raytaylor: In New Zealand, We are allowed to use channels 01-13
A standard wifi signal is 20mhz wide, but the channels are set at 5mhz intervals

Why we have channel 01-13
RSM have allocated the frequency space that channel 14 uses for other purposes.
Radio Spectrum Management at the Ministry of Economic Development are responsible for managing our radio bands and make up these rules.

In the USA they are only allowed channels 01-12. Many electronic devices are hard coded for the US band and will not operate on Channel 13.
In the USA, the FCC manages the radio spectrum and the radio frequency that channel 13 uses is privately owned by a company that has a historic license to use the frequency exclusively. The licence was issued before wifi was developed and the channel table was created. The company has made offers to give up their license but it hasn't happened yet.

So if you have a router that is set to the NZ region and the channel set to Auto, it will often see channel 13 as being available with the least amount of interference and will start to transmit its beacon on that clear channel 13. When you try to connect with a device (most laptops, phones etc) that are set for the USA region, they wont pick up the channel 13 router. This is a common problem for most telecom/thompson routers that are set to NZ:Auto out of the box. 

Now channel overlapping

A wifi channel is 20mhz wide.
However the channels are not spaced apart at 20mhz intervals.
In the space between 2402mhz and 2485mhz there is only space for three channels that are 20mhz wide.

At the same time, a channel table (01-13) was developed by the wifi people and uses centre frequencies that are at 5mhz intervals.

So channel 1 is centered on 2412mhz, but channel 2 is centered on 2417mhz.
This is what it looks like

So you can see from the above image that the only channels that dont overlap are 1,6 and 11

So you can have three AP's in close proximity to each other, and they will usually be okay.

This is how we would lay out a floor plan - by turning down the transmit power on the access points, we can reuse channels over another side of a building without causing self interference.
You can see the dick in the building next door has left his router's transmit power on high, and will interfere with nearby routers on channel 11 because most of channel 13 overlaps channel 11.

A big problem with wifi range in urban areas (since ISP's started issuing free wifi routers) is that neighbors will leave their routers set to high transmit power, and cause interference - reducing the range of each router in the street.
By turning down the power, there is less interference and channels can be re-used closer together.

Many routers only look at the amount of SSID's or network names they can pick up on each channel. They dont look at the signal level, overlapping effect or radio noise. So his router has seen channel 13 has the least amount of networks listed and will use that without taking into account that channel 1 is probably the cleanest. Its a good way to get things started but doesnt work well in a dense area.

Wifi channels were only a result of the wifi people creating them and assigning them to frequencies.
Eg. Channel 1 just happens to be 2412mhz
For the common person, its easier to remember channel 1 rather than 2412mhz.

However, you dont need to transmit on a pre-defined channel. Some advanced radios allow you to transmit on any frequency you like with the centre of the transmission being anything between 2412 at the low end, so the bottom of the 20mhz wide channel doesnt use anything below 2402mhz, and the top centre being at 2474mhz so the 20mhz wide channel doesnt go over 2485mhz.

So to sum up
Nothing wrong with transmitting on channel 3 - hes just being a dick and causing interference to both channel 1 and channel 6 leaving you only one channel (8 or higher) that doesnt overlap with him. However if you are in NZ, you could use channel 8 and 13 without any overlapping if other routers nearby didnt use channel 11.

thanks for that, ill have another play with the wifi :P