SHILOH: The Chinese sell us all sorts of trinkets. In exchange we pay them with dollars, which is fiat money (not gold). In fact we don’t even pay them with physical dollars, instead, we simply credit their accounts. What do the Chinese do with all this wealth (on paper)? They buy long-term US bonds.

This huge demand for dollar-denominated and US-issued bonds (treasuries and corporate paper) keeps long-term interest rates low. This translates in low interest rates for mortgages. There’s enormous excess liquidity in the system. The subprime crunch only means that deadbeats will always be deadbeats, but there’s still plenty of money available, they only need to figure out who is a better credit risk.

Long-term interest rates will remain low for some time, maybe for years, which will create a floor for how low house prices can drop.

There you go: Trade deficit with China ==> Demand for long-term bonds ==> low long-term interest rates ==> low mortgage rates ==> easy credit to buy a house (provided you have a history of paying your debts).