What financial crisis?

The international financial crisis has, for most of us, been a spectator sport so far. It's like watching a well-made American television series about global capitalism, where each instalment brings a new fantastic turn of events as banks lose billions in and crazy characters emerge like buff bond-dealer, Jerome Kervial, who blew £3.6bn on financial derivative bets for the French bank Societe General. A lot of City of London traders were feeling their collars after that episode.

In the ‘States, where they take their drama seriously, the FBI has been called in to investigate the sub-prime mortgage scams and the derivatives vehicles used by the banks to keep their losses - and their gains - off their books. The lawsuits are piling up so fast on Wall St. there is actually a shortage of lawyers to handle them all. The City of Cleveland alone has 21 lawsuits outstanding against leading banks like Goldman Sachs and Morgan Stanley.

But as I say, for most of us in Britain this has been a fascinating and compelling drama, but nothing really do with us. Crisis?what crisis? The talk of monolines, libor, collateralised debt obligations and credit default swaps goes way over our heads. Part of an exotic world far removed from the real economy, let alone our salary slips.

Until now. For, what has become clear in the last week or so is that this is not just about US mortgages, or turbulence in the international derivatives market, but a systemic crisis of the global economy. And we can’t escape it. Last week the Financial Services Authority said that a million sub-prime mortgage holders in Britain are facing ruin. Britain is about to rediscover the meaning of negative equity as the property bubble deflates and exposes all those dodgy mortgages from the likes of, well, Northern Rock. The banks are refusing to lend on the old throwaway terms. The number of new mortgages approved by the banks fell to ten year low last month.

This might explain why no new bidders have been prepared to enter the race for the Rock before tomorrow’s deadline, despite the government guaranteeing what is effectively a £50 billion loan of our money. That none of the big name banks are prepared to take on Northern Wreck speaks volumes for their confidence in the financial future. Gordon Brown seems determined to hand those billions over to the self-publicist Richard Branson, who didn’t even have a banking license when he made his initial bid.

The other way the crisis is going to hit home is through inflation. This is building as central banks cut interest rates in a desperate attempt to shore up the commercial banks many of which are, effectively, bankrupt. This means that the recent increases in the cost of essentials like food, housing and fuel - which have been running at 12% according to the Office of National Statistic - are not a blip.

Of course, the official inflation rate, the Consumer Price Index, is only showing 2.1%. But since that excludes things like council tax, energy costs and housing it is utterly discredited, especially in the eyes of union pay negotiators. This means that industrial relations are going to become a lot more interesting. Only ten days ago, the police took to the streets for the first time in history to demand that the government met their pay settlement in full.

But what about jobs? So far, employment has held up remarkably well in Britain and America, leading some to conclude that the recession can be avoided, whatever the gyrations of the stock market. But there are very few people in the financial world who take such a sanguine view. Look at your local high street. Those shops which aren’t charity outlets are estate agents, banks, hairdressers or cafes. Polish delicatessens have been the big growth area. Now, house prices are turning, the banks are not lending and debt-ridden consumers are reining back their casual spending as the essentials of life start taking up more of our income. So, the delis will shut, the estate agents will lay off staff and the banks will be closing branches to cut costs.

In the absence of manufacturing, our economy is now largely driven by consumer spending fuelled by house-prices and bank lending - a broken business model. Financial services has been the most dynamic sector of the Scottish economy over the last decade, responsible for around a third of all new jobs. This is going to crash into reverse, as the banks struggle to survive. The Royal Bank of Scotland’s recently saw its stock market value cut in half as a result of its exposure to US sub-prime -related derivatives. Scotland’s biggest company may have to go cap in hand to the sovereign wealth funds of the Middle East. HBOS - Bank of Scotland as was - is also in deep financial waters, and things aren’t looking very happy at Standard Life. This will feed back into the property slump as the bonuses, which went into all those million pound houses in Edinburgh, disappear.

As it happens, most jobs in Scotland depend on the public sector, so this should provide some kind of buffer. But state spending is also being squeezed as the government desperately tries to mend its own finances. Irresponsible spending by Gordon Brown during the boom, and now a collapse in tax revenues because of the credit slump, have blown a hole in the Treasury finances. The institute for fiscal studies says the government will have to raise £8bn in taxes and cut back on spending across the board, and this on the back of the tightest spending round in nearly a decade. If the public sector crashes into reverse, it means a disproportionate loss of jobs in Scotland - which might be one reason the SNP seems so optimistic about about incinerating all those semi-state ‘quangos’. They know that the party is over in the public sector.

But still, you look around, and you think. Well, things aren’t exactly tough right now, are they? Perhaps it’ll never happen? Personal bankruptcies are rocketing as are home repossessions, but they always seem to happen to someone else. And it’s true that the economies of the West have great resilience. The world economy is still growing.

But as the financier George Soros has pointed out, this credit crisis looks like the end of a long boom based, essentially, on the expansion of debt. Average earnings of households in Britain and America have been stagnant for the last decade and a half. The consumer boom, which has kept the economy going, has been fuelled by borrowing on a colossal scale. In Britain we collectively owe £1.4 trillion, more than our entire GDP. We are going to have to stop borrowing and start saving.

But no one wants to admit it. The government is still in denial and hoping that cuts in interest rates will somehow get the consumer spending again. But it’s not going to happen because the banks will not lend. The US Federal Reserve has found that unprecedently steep cuts in interest rates has just led to a collapse in the dollar and the return of ‘stagflation’. We need a new approach to economic management, based on technology and productive industry rather than financial speculation and debt. But by the time the politicians realise that, it could be too late to avoid the worst economic storm in a generation