Could Britain be heading for a crash?

We cannot postpone indefinitely the final acceptance that we must live within our means, writes Simon Heffer.

I had a long talk on Tuesday with one of the wisest and cleverest economic thinkers I know, and he was sure of one thing: we are heading for a crash. Is he right? The stock market has started the year strongly. Sterling is up against the dollar and was rising against the doomed single currency as well, until the Chinese – for their own Machiavellian reasons – bought vast quantities of euro debt
this week.

Sadly, other indicators suggest that such good news as we have is an illusion. It mystifies me why the Bank of England didn't raise interest rates this week, with the threat of inflation now blindingly apparent. Think, though, what that would do to a housing market already heading south; or to those people with other, shorter-term debts, the repayments on which could well become suffocating. For many of them, the day of reckoning has been long postponed. Now, it may be just weeks away.

François Fillon, the urbane and rather successful French prime minister, came to London this week and seemed to take for granted our continued support of the euro, arguing that our economic future depended upon it, too. He exaggerated, but did so because of the great fear in France that the game is up for their currency. It is hard to see why there is this fear. If the euro goes under, the French can simply resort to the franc and find themselves able to widen their export markets, because everything would be cheaper.

True, the financial sector, with its exposure to euro debt, would take a thumping – our own included. But these were risks taken by banks, and they would just have to bear them. In the same way that the Government has no business telling banks what they can pay their staff, it has no business continually bailing them out either. What is most important is that the Government should peer over the horizon at these potential problems, and work out how to manage their consequences.

Our rulers have encouraged the thought in the past couple of months that while things are still very difficult, and hardships inevitable, the worst is over. Perhaps it isn't, though; because maybe what they meant was that they had inflicted on us all the pain that they thought was needed, and no more was planned.

What they hadn't taken into account, as so often with this Government, is that factors beyond their control will now start to kick in. If there is some sort of external blow to the economy, whether in the shape of the euro ceasing to defy gravity, or simply more bad news from America, there will have to be a sharp adjustment to policy here. Our taxes remain far too high, and an obstacle to recovery as it is. If the recovery has to start from an even lower base, the obsession with not cutting taxes in case some "rich" person – possibly even an evil banker – becomes richer will have to be jettisoned once and for all.

Where my economist friend is almost certainly right is that, even without external shocks, interest rates must rise. Personal bankruptcies and business failures will rise with them; so will unemployment. House prices will fall, and possibly also many other asset values, including the stock market. We cannot postpone indefinitely the final acceptance that we must live within our means.

If such a downturn comes, then growth is the only way out of it. That requires the Government to stimulate demand. It will be all too easy, if things turn ugly, to act like the rabbit in the headlights. We have seen governments do this before. What our rulers need to remember is that such paralysis is always fatal.