize respectively the importance of scarcity
and the importance of elasticity. From the point of view I have been
developing, both have part of the truth but neither has it all. Thus,
liquidity is at the same time both naturally scarce and naturally elastic” 12


“As it expands, the hierarchy flattens and the qualitative difference between
credit and money becomes attenuated, but then the system contracts and the
hierarchy reasserts itself.” 11


“all of the instruments except gold appear as both assets and liabilities.
They are thus clearly all forms of credit. […] the difference between gold and
other forms of money is the difference between "outside" money and "inside"
money, an analytical distinction first proposed by Gurley and Shaw in their
seminal 1960 Money in a Theory of Finance. Actually, Gurley and Shaw treated
currency as outside money and deposits as inside money because they aggregated
only over the private economy, not including the government sector. […] by
contrast, we will typically be thinking about the entire economy, even the
entire world economy, so all financial assets will be inside, including
currency. […] I place the peak of the pyramid at zero even though there is a
positive quantity of gold, simply to emphasize that that quantity is
vanishingly small compared to the vast edifice of credit below. From the point
of view of the system as a whole, every liability is someone else's asset.” 10


“what counts as money and what counts as credit depends on your point of view,
which is to say it depends on where in the hierarchy you are standing.” 9


“For a country settling its accounts at the end of the day, national currency
is of limited value. What other countries want is their own currency, or the
international means of settlement, which means gold in the case of a gold
standard, perhaps SDRs (Special Drawing Rights at the IMF) in the modern case.
(The US is an exception because of the international role of the dollar.)” 9


“bank deposits are promises to pay currency on demand, so they are twice
removed promises to pay the ultimate money, and securities are promises to pay
currency over some time horizon in the future, so they are even more
attenuated promises to pay. […] for a bank settling its accounts at the end of
the day, currency or "high-powered money" is certainly the means of
settlement. But things look different farther down the hierarchy. For ordinary
people like ourselves, bank deposits are the means of settlement. Hence we
might be inclined to view deposits (and everything above them) as money, and
securities as credit.” 9


“under a gold standard […] gold is the ultimate money because it is the
ultimate international means of payment. National currencies are a form of
credit in the sense that they are promises to pay gold. […] When a currency is
backed by gold reserves, it is still a promise to pay, just a more credible
promise to pay because the presence of reserves makes it more likely that the
issuer of currency can fulfill on the promise if called upon to do so.” 8


“Always and everywhere, monetary systems are hierarchical. […] distinguish
money (means of final settlement) from credit (promise to pay money, means of
delaying final settlement). […] in one sense it doesn't go far enough because
it posits only two layers of the hierarchy. And in another sense it goes too
far because what counts as final settlement depends on what layer we are
talking about. What looks like money at one level of the system looks like
credit to the level above it.” 8


“The world has changed, and even the best textbooks lag behind. Existing
theory was developed to explain a very different world: postwar (govt debt)
and post Depression (govt guarantees, regulation). This led to emphasis on
intermediation story, and monetary policy story. Today we live in a different
world. Private financial markets, and globalization, are the key facts of our
time. Practical central bankers know this better than academic economists, and
traders in the money markets know this best of all. In terms of globalization
(trade and integration), the current world is more similar to the pre-WWI
world than the post-WWII world, the world when the pound sterling was king and
the Bank of England operated as central bank for the entire world. Longer
history thus gives more perspective on our current situation than does more
recent history. Bagehot helps us more than Irving Fisher. In terms of finance,
the current world is in many ways new. There are new financial instruments,
much more wide usage of existing instruments, electronics and
telecommunications, and new theories.” 6


Par—different types of money (currency, deposits)
Interest—future money (fed funds, Eurodollars, repo)
Exchange rate—foreign money
Price level—commodities" 6


"Four functions of banking Clearing, market making, advance clearing,
intermediation […] Four prices of money


“start with micro, and thinking of every agent in the economy as a kind of
bank, in the sense that every agent needs to be attending to the daily inflow
and outflow of cash balances. Every agent has to worry about this, but only
actual banks make a business out of worrying about it. […] Centrality of the
issue of liquidity—that is what makes banks special and different from other
corporations.” 5


“I locate myself in the distinctly American tradition of monetary thought that
stretches from Allyn Young to Alvin Hansen, Ed Shaw, and Hyman Minsky, all of
whom engage in one way or another with the great tradition of British central
banking thought that stretches from Walter Bagehot to Ralph Hawtrey, Richard
Sidney Sayers, and Charles Goodhart. […] the origins of monetary thought lie
in concrete banking practice” 3


Professor Perry Mehrling, “The Economics of Money and Banking” (BARNARD COLLEGE, COLUMBIA UNIVERSITY, 2016).


“in 1826, a Freemason called William Morgan was murdered in New York for
revealing masonic secrets, and there was such a popular outrage and backlash
that Freemasonry was all but destroyed in the United States. If the real
intention had been to found a Freemason’s lodge, it would have been wise to
disguise it as something else. Why the skull and bones was ever chosen as the
name and symbol is unexplained. The ‘322’ on the order’s stationery is said to
mark the date of death of the great orator Demosthenes, but ‘32’ might refer
to the year of the order’s inception, with ‘2’ signifying that it was the
second chapter after the German original. The invitation to join the Skull and
Bones comes in a student’s junior year with a tap on the shoulder as the tower
clock strikes eight and a Bonesman demands, ‘Skull and Bones, accept or
reject?’ President William Howard Taft and various Chief Justices of the
Supreme Court and other important figures in the highest ranks of American
government have been members. […] President George W. Bush was asked about his
time there but would only say, ‘In my senior year I joined Skull and Bones, a
secret society, so secret I can’t say anything more.’ And when Senator John
Kerry, Bush’s rival in the 2004 presidential election, was asked what it meant
that both he and Bush were Bonesmen, he replied, ‘Not much because it’s a
secret.’ George W. Bush’s father, George H. W. Bush, was also a Bonesman; he
was president from 1988 to 1992, and had earlier been head of the CIA.” (Haag,
2010, p. 116)


“Charles de Gassicour and the Abbé Barruel, who saw the French Revolution as
the culmination of an ancient historical plot by the Templars and Freemasons
who were in league with everyone from the Assassins to the Jews.” (Haag, 2010,
p. 115)


“Joseph Smith was himself a Freemason, as were his brother and his father and
many of their friends and co-religionists; Brigham Young, who was Smith’s
successor as leader of the Mormons and led them into Utah where they founded
Salt Lake City, was likewise a Freemason. In America Mormonism and Freemasonry
grew out of the same soil. Indeed there are many parallels between Mormonism
and Freemasonry, including degrees of elevation, sacred treasures hidden in
the earth, an interest in ancient Israel and Egypt, symbolic clothing, secret
means of recognition and a belief in the creative role of a supreme being.
Also both organisations have made extensive use of such motifs as the beehive,
the square and compass, the all-seeing eye, the two right hands clasped to one
another, and the sun, the moon and the stars. In particular, Masonic legends
of a lost sacred word, once engraved upon a triangular plate of pure gold,
profoundly affected the Smith family, which became well known for its
treasure-hunting activities; and it was on such plates of gold, unearthed by
Joseph Smith in upstate New York, that he found what he said were the words of
the Angel Moroni and which he translated and published as the Book of Mormon,
the gospel of the new faith of which Smith himself was its prophet. The
mission of the Mormons is to restore the true revelation which became
corrupted after the death of Jesus. And according to the Mormons their rituals
and symbolism have come to them by divine revelation and originate in
Solomon’s Temple.” (Haag, 2010, p. 115)


“there is nothing specifically masonic about the all-seeing eye, which was
part of the cultural iconography of the seventeenth and eighteenth centuries.
For example in 1614 the frontispiece of Sir Walter Raleigh’s History of the
World showed an eye in a cloud labelled ‘Providentia’ overlooking a globe.”
(Haag, 2010, p. 114)


“The seal was commissioned by Congress on 4 July 1776, immediately after it
had voted its approval of the Declaration of Independence, but it would pass
through three committees and take six years before a final design was
approved. Benjamin Franklin, who was on the first committee, was the only
Freemason involved, and his non-masonic suggestion that the seal should depict
the Jews escaping from the tyranny of pharaoh was rejected. The obverse of the
seal shows an eagle clutching thirteen arrows, an olive branch with thirteen
leaves and thirteen fruits, the eagle defended by a shield with thirteen
stripes, and above his head thirteen stars arranged in the form of the Seal of
Solomon, also known as the Star of David. Thirteen represents the original
thirteen American colonies that rebelled against Britain and came together to
form the United States. The motto reads ‘E Pluribus Unum’, meaning ‘Out of
Many, One’. The arrangement of the stars has aroused speculation, but biblical
and Hebrew symbolism were as common in the eighteenth and nineteenth centuries
as classical symbolism. Charles Thomson, a Latinist who was Secretary of
Congress and the person who set the various ideas for a seal into their final
form, explained simply that ‘the constellation of stars denotes a new State
taking its place and rank among other sovereign powers’. The reverse of the
seal shows a pyramid surmounted by an eye. The pyramid has thirteen courses
and is inscribed at its base with MDCCLXXVI. There are two mottoes, one above
the eye, the other below the pyramid. Again Charles Thomson gave his
explanation: ‘The pyramid signifies strength and duration: The eye over it and
the motto, Annuit Coeptus [He [God] Has Favoured Our Undertakings], allude to
the many interventions of Providence in favour of the American cause. The date
underneath is that of the Declaration of Independence, and the words under it,
Novus Ordo Seclorum [A New Order of the Ages], signify the beginning of the
new American era in 1776.’” (Haag, 2010, p. 114)


“In the United States there has been a well-established legend that the
Freemasons were behind the American Revolution. They are said to have
instigated violent resistance to the British […]. A few Freemasons may have
participated in the Boston Tea Party, but it was planned and executed by a
group of radical artisans called the Sons of Liberty. Of the Committee of Five
who drew up the Declaration of Independence, only one, Benjamin Franklin, was
a Freemason; the Declaration was almost entirely written by Thomas Jefferson,
who was not a Freemason. Of the fifty-five Americans to sign the Declaration
of Independence, only nine were certainly Freemasons; and of the thirty-nine
who approved the Constitution, only thirteen were or later became Freemasons.
George Washington had become a Freemason at the age of twenty but did not take
it seriously, regarding his lodge as a social club and showing up for only two
meetings in the next forty-one years. The higher ranks of Freemasonry in the
American colonies were pro-British and remained loyal to the Crown, as did at
least a third of the American population. Benedict Arnold, who won the first
great battle of the revolutionary war for the Americans at Saratoga, and who
then defected to the British (so that in America his name is synonymous with
treason) was a Freemason. Yet in 1793, at the dedication of the Capitol
building, George Washington, in his capacity as first president of the United
States, but wearing his masonic apron, placed a silver plate upon the
foundation stone and covered it with masonic symbols of maize, oil and wine.
[…] The explanation lies in the creation of the revolutionary army with
Washington at its head. His officers had been thrown together from a diversity
of regional origins, religions and social rank, and had great responsibilities
thrust upon them. Freemasonry had been popular among officers in the British
army in North America, and the revolutionary army continued the practise of
having military lodges, which it turned to good account. Freemasonry’s ideals
of honour and fraternity offered American officers the bonds on which to build
the camaraderie necessary for the survival of the army, and therefore of the
American republic.” (Haag, 2010, p. 113)


“The masonic Scottish Templars had done what masons always do: they invented a
tradition, a connection with the past, and a very flattering one for Scots
Freemasons. These inventions were never meant as factual history. This is
explained by Robert Cooper […]. None of the traditional histories of any of
the branches of Freemasonry are, or were, intended to be taken literally. Our
forebears in all the Masonic Orders manufactured suitable ‘pasts’ for
allegorical purposes. They did so with romantic notions at heart but
understood that these histories manufactured by, and for, themselves were not
literal truths.” (Haag, 2010, p. 111)


“The eighteenth and early nineteenth centuries saw an explosion of orders,
degrees and societies, among them benevolent societies that survive to this
day such as the Oddfellows and the Royal Antediluvian Order of Buffaloes, or
spiritual groups such as the Druids, given to pantheistic nature worship in
imitation of Bronze Age Celtic Druids. By 1800 there were hundreds, maybe over
a thousand, of these organisations in Britain, and like the Freemasons they
gave themselves antique histories; the Oddfellows, for example, traced their
spiritual origins back to the Jews at the time of their Babylonian exile in
586 BC. In addition to these organisations, there were other orders or
degrees, about thirty in all, which claimed to be masonic, indeed were often
operating unofficially within local lodges, among them the Knights Templar.
Chivalry and mysticism were very much in fashion, and though at first both the
English and Scottish Grand Lodges rejected the Knights Templar, saying they
were a foreign corruption, in the age of Romanticism the fashion proved
irresistible and eventually the Templars were accepted within British
Freemasonry.” (Haag, 2010, p. 111)


“A few years later Barruel added Jews to the conspiracy, seeing them as the
real power behind the Templars and the Freemasons and the ultimate
manipulators of European events […]. Barruel was in exile from revolutionary
France and published his Memoirs in London, where he was politic enough to
thank the British government for granting him asylum and wrote that his claims
of dangerous Freemason activities did not apply to the respectable Freemasons
of Britain. The British government agreed. Worried about the virus of
revolution from France, in 1799 it passed the Unlawful Societies Act, although
this specifically excluded the Freemasons.” (Haag, 2010, p. 110)


“At the time Ramsay said nothing about the Templars, perhaps because he might
have offended the still powerful French monarchy and Church. In 1749, however,
six years after his death, Ramsay’s monumental work The Philosophical
Principles of Natural and Revealed Religion was published in Glasgow, and in
it Ramsay said, ‘every Mason is a Knight Templar’, a remark that was not
forgotten. The Crusader link was further developed in Germany in about 1760,
when a Frenchman who pretended to be a Scottish nobleman and called himself
George Frederick Johnson claimed to have direct access to Templar secrets.
This too served local tastes, as Germany was an old-fashioned society
dominated by notions of rank which resisted the egalitarian and rationalist
ideas inherent in British Freemasonry. A spurious connection with Templars
provided the German Freemasons with Gothic atmosphere and a strong flavour of
the occult. According to Johnson’s concoction of history, the Templar Grand
Masters had spent their time in the East learning the secrets and acquiring
the treasure of the Jewish Essenes, later famous for the Dead Sea Scrolls, and
the people with whom John the Baptist probably had some association. This
learning and this treasure was handed down from one Grand Master to another,
and so came into the possession of James of Molay–who according to the story
also bears the name of Hiram. On the night before his execution, James of
Molay was said to have ordered a group of Templars who were somehow still at
large to enter into the crypt of the Paris Temple and make off with the
treasure, which consisted of the seven-branched candelabra stolen from the
Temple by the Roman Emperor Titus, the crown of the Kingdom of Jerusalem and a
shroud. These were taken to the Atlantic port of La Rochelle from where
eighteen Templar galleys made their escape to the Isle of Mull where they
called themselves Freemasons. The Scottish Freemasons, said Johnson the fake
Scotsman, were the Templars’ direct heirs. Then came the French Revolution in
1789, which shook the European public to the core. In an effort to understand
those dramatic events, many accepted the fiction that secret organisations
were manipulating public affairs.” (Haag, 2010, p. 109)


“Though the Freemasons in Britain were an innocuous and largely middle-class
fraternal organisation, whose lodges fulfiled a similar social function as the
London coffee house, they acquired a cult of secrecy and linked this to a
mysterious knowledge associated with Solomon’s Temple. Earlier, Agrippa had
linked the Templars to witchcraft and occult powers. It remained for these
elements to be drawn together into one powerful occultic myth, and this is
what happened when the Freemasons were directly linked to the Templars–which
happened not in Britain but in continental Europe. The first step was taken in
1736 or 1737 by a Scotsman called Andrew Michael Ramsay, a Jacobite exile
living in France who, as chancellor of the French Grand Lodge, introduced a
fictitious Crusader background to the Freemasons and notions of aristocratic
class. British Freemasonry was democratic in nature; its members included
artisans and aristocrats, professional men, learned men and middle-class
traders, all content to rub shoulders with one another. But neither rubbing
shoulders nor belonging to an institution that had grown from workingmen’s
beginnings appealed to the upper strata of French society. The gentry and
nobility of France wanted recognition of social distinctions, and they wanted
it reinforced by style, nostalgia and romance. Ramsay gave it to them by the
bucketful, suggesting that the stonemasons had also been knightly warriors in
the Holy Land, and soon he had turned the French Freemasons into an ancient
chivalrous international secret society. ‘Our ancestors, the Crusaders, who
had come from all parts of Christendom to the Holy Land, wanted to group
persons from every nation in a single spiritual confraternity’, Ramsay
announced in his Oration to Saint John’s Lodge in Paris, variously dated 27
December 1736 or 21 March 1737. In Ramsay’s version of the past, the Crusaders
had attempted to restore the Temple of Solomon in a hostile environment and
had devised a system of secret signs and rituals to protect themselves against
their Muslim enemy, who otherwise would infiltrate their positions and cut
their throats. Ramsay also said that at the collapse of Outremer the Crusaders
returned to their homelands in Europe and established Freemason lodges there.
But their lodges and their rites were neglected over time and it was only
among Scotsmen that the Freemasons preserved their former splendour.” (Haag,
2010, p. 109)


“One of the greatest figures of the Enlightenment, the scientist and
mathematician Sir Isaac Newton, wrote something like four hundred and seventy
books–many of them on theological subjects and several about the Temple of
Solomon. Newton was convinced that Solomon was the greatest philosopher of all
time, and he also believed that he owed his own breakthrough formulation of
the law of gravity to his close reading of those portions of the Bible, 1
Kings and 2 Chronicles, which give in great detail the measurements of
Solomon’s Temple. Moreover Newton saw in those same figures all manner of
prophecies of great and terrible events that would take place over the coming
four hundred years, including the Second Coming of Christ in 1948.” (Haag,
2010, p. 108)


“At a time when most workers were tied to the land, masons were freelancers
who sought work where they could, and in Scotland and England during the
Middle Ages they began to form themselves into mutual help associations. There
were two kinds of masons, the ‘rough masons’ who worked in hard stone, laying
foundations and raising walls, and the more mobile masons who carved the fine
facades on cathedrals from softer stone, freestone as it was called, and these
elite masons were called freestone masons, or freemasons for short. As the
freemasons travelled round Britain they would stay at lodges, and after the
Reformation in the sixteenth century one of their activities at their lodges
was to read the Bible. The Catholic Church had discouraged the translation of
the Bible into the vernacular, fearing that the Bible would replace the Papacy
as the font of authority. This was precisely what Protestants in Scotland and
England were eager to do, for the Bible was discovered to have revolutionary
implications; for example it spoke of prophets who had overthrown wicked
kings, and at the same time it failed to support the notion that the bishop of
Rome, that is the Pope, should be the supreme leader of a universal Church. On
the other hand the Protestants decided that the Bible was itself the word of
God, and those who were freemasons paid close attention to the Second Book of
Chronicles with its description of how Solomon asked Hiram to build the
Temple, and to the detailed measurements of the Temple, which God would only
have troubled to mention, in their view, because they contained some profound
theological truths. The freemasons were particularly impressed by that other
Hiram, not Hiram the king of Tyre, but Hiram the widow’s son, the one they
called Hiram Abiff. The most remarkable work at Solomon’s Temple had been done
by Hiram Abiff, the casting of the enormous basin known as the Sea of Bronze
and of the huge bronze pillars known as Jachin and Boaz. As the Bible said,
this Hiram was a man ‘filled with wisdom and understanding’. The efficacy of
these freemasons’ mutual assistance associations depended on their
exclusivity, that they should be clubs open to freemasons only, and the point
was made by developing a system of signs and rituals supposedly passed down
from ancient times and by means of which adherents gained access to the
private meetings. One such ritual concerned Hiram Abiff, to whom the masons
gave a history that went far beyond his brief mention in the Bible. Hiram
Abiff, they said, knew the secret of the Temple. Three villains kidnapped
Hiram and threatened to kill him if he did not reveal the secret ‘Master’s
word’–a term used by the masons in their trade to differentiate the pay and
assignments of workers, but also, as the ritual now implied, bearing deeper
and mystical significance. But Hiram refused to reveal the secret, and his
assailants murdered him. When Solomon heard about this, he wondered what was
Hiram’s secret, and he sent three masons to look for his body, also telling
them that if they could not find the secret, then the first thing they saw
when they found Hiram’s body should itself become the secret of the Temple.
The masons found Hiram Abiff’s coffin, and when they opened it the first thing
they saw was his hand–and from this the masons made the handshake and other
signs of recognition the new secret. On the basis of this story, the masons
developed the ritual by which a Freemason advances through degrees, the first
being apprentice mason, the second being entered apprentice, and so to the
third degree when he becomes a master mason. Advancing to the third degree
requires that the initiate must agree to undergo the sufferings of Hiram Abiff
should he ever reveal the Freemasons’ secrets, and that if he ever broke his
oath it would be right for his fellow Freemasons to cut out his heart, his
liver and his entrails, in the same way as a traitor was disembowelled as part
of the process of being hanged, drawn and quartered. But already these
associations of artisan freemasons were undergoing a transition that would
alter their fundamental nature. To enhance the standing of their associations,
freemasons invited influential people to serve as patrons. This gave the
freemasons a social appeal which together with their study of the Bible began
to attract an inquiring elite comprising gentlemen and scholars, professionals
and merchants, so that by about 1700 these ‘admitted’ or ‘speculative masons’
outnumbered ‘operative masons’, as the artisans were called. In fact the
modern institution that we recognise as Freemasonry was born when a group of
four London lodges made up of both operative and admitted masons merged in
1717 to create a Grand Lodge. They placed at their head not a practising mason
but a gentleman, and never again would a true stonemason ever serve as a Grand
Master.” (Haag, 2010, p. 107)


“The book was De Occulta Philosophia; it was by a German, Henry Cornelius
Agrippa, and after its publication in 1531 it became the most widely read and
influential of the Renaissance magical texts. Agrippa was a serious humanist
scholar whose interests spilled over into folklore and the occult. The purpose
of his book, he said, was ‘to distinguish between the good and holy science of
magic and the scandalous and impious practises of black magic, and to restore
the former’s good name’. In the process he examined the various ways in which
the powers emanating from spirits and demons could be harnessed and
controlled. And then he wrote these fateful lines: ‘It is well known that evil
demons can be attracted by bad and profane arts, in the manner in which
Psellus relates that the Gnostic magicians used to practise, who used to carry
out disgusting and foul abominations, like those formerly used in the rites of
Priapus and in the service of the idol called Panor, to whom people used to
sacrifice with their private parts bared. Nor were they much different, if
what we read is truth and not fantasy, from the detestable heresy of the
Templars; and similar things are known about the witches and their senile
craziness in wandering into offences of this sort.’ By placing the Templars
alongside witches as his two examples of perverted Christian magicians Agrippa
thrust the order into the phantasmagoria of occult forces which were the
subject of the persecuting craze for which the Malleus Maleficarum was a
handbook. Suddenly the Templars were raised from the depths of half-forgotten
failures and became the focus of the darkest disturbing forces in the European
mind–its victims or its masters. In this way the Templars entered the
Renaissance and were to advance into the Age of Enlightenment.” (Haag, 2010,
p. 106)


“Here at Sagres Henry attracted astronomers, geographers, cartographers and
sailors, a community of scholars and adventurers who joined together under his
direction to conquer the unknown. Prince Henry died and was buried at Sagres
in 1460, but the impetus of his work continued.” (Haag, 2010, p. 103)