The economy is something that people generally uses GDP to express, so how should we understand GDP?

To be precise, GDP is not a measure of a country’s wealth, but rather a measure of the flow of wealth. More specifically, it is a measure of the total amount of all goods and services traded in the country in a year (excluding financial asset transactions), because only the larger the scale of wealth itself, the larger the scale of goods and services traded is possible, so people usually take GDP, as well as GDP per capita, as the main indicator of whether a country is rich or not.

In contemporary society, almost all economic activities and all exchanges of goods and services are denominated in money, and the statistics of all money that can be directly used in the exchange of goods and services is commonly referred to as “broad money supply”.

For China, the indicator of broad money supply is the M2 data published by the central bank every month.

For example, if wealth is understood as the number and size of pits, then GDP can be understood as the process of digging pits, that is, the process of creating wealth, while M2 can be understood as the salary of the digger.

In this way, the ratio of M2/GDP can basically be thought of as the cost of digging a pit, that is, how much money is needed to bring about such a size of GDP.

The ratio of new GDP/new M2 can basically be summarized as the efficiency of digging a hole in a given year, that is, how much GDP can be brought in by adding one dollar of new M2 in the past year.

Let’s say that in 1995, China’s GDP was RMB 6.13 trillion, while M2 at the end of December that year was RMB 6.08 trillion, and 1 Yuan of M2 corresponded to 1 Yuan of GDP; however, in 2022, China’s GDP is 121 trillion Yuan, while M2 at the end of December was 266.4 trillion Yuan, and it took 2.2 Yuan of M2 to correspond to 1 Yuan of GDP, which means that the cost of China’s GDP is getting higher and higher.

Let’s say that China’s GDP in 1995 was 1.27 trillion Yuan new compared to 1994, while M2 was 1.38 trillion Yuan new compared to 1994, 1 Yuan of new M2 can bring 0.92 Yuan of new GDP; in contrast, China’s GDP in 2022 was 6.1 trillion Yuan new compared to 2021, while M2 was 28.14 trillion Yuan new, 1 Yuan of new M2 can only bring 0.22 Yuan of new GDP.

If a country, the cost of digging a hole is getting higher and higher, but less and less efficient, certainly not a good phenomenon

With all this foreplay explained, I’ll now give you a table of the data related to China’s “digging” over the past 20 years.

From the M2/GDP data of the past 20 years, except for the golden period of 2004-2008, the overall cost of digging a hole in China is getting higher and higher, which means that the same scale of credit, China’s ability to create wealth is gradually weakening.

On the other hand, looking at the new GDP/new M2 data, China’s efficiency in digging pits can fluctuate greatly from year to year, with wealth creation being particularly efficient in years like 2004-2007, but particularly inefficient in years like 2009, 2015, 2020 and 2022.

With the relationship between GDP and M2 clearly stated, let’s talk about asset prices.

According to Fisher’s formula: MV = PT.

(where M is the quantity of money, V is the number of money flows, T is the total amount of goods and services, and P is the overall price of goods and services, this formula means that in economic exchange, the product of the quantity of money and the number of flows is constantly equal to the product of goods and services and the overall price)

Within a one-year period, we can interpret the “PT” in Fisher’s formula as nominal GDP, assuming that the velocity of money flow V will not produce large changes in a short period of time, M will be replaced by broad money M2, and we can logically deduce that

M2 growth rate

= nominal GDP growth rate

= real GDP growth rate + real inflation rate.

Assuming that the GDP growth rate announced by the state is real and the CPI inflation rate is also real, then theoretically the growth rate of broad money M2 should be equal to the sum of these two, what about the actual situation?

According to the above table, before 1996, the GDP growth rate + CPI inflation rate, is roughly close to the M2 growth rate, even if there is a little gap, the average of the two years before and after, can be roughly right.

However, after 1997, the GDP growth rate + CPI inflation rate, and M2 growth rate is increasingly inconsistent, even if we take into account the years before and after, there is still a big difference, and the general situation, are GDP growth rate plus CPI inflation rate, far from catching up with the M2 growth rate.

Even taking into account the systematic falsification of the CPI (GDP data we assume for the moment to be true), there is still something not quite right.

What is the problem?

The answer I personally give is this.

After 1997, a large portion of the growth rate of M2 ran to the capital market – that is, the stock and housing markets.

Previously, the over-issuance was either reflected in GDP or inflation; with the increasing size of capital markets, most of the over-issuance is now reflected in the housing and stock markets.