British house price inflation is staggeringly high. Inflation? Please, no rude words here. U.S. Federal Reserve chairman Alan Greenspan, for example, has referred to “solid gains” in house prices. But inflation in prices is what we are talking about, and it is very high.

The Halifax Bank of Scotland has tracked house prices in an authorities survey for many years. In the bank’s latest monthly release on the subject, issued August 4, its Chief Economist, Martin Ellis, avoids the rude I word when he says, “House prices grew by 1.3 percent in July, which was very similar to June’s 1.2 percent rise. The house price gains in June and July represent a clear step down from the 2.0 percent plus monthly price growth seen, on average, in the preceding six months.”

Two percent as an annual consumer price inflation rate is most central banks’ idea of a reasonable annual target. Yet the Bank of England, focused on the overall price level and the level of economic growth, has let irrational exuberance in houses get out of hand. Given the marked impact of house price rises — and house price falls — on an economy, this would seem a huge mistake.

For the effects of compound inflation, like those of compound interest, are remarkable. According to the Halifax, “The average UK house price rose above the £160,000 mark for the first time in July 2004 to £161,831. This is more than double the average UK house price of £78,055 five years’ ago (July 1999).”

Thus the average British house price, in the Halifax statistics, has risen by 105 percent in five years, which is equivalent to an annual average interest rate of 15.4 percent. A pity the bank does not pay that amount on savings; then we could all double our money in just five years.

How does this rate of house price inflation compare with that in the United States? According to the Conventional Mortgage Home Price Index compiled by Freddie Mac, the government sponsored organization that supports the housing market, the average house price in the United States had risen in the first quarter of this year by 43.3 percent from five years before. This is still equivalent to average annual house price inflation of a quite high 7.5 percent but is less than half the UK pace.

Such high house price rises in Britain have helped to drive ahead the nation’s economy. A wealth effect generated by rising house prices — a phenomenon also seen in the United States — has helped to keep consumption, retail sales and overall GDP growth strong.

In a recent report, John Butler, UK economist of HSBC Bank in London, charts the housing market and its role in the UK economy. What do you do with inflation in asset prices? You spend it, of course. British households are using mortgage refinancing to free up cash. “Mortgage equity withdrawal,” as it is called in the UK, provided more than 8 percent of the average household’s post-tax income in 2003.

Another telling statistic highlighted by Butler is that the average UK house price is now more than five times average earnings. This is abnormally high. During the past thirty years the average house price has rarely moved above or below a range of three to four times average earnings. A previous peak of 4.5 times earnings in 1989 was followed by a long and deep decline in the UK housing market that left many households in difficulties and depressed the UK economy for some years into the 1990s.

At present, with the tide of prices still rising, there is no sign of this sort of financial distress. Flying houses and rising debt buoy the economy up, not weigh it down. Home-owners are happy. Interest rates and debt servicing costs are still low on a historical basis as a share of income. Households use increasingly flexible mortgage markets to withdraw equity from their prize asset. But perhaps they need to, to help out their children.

For those who do not already own a home do face a problem when prices keep rising so dramatically. Alex Bannister, Group Economist of Nationwide, a financial institution which has also long tracked the UK housing market, writes in the Nationwide’s most recent commentary on the housing market that in 1994 three in every five first-time house buyers came from the 18-30 age group; now only two in every five do. The average deposit put down by half of the young first-time buyers now exceeds GBP12,000 ($22,000) compared to just GBP2,500 in 1994. Young people, in other words, with earnings falling further and further behind house prices, are finding it difficult to afford to buy — unless their families help them. “In many cases this is likely to involve parents withdrawing equity on their own property,” Bannister writes.

What this means is that parents extract equity from their inflated property to lend money to their children so that they can put down a deposit, borrow a lot of money, and buy a house whose price has also been inflated. The price bubble feeds off itself, leaving more and more debt and danger.

Has something gone wrong? Many economists would deny it. “Affordability!” is their cry. Inflation is low, and so are interest rates and debt servicing costs. But the lesson of the past is that the relationship between house prices and earnings can and does get stretched a long way, but then snaps back again.

What would snapping back mean? At present the average UK house price, according to the Nationwide’s calculations, is GBP154,299, slightly lower than the Halifax estimate, and is equal to roughly five times average earnings. At the historical house price average of three and a half times earnings, the average price would drop to GBP108,009. If house prices correct to a more “normal” level many mortgages are going to far exceed the value of the houses that back them. There is going to be a great deal of distress in British households and a lot of bad debt for British lenders.

It should be said, however, that this snapping back may not be imminent. If Global View’s assessment of the U.S. economy is correct, the global economy is heading for weakness, declining inflation and lower interest rates, not for the higher inflation and higher interest rates that would wreak havoc in Britain and the United States.

But the fact remains that UK house prices have got out of hand, as have U.S. ones, and that at some point in the future this will do great harm.

Britain and the United States are not unique in this. Property prices have soared in Ireland, and have risen, though not as much, in some continental European counties. But the phenomenon is mainly Anglo-Saxon. Why?

The reason is the British and American desire to own property, the flexibility of these countries’ capital markets, and the hot competition between lenders. All of these may normally be considered good things. But combine them with central bankers who have been too ready to slash interest rates and too unwary of soaring asset prices and you prepare the cash-sodden ground for a return of the post stock market bubble weakness that has dogged the U.S. economy since 2001.

And if, in Britain and the United States, the housing bubble, remedy for the burst stock market bubble, bursts, what new trick will be left to offset a slump?