When First Principles Fail

— Preface of the book Macroeconomics Has No Clothes

Economists continuously pursue new ideas and have achieved considerable success—yet few pause to ask whether the foundations beneath them are truly solid. In my view, they are not.

Demand has two dimensions: willingness and ability to pay. Willingness without ability is mere desire — and desire is boundless. The substance of demand, therefore, lies entirely in the ability to pay.

The ability to pay, then, does not lie in money itself—money is merely a claim on goods and services. It is those goods and services that constitute the true ability to pay.

Money is merely a medium of exchange—a veil over what is fundamentally goods and services trading for goods and services. Your capacity to demand what others produce is ultimately proportional to what you produce yourself.

All goods and services must be produced. Demand, therefore, is ultimately a supply-side phenomenon. In aggregate, demand and supply are not opposing forces—they are identical, differing only in the angle from which they are viewed.

The mainstream case for a shortage of effective demand rests on two laws—diminishing marginal propensity to consume and diminishing returns on investment—that cannot bear such weight. Both are tools of partial equilibrium analysis, valid only when all other factors are held constant. In the real world, nothing is held constant. The conclusion does not follow. Take consumption as the first example: a shift in its structure is enough to break the pattern of diminishing marginal propensity. Capital is no different. Diminishing returns arise only because labour is assumed to lag behind capital—but that assumption treats capital as one undifferentiated mass. Split it into Capital A and Capital B, and the logic unravels. If Capital A expands rapidly through, say, advances in intelligent machinery, there is no reason the return on Capital B must fall

Since demand and supply are essentially identical at the aggregate level, the aggregate supply and demand model (AS-AD) does not hold. And if the model itself does not hold, what becomes of the analyses built upon it?

Mainstream macroeconomics measures GDP with considerable sophistication—yet it omits a concept without which the measurement is fundamentally misleading: pseudo-GDP. Misguided investment destroys wealth; it cannot, by any honest accounting, be counted as GDP. But without this distinction, it is. The consequences are serious. In theory, the framework ties itself in knots. In practice, misguided production is misdiagnosed as overcapacity or insufficient demand, and stimulus is applied where loss-cutting is what is needed. Introduce pseudo-GDP, and what mainstream economics calls a shortage of effective demand reveals itself as something else entirely.

The formula GDP = C + I + G + NX tells you how to measure GDP — nothing more. Measurement is an act of categorisation and summation; it says nothing about cause and effect. Yet mainstream macroeconomics treats this accounting identity as a causal model, concluding that if C and I fall, raising G will compensate. This is a category error. The formula licenses no such inference. The entire three drivers of economic growth , and the macroeconomic management built upon it, inherits this error—and collapses with it.

Money exists for one reason: to reduce transaction costs, facilitate trade, and deepen the division of labour. Yet mainstream macroeconomics has turned this plain instrument into a lever for achieving economic growth, full employment, and balance of payments equilibrium—goals it was never designed to serve. Whether monetary policy can even achieve these goals is a separate question; the more fundamental problem is that the entire approach has the cart before the horse. The same confusion runs through the mainstream endorsement of mild inflation as economically beneficial. Where exactly is the threshold between mild and non-mild? And more importantly: inflation is a seigniorage tax—a covert erosion of property rights. That undermining property rights could be good for the economy is a claim mainstream economics asserts but never seriously defends. These are not minor oversights. They are foundational failures

If monetary policy were confined to a single objective—maintaining the stability of the currency's value—the conundrums outlined above would dissolve. Constructs such as the Mundell-Fleming trilemma would cease to exist. This book takes precisely that approach. I make no claim that it is the only path to a sound theory, but a theory built on this foundation is demonstrably more concise and logically consistent than what mainstream economics currently offers. It is a direction that deserves serious attention.

Exchange rates offer another illustration. Since prices in microeconomics are determined by supply and demand—beyond anyone's control—artificial intervention can only substitute non-monetary prices for monetary ones, never eliminate the adjustment itself. This reduces the entire debate between fixed and floating exchange rate regimes to a single practical question: which adjustment mechanism is more effective? Floating regimes move the nominal rate directly; fixed regimes achieve the same end indirectly, through shifts in wages and prices. Strip away the complexity mainstream economics layers onto this subject, and that is all there is.

Or so it appears. The book goes further—and so can the reader.

This book addresses the fundamentals of macroeconomics — and fundamentals are where everything begins. When first principles fail, no structure holds — however sophisticated the edifice built upon them. I cannot claim that every argument in this book is correct, but I am confident that the questions it raises and the insights it offers are genuinely illuminating. My hope is that readers come away with one lasting conviction: that the foundations of economics must be able to withstand the scrutiny of both theoretical logic and practical experience. At present, they do not.

I owe a debt of gratitude to Mr. Zhou Mingjun, Mr. Wang Guohai, and Mr. Chen Jin for their generous support throughout the publication and translation of this book. My deepest thanks go to all the students in my masterclass. It was your probing questions, your refusal to accept easy answers, and our countless hours of tireless discussion that drove home a truth I now hold firmly: foundational problems cannot be resolved by memorising answers — they must be hammered out through meticulous, painstaking work. In every class, the roles quietly reversed. Rather than me instructing you, it was you who compelled me to re-examine every inference I had thought settled. The most valuable insights in this book were forged in precisely those moments when your challenges stopped me mid-thought and sent me back to think it over again.

A special word of thanks is due to Mr. Chen Jin. This translation has been four years in the making, and without his tireless dedication, this book would never have found its way to English-speaking readers.

Xie Zuoshi
Tuesday, 12 May 2026

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