Bank lending should switch from extremely expansionary to neutral for the remainder of the year. Neutral means the bank loan/GDP ratio should remain the same. For example, the current loan stock is 37 trillion yuan, or 1.2 times GDP. If nominal GDP grows by 200 billion yuan per month, or 8 percent for the year, bank lending should grow by 240 billion yuan per month. Lending in April cooled to 640 billion yuan from an average of 1.4 trillion yuan for the previous four months. It is still too high relative to the neutral level. Monetary tightening has a long way to go.

China should focus more on improving supply side efficiency to sustain high growth. The global economy is likely to be much slower over the next decade than in the past. China has to be much more efficient to achieve the same growth rate. But efficiency improvement in the future cannot rely on fixed asset expansion. Small facilities and old equipment are no longer problems. Most of China's industries seem to have state-of-the-art equipment but suffer from excess capacity.

Efficiency improvement in the future is less an investment issue than systemic or incentive issues. Because fine-tuning rather than brutal force must drive productivity growth, market forces rather than government intervention should drive efficiency.

Many now argue that what's happened in the United States and in developed economies shows the bad side of the market economy and, hence, China should not continue moving toward the market. This is drawing the wrong conclusion from the current crisis. The market remains the best tool for motivating businesses to deliver the best products at the lowest possible prices. All other systems have failed to deliver prosperity. Markets, however, need regulations to function properly. For example, food safety standards need to be in place for that industry to function properly. The main purpose of regulation should be to encourage more efficient market functioning, not replace the market.

Some economies such as those in the United States and Britain deregulated too much a decade ago, laying the foundation for today's crisis. China's economy, however, is excessively regulated and controlled by the government. The lesson from today's crisis has little bearing on China's policy forward. China still has a long way to go before its market is "too free."

Excessive liquidity stimuli today may lead to inflation and economic chaos in the future. It's time for China to rein in its money supply. The policy focus should shift toward promoting household demand and supply side efficiency. Otherwise, China could suffer from low growth and high inflation for years to come.

Full Article in Chinese: http://magazine.caijing.com.cn/2009-05-24/110170566.html