Banking Implies Hierarchy
A Natural Money Structure
As we've seen,1 banks issue IOUs (deposits) that everyone else uses as money, and the central bank issues IOUs (currency, reserve deposits) that the banks themselves use as money. The following diagram shows deposits as claims on the banks and currency as claims on the central bank.
Always and everywhere, monetary systems are hierarchical.
(Mehrling 2013, 394)
Credit issued higher up serves as money for the entities below.
We choose to hold a lower form of money—inserting banks above us—because banks make owning deposits more convenient than holding currency. The emergence of banking is the emergence of hierarchy (Howlett 2024).
Clip Length: 3:51 (2017 Lec 1, 25:37–29:28)
We're uncomfortable with hierarchy. And we're uncomfortable as economists. When we hear the word "hierarchy," we think of power; we think of monopoly—as opposed to markets. We're in favor of markets. Markets are flat. But I'm saying: Here at the very center of the market system, the monetary system is not flat. And, as we'll see, there are reasons it's not flat and probably cannot be flat. So we need to adapt to that and understand that phenomenon and how we can manage that system for the general good.
(2017 Lec 1, 28:43)
Monetary hierarchy can take many forms. There was a time in history when global money consisted of claims on gold. That's not today's world, but it is a world that's easier to think about. For pedagogical simplicity, Mehrling places gold at the top of the hierarchy and securities at the bottom. Gold represents money that's above everyone. Securities (e.g., bonds) represent credit instruments that nobody uses as money.
The following diagram, adapted from Mehrling, illustrates the four layers of Mehrling's hierarchy along with a pyramid showing that there's more stuff at the bottom than the top.
The Money and Banking lectures (Mehrling 2012) focus on the mechanics of money and credit without dwelling too much on the top of the hierarchy. These mechanics work largely the same regardless of how the monetary standard is ultimately anchored.
Meanwhile, banks are more than just deposit-taking institutions. They also lend. Every layer of the hierarchy faces a survival constraint2 that can be relaxed by borrowing from banks above.3
The below diagram illustrates bank lending as a mutual obligation4 (swap of IOUs) in two different ways: payment arrows on the left and balance sheets on the right. The borrower receives deposits in exchange for promising to repay the loan. The bank issues deposit liabilities in exchange for a loan obligation from the borrower.
If there's no layer above us, the survival constraint will induce us to insert one by paying banks to lend. Banking emerges as a natural response to our need to meet our payment commitments. The survival constraint makes the hierarchy of money inescapable.
References
Howlett, Alex. 2024. "The Many Faces of Money and Hierarchy." Working paper, The Greshm Institute. https://www.greshm.org/files/2024-01-31-the-many-faces-of-money-and-hierarchy.pdf.
Howlett, Alex. 2025a. "Settle or Die: Payment, Liquidity, and Survival." The Survival Constraint (blog). February 9. https://survivalconstraint.substack.com/p/settle-or-die.
Howlett, Alex. 2025b. "Transactions: It Takes Two." The Survival Constraint (blog). February 24. https://survivalconstraint.substack.com/p/transactions.
Howlett, Alex. 2025c. "The Alchemy of Banking: Transmuting Promises into Money." The Survival Constraint (blog). March 1. https://survivalconstraint.substack.com/p/the-alchemy-of-banking.
Howlett, Alex. 2025d. "Public-Private Monetary Hybridity: Money as a Creature of the Market." The Survival Constraint (blog). March 9. https://survivalconstraint.substack.com/p/public-private-monetary-hybridity.
Mehrling, Perry. 2012. Economics of Money and Banking. Online course. Coursera. Accessed 2015–2025. https://www.coursera.org/learn/money-banking
Mehrling, Perry. 2013. "The Inherent Hierarchy of Money." In Social Fairness and Economics: Economic Essays in the Spirit of Duncan Foley, edited by Lance Taylor, Armon Rezai, and Thomas Michl, 394–404. London: Routledge.
Mehrling, Perry. 2017. "Lecture 1: Why Is Money Difficult?" Warsaw School of Economics, recorded October 11, 2017. Video of lecture, 1:33:46. https://youtu.be/9DozcacGdYI