Inadvertently, the Chinese Communist Party has once again achieved a world record in the financial sector: according to data from the central bank, by the end of March, the broad money supply M2 in China reached 304.8 trillion yuan, making China the only country in the world with an M2 exceeding 30 trillion yuan.
In fact, by the end of March 2013, China’s M2 reached 103.61 trillion yuan, surpassing the one trillion yuan mark for the first time. It took over 60 years since the founding of the Communist Party of China, or over 30 years since the beginning of the “reform and opening up” in 1978. However, in January 2020, M2 surpassed 200 trillion yuan (202.3 trillion yuan), exceeding the sum of the United States and Japan, as well as the sum of the United States and Europe. The second trillion only took 7 years, while the third trillion took only 4 years and 3 months.
This indicates that monetary expansion is a dominant factor in China’s economic growth, as stated by official sources.
From December 1978 to January 2020, China’s M2 compound annual growth rate was 19.93%, double the compound annual growth rate of GDP during the same period (9.18%). For example, official data shows that by the end of December 2023, China’s M2 balance was 292.27 trillion yuan, a year-on-year increase of 9.7%, while China’s GDP in 2023 was 126,058.2 billion yuan, with a 5.2% growth from the previous year at constant prices. This means that China’s M2 growth rate has consistently exceeded its GDP growth rate in the long run.
As a result, China’s economy’s dependence on the money supply is much higher than that of several other major economies in the world. By the end of 1978, China’s M2 was only about 35% of GDP; in 2000, M2 was 1.3 times GDP; currently, M2 is 2.3 times GDP (much higher than that of the United States and Europe).
In reality, the diminishing marginal utility of driving GDP growth through monetary expansion in China is becoming more evident. In 1988, one unit of M2 could drive 1.7 units of GDP; by 2019, one unit of M2 could only drive 0.45 units of GDP.
Although expanding the money supply to promote GDP growth during the transition from a planned economy to a market economy can be seen as a reasonable approach within a certain range or timeframe, when the indicator exceeds a certain threshold, the risks of high inflation and excessive money supply become significant. China currently faces this situation.
One reason behind China’s high M2/GDP ratio is the inefficiency of the financial system and a high non-performing loan ratio. The M2/GDP ratio measures the amount of money supply needed per unit of output. An increase in output efficiency under a fixed money supply will reduce this ratio. Hence, the M2/GDP ratio is closely related to economic efficiency and can reflect technological progress and economic efficiency to some extent. Higher economic efficiency will curb a rapid increase in the M2/GDP ratio. For example, the United States’ M2/GDP ratio has remained stable around 60%, only experiencing a slight increase after the global financial crisis. In contrast, China’s M2/GDP ratio continues to rise.
Another reason is that the United States relies more on direct financing (such as issuing stocks, bonds, etc.), which does not alter the total amount of money in circulation, resulting in a lower M2/GDP ratio. China, on the other hand, primarily relies on indirect financing, with bank loans as the main financing method. The expansion of bank loans leads to increased deposit creation, thereby increasing the money supply and raising the M2/GDP ratio. This highlights the underdeveloped state of China’s financial markets and a lack of sufficient investment options, weakening the ability to diversify financial risks.
Moreover, the high M2/GDP ratio in China is also linked to a high tax burden. Research shows that the higher a country’s tax burden, the higher the M2/GDP ratio. In 2021, including non-tax revenue and government fund income outside of tax laws, China’s overall GDP tax burden rate was 6.5 percentage points higher than that of the United States. On the other hand, in 2021, Americans received transfer payments from the government totaling 3.9069 trillion US dollars, accounting for 17% of GDP; whereas Chinese residents received only 971.77 billion yuan in transfer payments, accounting for 6.8% of GDP. This means the proportion of government transfers to citizens in the United States is much higher than that in China, making China a “country rich in wealth but poor in people,” a situation created by the Chinese Communist Party.
Behind the high M2/GDP ratio in China is also a significant wealth gap. A notable characteristic of the Chinese economy is a growth model driven by high savings and investment levels. China’s household savings rate has consistently ranked at the top globally (remaining between 36% and 45%), and as China’s financial structure continues to depend mainly on indirect financing, the significant amount of idle deposit money demands more newly created money to support the financing needs of the real economy. This results in a higher overall money supply and M2/GDP ratio for the entire society. However, the high savings rate among Chinese residents masks a significant wealth gap. For example, in 2023, the average annual wage income in China was only 22,000 yuan, while household deposits increased by 1.667 trillion yuan.
These are just a few examples. The significance of China’s M2 exceeding 30 trillion yuan and the high M2/GDP ratio carries many economic implications, and the future trends of the Chinese economy suggested by them are still not fully understood. However, it is undeniable that China’s economy is currently in a crisis.
It’s worth noting that M2 is a stock data, while GDP is a flow data, so strictly speaking, the two are not directly comparable. Research has constructed an index comparing the growth in M2 to GDP and compared it with other countries in the world. The results show that although China’s M2/GDP ratio is lower than Japan’s, the rate of change (ΔM2/GDP) is significantly higher in China, and Japan’s ΔM2/GDP remains in a stable low range. In other words, at the same level of national income, China adds more broad money supply annually. This research conclusion is consistent with the discussion in this article.
Source: Shangzheng Research Report [2017] No. 020 “The Mystery of China’s High M2/GDP Ratio”.