Let us assume that nominal economic growth is say 5% (real 3%), and money supply growth is 8%, money stock is $20 and the asset allocation component of money supply starts at 50% of the stock of broad money. The asset allocation component starts at $10. If nominal GDP growth is 5%, then return on equities would be 5% plus dividends. With a 3% excess money supply growth, the growth rate of asset focused money supply is 11% or 220% of nominal economic growth; this annual rate of excess money supply growth is similar to average excess broad money supply growth in the US from 1995, based on the data in chart 7.
Over 1 year, assuming 4% of the additional wealth is consumed each year, GDP growth would increase by an additional 0.24%; after 10 years, nominal GDP growth would increase by an additional 3.1% per annum; in other words, an additional 3.1% of inflation in the absence of a higher real rate of economic growth.
The real non linear world is more complex, but the imperative implied by the dynamics remains. Sustained excess money supply growth, over long periods of time, can build significant amounts of excess demand in the global economy; the ability to manage this excess demand depends on balanced economic growth, a factor lacking in the current environment.
Mean variance optimizers look at historic risk/return relationships. As noted in this analysis, risk and return for asset classes are impacted by demand and supply. Many of these linear allocation tools hold the risk and return relationships constant while determining optimum allocations to these assets/securities. This is clearly flawed, since only small changes in net demand need significantly impact price/risk and return; higher allocations to an asset not only increases its price and reduces its return per unit of risk but, also reduces the price of other assets and increase their prospective return per unit of risk. You cannot hold risk/return relationships constant when asset allocation/demand are being adjusted.