The common view of China's economy today is that overcapacity is a fact of life and has been for some time. With excess savings and an undervalued exchange rate, the thinking goes, companies enjoy a too-low cost of capital that allows overinvestment. But what if this is wrong? As it happens, the consensus probably is wrong, and that has important implications for policy making.
The central question is how cheap capital truly is, and the answer is "not as cheap as people usually assume." Certainly, the undervalued exchange rate keeps official interest rates low. Benchmark rates set by the central bank are sometimes below the rate of inflation, and almost always less than the rate of nominal economic growth. If there was a recipe for a credit bubble, this would clearly be it.
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