Higher prices alone automatically solve much of the energy conservation and energy efficiency issues China faces. Just this week NDRC's latest 1st-half-year statistics show that low administratively-set prices have caused the nation's energy efficiency to continue declining, especially in energy-intensive industries (except for construction and steel where higher world steel prices have reduced demand growth).

Hopefully the NDRC will next move toward "demand-side management" or market-price-driven reduction in electricity, gasoline and natural gas demand growth that enables producers to recover 100 per cent of their costs. NDRC can do this by marketizing retail gasoline pricing and the demand side of electricity, and by marketizing natural gas distribution and encouraging the building and opening of an intercity natural gas pipeline grid that is operated independently of production just like the electricity grid. An intercity gas grid is needed to support a market for natural gas trading. It would also deliver clean energy to all China's cities, including the gas from coastal Liquified Natural Gas terminals, and the gas from coal mines, whose extraction makes the mines safer and more profitable.

The third reason for ignoring prices and blaming the fixed RMB for contradicting tighter monetary policy is the common misidentification of inflation with price increases and ignoring that price increases are in fact non-inflationary, especially when they prompt productivity or efficiency improvements which raise both incomes and the supply of goods. Price increases are actually counter-inflationary: they increase the demand for money, not the money supply whose increase is defined as inflation.

It is what the People's Bank does or does not do in response to increased money demand that is inflationary or not: It can expand credit or let interest rates rise. And that is a very complicated judgment, informed by the fact that any upward-biased effect on the RMB is neutralized by the higher goods prices. If prices ever began increasing in anticipation of an inflationary monetary policy, we would enter the bottomless pit of hyperinflation, which China's sound monetary policy is nowhere near.

Accordingly, higher prices, not just of credit, can have the effect of controlling economic growth. Allowing prices to adjust, ideally through market mechanisms, precisely makes the policy of a fixed RMB exchange rate consistent with any credit-tightening. The temptation, in a system of regulated prices, may be to attempt to use a single blunt instrument, like credit-policy through the People's Bank, to achieve an objective that is very complicated to co-ordinate. Moreover, compared to markets, government regulation of prices or supply carries the added burden of secrecy and a temptation of corruption, suggested by the modest gas-pump queues seen on the eve of a gas price increase, or by the rise in the stock-market price of energy producers when a price-increase is announced.

The author is a Canadian and American investment banker, economist and energy expert currently in Beijing.

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