China's real estate sector may be over-invested in some cases, driven not by income which is very low on many properties but by anticipated capital gains from further price increases. But the overall economy probably is not over-invested.

Energy-intensive sectors have also drawn too much investment. The over-investment reflects regulated domestic energy prices that were too low compared with prevailing world prices. The result was energy inefficiency, which is actually declining energy productivity. The simplest way to correct this is with a new energy law that makes both supply and demand competitive and responsive to market prices.

Productivity also neutralizes price increases, preventing inflation.

China's statistics bureau covers productivity only in certain sectors, not in the entire economy. Without tracking the entire economy, it is hard to determine how inflationary price rises are. The growth in the money supply alone does not tell the story.

The high 19 percent annual growth in China's money supply need not be inflationary because China is still very much a cash economy, with checking and credit cards still not the main means of payment.

That means the velocity of money the rate at which money circulates is comparatively low in China. Since velocity times supply of money equals the gross domestic product, the money supply can be expected to grow comparatively rapidly to support GDP growth.

China has vast potential for improving productivity. This is the ultimate weapon against inflation, which undoes economic growth.

Improving productivity is an effective response to price increases. It also allows increasing wages without increasing prices.

The People's Bank of China, the central bank, helps counter inflation by reducing the growth of the money supply. The central bank borrows money in the economy to purchase foreign currency, mainly US dollars, from exporters and foreign investors in China.
In the long run, the People's Bank should instead create new money to purchase foreign currency, thereby increasing the money supply.

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