Two months on, the slump in US housing sales is obvious to all but the most blinkered. And still many don't get it.

The FTSE, the Dow Jones and the Nasdaq are still rising to delirious heights.

Traders seem confident that the housing slump is just grit in the pistons of the engine driving globalisation forward.

They are not alone. UK politicians, economists (with one or two rare exceptions) commentators and consumers are treating the US housing slump with equanimity.

Very few believe that a collapse in US house prices can pose a threat to the UK, or to the liberalised and integrated global financial system.

The US housing slump, so the argument goes, is just a "correction", probably a necessary correction, and like the 2003-4 plateau in UK house prices, can be expected to respond to supply and demand and stabilise at the natural level. The problem it seems is that there are just too many homes on the range.

Here in the UK house prices and levels of debt are regarded as sustainable by orthodox economists. Borrowers are considered rational and debt crises unlikely. (Have we been rational about pensions?) They argue firstly that our asset prices far exceed our debts and are therefore payable (even though we don't usually pay our debts by selling our homes/assets) and secondly that our housing and other asset markets enjoy rising prices because they are simply acting in accordance with the laws of supply and demand. In other words, in the UK "it's the shortage of houses, stupid".

In this column, I want to explain why a collapse in asset prices can occur, regardless of the economic laws of supply and demand. But first, back to square one.

The economics profession, as a whole, has a blind spot for finance. Economists conduct their analyses without reference to the creation of credit and debt. They regard money as "neutral" and ignore, on the whole, the role of credit. As Schumpeter once wrote, economists treat the "phenomena of economic life ...in terms of goods and services, of decisions about them, and of relations between them. Money enters the picture only in the modest role of a technical device that has been adopted in order to facilitate transactions." So the Bank of England's model of the UK has no debt components. Of course it is recognised that there are, every so often, monetary "disorders" - but money is "of secondary importance in the explanation of the economic process of reality."

This explains economic orthodoxy's blind spot and apathy towards the creation of today's gigantic credit/debt bubble - a bubble that should cause greater concern than the rampant housing bubbles of Anglo-American economies. It also explains the poor record and extraordinary optimism of economic analysts and forecasters. In a survey in March 2001, 95% of US economic forecasters predicted that there would not be a recession in 2001. "Too bad", notes Nouriel Roubini, "that the recession had already started exactly in March of that year."

Why is a lending bubble the real problem? Because housing and other asset bubbles are but an expression of that much bigger bubble: the giant credit/debt bubble, which in turn is the result of easy (unregulated) but costly lending. When the housing bubble bursts, it will be because the lending bubble has burst, not because 'there are too many homes on the range'.

Those of us who are pessimists believe that it is the US credit bubble that is bursting. This is happening in what is a de facto deflationary environment. Why should this be scary? Because the value or cost of debt rises in a deflationary environment (the opposite happens under inflationary conditions) and these increasingly expensive debts will further drain American consumers of their hard-earned wealth. Even while the US Federal Reserve pauses on interest rates, falling inflation means that "paused" interest rates are rising in real terms.

As Americans endure shocks (higher real interest rates and therefore bigger debt repayments, lower real wages, higher energy bills, unemployment, bad health) their debts (and their negative savings rate) will cause trouble. Elizabeth Warren of Harvard University has shown that the American middle classes are on the precipice. "Fully 75% of family income is earmarked for recurrent monthly expenses ... Short of moving out of the house, withdrawing their children from preschool, or cancelling the insurance policy altogether, they are stuck ... Today's family has no margin for error ... Their basic situation is far riskier than that of their parents a generation earlier."

Those that have "maxed out" on "refis" and other mortgage debts soon will have to sell their homes - to pay off and manage their falling disposable income and excessive debts. However, far from easing the crisis, the downward pressure will apply, first, to those most indebted and then to those considered wise and careful borrowers. Their assets will fall in value along with those of the over-borrowed - automatically raising debt-to-income ratios for sensible borrowers.

So the crisis will come about because the lending bubble will burst first, and the asset bubble will follow almost immediately, if not simultaneously. It was ever thus. (Think of 1929; of Japan in 1990; of the dotcom crash).

There will be defaults (there already are) and then banking crises (it is widely rumoured that Freddie Mac and Fannie Mae, the big government-backed mortgage lenders, are candidates). These will be followed by business failures, and more rises in unemployment, leading to lower economic growth, a fall in US demand for imports and a further decline of the dollar.

A deep and sustained US debt-deflationary recession, will impact most grievously on the global economy. We know, because the last time there was a fall in US demand for imports in 2001, stock markets spiralled downward, commodity prices fell, and government finances across the world came under strain.

Because of the forced integration of the global economy; because of the deregulation of the international financial system; because of the crazy unregulated risks taken by hedge fund managers (most recently Amaranth and Vega) on salaries of $150m (£81m), the coming crisis will be systemic. Or to put it in the words of Tim Geithner, a governor of the US Federal Reserve, the crisis will be "borderless".

There will be no place to hide. For the majority, that is. What of those optimistic economists, bankers and financial rentiers? They will gather together their wealth, scuttle off into obscurity, and let it be known that blame for the crisis should rest with "reckless" US and other consumers. In other words with the innocents who, encouraged by politicians, economists, central bankers and financiers, have propped up the global economy for two decades. Their borrowing and spending has enriched the very rich and lifted millions of Chinese workers out of poverty. Soon, blame will be heaped upon these American heroes - they will be accused of borrowing too much and living beyond their means.

Thus will the perpetrators of these economic crimes escape and blame, once again, fall upon the victims.

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