China can push their cheap goods, and with manipulations in the CPI (exclusion of house prices and other things), is makes it possible for us to expand credit at a rate that keeps us going. . It also makes it possible to hold the CPI inflation at a stable rate.
What we are seeing now, much more important than the UK market, is that the US economy are slowing. This will limit demand for Chinese goods, weaken the USD (since the chinese goverment will buy less USD as they sell less goods), and cause a destructive lack of demand driven deflation in china (not supply driven / competitive as it have been so far), and reduce the price of Chinese goods even further (just as seen with Japan in the seventies, only on a larger scale). The US economy will do as they always have, keep the economy propped up with credit. There is no payback time for the US. They will never pay back the Chinese what they own. They will create inflation by dropping cash on the economy if they have to. This does reduce the value of cash in the bank. The true rate of inflation is almost identical to the amount of money the printing presses produce. Look at the value of gold, it have more than doubled. A conflict free oil price is probably around 45 USD after the latest run of inflation.
The reason housing are overvalued is because income is to low for a group of buyers, CPI inflation is really not a useful tool to compare with. However this group of buyers does not need to buy. Landlords can rent out to them and make a profit.
So according to true inflation, house prices are probably undervalued. But as long as the increase in salary does not follow true inflation (the debt bubble), the housing market is creating a condition where earlier homeowners back to 1970 who did not have to deal with this faulty inflation figures could buy their homes at the right price.
This situation with cheap Chinese goods can go on very long, and a weakening US demand could further amplify it. Thus the conditions for low interest rates could remain strong for a long time. A US recession could even push the rates down.
Because homes will be priced based on the affordability and not on value, prices could come down to a level where first time buyers can afford them at the current interest rates. However this is not sure. The central bank could let inflation slip out of their zone, and let is rise, to avoid bursting the housing bubble by keeping rates low enough. Since breaking the housing bubble could cause a recession it is not a crazy idea. With todayís China situation, and stagflation they will probably avoid pushing up rates, or else they will kill all growth just to have the CPI bogus inflation figures in check. The FED will set the trend for this. If they let inflation go, all the other countries will do the same as teh US is the leader. China and Japan, the biggest debtors would be screwed. That could mean flat prices in nominal terms, while the inflation have a run like in the seventies, making a loan an attractive option with negative real interest rates, more attractive than sitting with cash in the bank that quickly loose value to a red hot printing press. Hyper stagflation is a real option, because it could save the US from a depression and at the same time ease their debt due to inflation. Due to deflationary pressures in china in the case of weakening US demand, interest rates here will be lower than they should. Itís the first time buyer generation who pays the price for cheap Chinese goods, and an economy who sadly cannot grow without excessive debt. Some say the debt have to go out of the system through a deflation. But I think more debt, and inflation is more likely. I am not sure if a deflation like Japan had, is possible in the US, due to their willingness to screw their debtors, by dropping cash on the economy for free, if nobody wants to borrow it (unlike japan).
Whatever happens will be what suits the US best. It could be hyper stagflation and negative real interest rates.
Edited by carseller, 22 July 2006 - 08:32 PM.