Chapter 20: Economics

Subjective foundation

Economics contains many competing schools of thought, and disagreement extends to its foundations. Economists dispute the nature of money, the stability of markets, the causes of growth and recessions, the determinants of prices, how people should be modelled, and whether mathematical methods illuminate or obscure economic activity. Much of the subject therefore remains contested rather than established knowledge on which all economists agree.

These disagreements produce opposing recommendations on fundamental questions: whether stimulus spending after a crash helps recovery or delays it, whether a minimum wage helps low-paid workers or excludes them from employment, and whether large government debts support stability or threaten it. Invoking economic expertise does not identify a settled course of action. It requires choosing which school of thought, assumptions, and predictions to trust.

Unpredictability

If economic theory could reliably predict the future, such as what will happen to interest rates or the stock market, or whether a crash is imminent, people could use those predictions to change their course of action. Those changes would alter the predicted outcome and destroy the very predictability on which they were based. Economists who successfully predict such events can therefore do so only to the extent that they know something that other market participants, including mainstream economists, do not.

Intervention

Economists cannot reliably predict economic conditions, turning points, financial crises, or the consequences of policy changes. Measuring aggregates after events occur is not the same as forecasting them. To recommend an intervention, an economist must predict both what would happen without it and how people and markets would respond to it.

The lack of an agreed economic foundation described above compounds this poor predictive record. Without reliable predictions of counterfactual outcomes, there is no reasonable basis for trusting economists to steer the economy. An intervention changes prices, incentives, expectations, and behaviour, making the system still harder to predict. Giving discretionary economic power to people who have demonstrated little predictive ability does not solve uncertainty; it allows their forecasting errors to affect the entire economy.

Subjective value and voluntary exchange

VoTa begins with the praxeological understanding that value is subjective. Nearly all interpersonal economic activity under VoTa then has the same underlying form: voluntary exchange. A buyer transfers Central Bank currency because the buyer values what is being acquired more highly than the currency surrendered. The seller makes the opposite valuation, preferring the currency to the good, service, asset, right, or contractual commitment being transferred. The transaction proceeds because both parties expect to benefit. Their valuations can differ without contradiction because value belongs to the person making the choice, not objectively to the things being exchanged.

This principle applies regardless of scale. Purchasing a pencil, employing a worker, lending to a business, constructing a railway, and providing a public service may differ greatly in complexity, but each consists of voluntary transactions between people willing to supply and people willing to pay. A large project is not a different kind of economic activity; it is a coordinated network of exchanges involving more participants, resources, contracts, risks, and time.

Tax choice extends voluntary exchange to collectively purchased services. Tax contributions arise from individual transactions, and taxpayers choose the public-service contracts towards which their contributions are directed. Each taxpayer becomes a willing contributor towards services they want provided. The water-filling algorithm combines these choices, while competing providers decide whether they are willing to supply the services at the resulting contract prices.

Central Bank currency provides a common settlement medium for these exchanges. A payment transfers existing currency, which the seller subjectively values, from the buyer's account to the seller's account. The amount leaving one account is exactly the amount entering the other. Ownership changes, but the total currency supply does not. Once the currency has been created and initially distributed, conservation therefore follows from treating every payment as a transfer of existing property through voluntary exchange. Economic activity changes the distribution of currency, the ownership and use of resources, and relative prices without requiring the creation of additional money.

Discretionary money creation does not have this structure. It gives an issuer or borrower additional purchasing power without that currency first being transferred by an existing owner. When the new currency is spent, the resulting purchase may be voluntary, but the creation which enabled the additional bid was not a voluntary exchange: no previous owner chose to surrender the newly created currency. Nor was it an exchange with the existing currency holders whose relative purchasing power is affected.

The medium of exchange should facilitate voluntary exchanges without itself altering the distribution of purchasing power. Commercial bank money fails this test because it is created through selective lending. When a bank approves a loan, it creates a new deposit rather than transferring existing currency from a saver. The borrower can therefore bid for labour, property, materials, and other resources without another currency holder first choosing to surrender equivalent purchasing power.

This combines two functions which VoTa separates. A medium of exchange should provide a common means of settling transactions, while credit allocation should determine who receives command over currency which an existing holder is willing to lend. Commercial bank money makes the payment medium itself an instrument of credit allocation. Banks decide who receives newly created purchasing power first, which industries and assets attract it, and how the resulting bids affect relative prices. Although the loan agreement between the bank and borrower may be voluntary, existing currency holders whose relative purchasing position is affected are not parties to it.

Using created commercial bank money as the general medium of exchange therefore distorts voluntary exchanges in a free market. VoTa instead provides a safer and more desirable Central Bank currency which is likely to crowd out commercial bank money through people's free choice, not prohibition. It creates this currency once to bootstrap the system and conserves the resulting supply thereafter. Central Bank currency then acts only as the lubricant of exchange: lending reallocates existing currency through voluntary agreement, and all subsequent purchasing power must be obtained through voluntary transfer.

Interest rates follow the economy

Economic schools generally assume that interest rates drive the economy: lower rates stimulate borrowing and growth, while higher rates suppress them. Research by Richard Werner and Kang-Soek Lee found the opposite relationship. Interest rates were positively correlated with economic growth, and causality more often ran from growth to interest rates rather than from interest rates to growth (see Reconsidering monetary policy and their subsequent study of 19 countries).

The result is easy to understand. When an economy is doing well, businesses see more profitable opportunities and demand more funding. When demand for investment funds rises relative to available savings, market interest rates tend to rise. When opportunities are scarce, demand for credit falls and rates tend to decline. Interest rates therefore reflect economic conditions rather than simply driving them.

Japan provides a striking example. The Bank of Japan introduced zero interest rates in 1999 and later used quantitative easing, negative rates, and yield-curve control, with these unconventional measures continuing until March 2024 (see the Bank of Japan's policy chronology). Yet prolonged suppression of interest rates did not produce sustained strong growth. This does not prove that the policies had no effect, since Japan might have performed worse without them, but it suggests that interest rates are a weak lever and is consistent with the view that weak growth causes low rates rather than low rates causing strong growth.

Interest rates are nevertheless an important measure of economic conditions. Market rates aggregate the supply of savings, the demand for investment funds, people's preference for present rather than future consumption, expectations of inflation or deflation, perceptions of risk, liquidity, and the duration of loans. Higher rates encourage saving and require proposed investments to clear a higher hurdle; lower rates may indicate that funding is more readily available. People need these signals when deciding whether to consume, save, lend, or invest. Turning interest rates into policy levers obscures that information, making it harder to distinguish genuine market conditions from central-bank intervention and increasing the risk of poor investment decisions.

Under VoTa there is no central bank policy rate. Interest rates are set by competition between lenders for borrowers and borrowers for existing savings. They are market signals produced by the economy, not policy levers used in an attempt to control it.

Capitalism does not require money creation

Joseph Schumpeter treated bank credit creation as central to capitalist development, writing that “capitalism is that form of private property economy in which innovations are carried out by means of borrowed money” (see the Federal Reserve Bank of Dallas compilation Schumpeter—In His Own Words). Steve Keen endorses this argument. He explains the Schumpeterian position in his interview with Lex Fridman and writes that “the endogenous creation of money by the banking sector gives entrepreneurs spending power that exceeds that coming out of ‘the circular flow’ alone” (see The Debtwatch Manifesto). He regards productive use of that created money as integral to the dynamics of capitalism.

Keen does not, however, regard full-reserve banking as unworkable and explicitly says in the same manifesto that he is not opposed to it. His principal reservation is that conventional full-reserve proposals transfer responsibility for creating additional money from private banks to the State, whose agencies he does not trust to exercise that power competently. VoTa does not make that transfer. Neither commercial banks nor the State can create Central Bank currency; the supply is conserved, while decisions about which entrepreneurs and projects receive finance remain with private lenders and investors. Keen might still prefer productive private money creation, but his stated objections to conventional full-reserve proposals do not establish an objection to VoTa.

Capitalism requires the productive allocation of real capital, not the continual creation of money. Creating money does not create workers, machinery, energy, land, materials, or expertise; it merely changes who can command those resources. Economic growth can occur with a fixed money supply. Existing savings can fund productive businesses, money can circulate repeatedly, and increasing production can be reflected in falling prices and greater purchasing power.

No particular quantity of money is required to support a given quantity of production or exchange. If production increases while the currency supply remains fixed, prices can fall and each currency unit acquires greater purchasing power. Because Central Bank currency is electronic and highly divisible, the same conserved supply can represent and transfer any quantity of real value. Money also circulates repeatedly, so growth in the volume of transactions does not require proportional growth in the number of currency units.

Central Bank currency can also circulate very rapidly. Transfers generally complete within a fraction of a second, so currency received from a commercial transaction can be made available for investment almost immediately. Under standing or prearranged instructions, it may pass from a consumer to a business, from that business to a financial intermediary, and from the intermediary to a borrower in rapid succession. The borrower can then use it to acquire labour, materials, equipment, or other resources. No new currency is created, but the same conserved units can support many successive transactions and investments. Credit assessment, contractual agreement, and project planning may take time; settlement in Central Bank currency does not need to.

A project may also prepare by accumulating Central Bank currency before work begins. These savings represent consumption postponed and an ability to acquire resources in the future. The project may combine accumulated savings with staged loans and later investment. Because the supply of Central Bank currency is conserved, banks cannot create new units which compete with those savings for available labour, materials, equipment, or land. Relative prices can still change, but the project's saved currency cannot be diluted by monetary expansion arising from bank credit creation.

Nor must the entire cost of a large project be assembled and transferred before work begins. Large projects consume labour, materials, equipment, and services over time, and their financing can follow the same schedule. A lender or group of lenders may commit by contract to provide specified amounts when construction stages are reached, invoices become due, or other agreed conditions are satisfied. This is already normal financial practice. Committed credit lines remain undrawn until funding is required (see the Bank for International Settlements discussion of credit-line commitments), while project loans use withdrawal schedules and disbursements linked to eligible expenditure and actual progress (see the World Bank's project-disbursement guidance).

The same arrangements are available under VoTa. A financing commitment is a contractual promise, not Central Bank currency and not an immediate transfer of the project's entire budget. At each drawdown, the lender transfers existing Central Bank currency to the borrower. The lender may fund later drawdowns from currency it already holds, income, repayments from other loans, its own borrowing, new investors, or other members of a lending syndicate. It need not leave the full lifetime cost of the project idle from the day the agreement is signed. It does, however, bear the contractual risk of being unable to provide currency when promised; failure to meet an unconditional commitment is a breach of contract.

Staged finance answers the timing problem without creating money. It allows work to begin once the funding needed for the first stage is available and provides contractual assurance for later stages. Creating additional purchasing power would not make the future labour, machinery, energy, or materials available sooner. It would merely allow the project to bid those resources away from other uses by reducing the purchasing power available to existing currency holders. Under VoTa, that reallocation instead occurs openly through saving, lending, investment, interest rates, and prices.

When investment must be funded with existing money, investors must choose one project over another and bear the opportunity cost. This imposes discipline on the allocation of scarce resources. When banks can manufacture credit, projects may proceed without anyone first choosing to defer consumption and put existing money at risk. The result is not necessarily more productive investment, but often more malinvestment: businesses, developments, and speculative projects that consume real resources before ultimately failing.

Liquidity traps and malinvestment

Paul Krugman argues that an economy can enter a liquidity trap when people want to save more than businesses are willing to invest, even after nominal interest rates have fallen to zero. If prices are also falling, holding money earns a positive real return, so he argues that the economy may require a negative real interest rate to induce sufficient spending and investment. His proposed remedy is for the central bank to create an expectation of inflation, the reasoning behind deliberately targeting a positive inflation rate such as 2 percent (see Japan's trap).

VoTa rejects this interpretation. There is no central bank policy rate and no attempt to force investment to a politically preferred level. Expected inflation or deflation is incorporated into market interest rates. An investment must offer a better risk-adjusted return than holding money before a well-informed investor will fund it. That is a valuable test of whether the project should consume scarce labour, materials, energy, and capital.

The waste caused by speculative and failed ventures is extremely important. Creating money or inflation to make marginal projects appear worthwhile does not create the real resources those projects require. It overrides the judgement of people who would rather save than invest and redirects resources into ventures that cannot justify their risks. If a well-informed investor prefers to hold money, manipulating the real interest rate until the investment proceeds is not a cure for market failure; it is a malinvestment waiting to happen.