Gordon Brown's banking friends desert as UK economy redlines.

Those whom the gods wish to destroy they first make finance ministers. Last week, the Chancellor, Alistair Darling, announced that the latest cunning plan for the economy was to bung £120 to basic rate tax payers. The purpose, he said, was to boost the economy by putting our money, £2.7 bn of it, back in our pockets - oh, and to compensate for the ten p tax band along the way.

Gordon Brown called it a “welcome fiscal stimulus” at a time of financial difficulty for hard working British families. And what a brilliant idea! Why had no one thought of it before? If consumer demand is failing because times are tough why not just give people more money? Problem solved.

Except that this give-away economics doesn’t seem to extend to public sector workers who are being told to accept a pay settlement lower than the rate of inflation. Surely, this is inconsistent, since this pay cut for millions of state employees will depress their buying power by almost the equivalent of the chancellor’s tax handout. Giving with one hand to take away with another doesn't make a lot of economic sense.

You might well ask why the Chancellor isn’t giving everyone a fiscal stimulus. Following Darling’s logic, if the government just gave everyone a 20% pay increase there would be no economic slowdown at all. Well, not until the public finances cracked under the strain of double digit inflation, fiscal deficits and a run on the pound. What the heck, it’s probably going to happen anyway, because the government is printing money faster than at any time since the 1970s. The results will be similar.

Like most improvised policies, the £2.7bn tax hand out was a sign of desperation. It was a spatch-cocked political bribe by a prime minister who has lost authority and a government running scared of a by-election defeat. The government has simply stopped making sense. Ministers still insist that, thanks to their prudent stewardship, the ‘economic fundamentals’ are strong. Except that increasingly they aren’t: inflation is up, unemployment is up, cost of living is up, the pound is down, housing starts are down, house prices are down etc..

And the government is all over the place. The housing minister, Caroline Flint, inadvertently revealed in her see through cabinet brief last week that the government’s own forecasts see a fall of up to 10% in house prices this year, possibly more. Now, falling house prices should, by the government’s own logic, be a good thing. One of the big themes of Gordon Brown’s premiership was supposed to be affordable housing. If housing is going to become affordable, prices must fall. So why keep this secret? Why not hail this remarkable achievement?

Well, because the government is as obsessed by house prices as Cherie Blair and just as fearful of them falling. So anxious are they that ministers are trying to lure first time buyers into a falling market by offering various subsidies when they should be doing the opposite. Ms Flint should be warning young families NOT to take on massive loans they probably can’t afford at a time when prices are expected to fall. First timers risk being in negative equity within twelve months, making the government party to a mis-selling scandal comparable to sub-prime lending.

Of course it is difficult for this government to adjust to the new economic reality. The economy has turned from nice to nasty in record time - too fast for the political cycle to catch up. But it cannot afford to be in denial. The trouble is that Gordon Brown still believes he is a master of the universe. During the boom years, he was celebrated as the greatest chancellor in over a century; a miracle worker who could defy shocks like the dotcom crash and deliver year on year growth indefinitely. In reality, he was - like the banks - riding an irresponsible and unsustainable housing and credit bubble. Tax cuts to the rich disguised how real peoples’ incomes had stagnated.

New Labour revealed itself as the bankers’ new best friend. Brown gave them “light touch” regulation, which basically meant turning London into a global Liechtenstein. Property prices entered the stratosphere, fuelled by bonuses paid to City workers - ably assisted by Cherie Blair and other Labour plutocrats who saw personal enrichment as the new socialism. Brown’s single defining act was to “liberate” the Bank of England, making it immune from political guidance or interference on interest rates. It was the definitive gesture of “hands off” - Labour laissez faire.

So, Gordon probably thought that his banking friends owed him a few favours. That if things got difficult they would stand by him, not let a liquidity shortage lead to a mortgage famine; keep the economy going by keeping interest rates low and passing any reductions on to home-buyers How wrong he was. Bankers are unsentimental creatures who don’t do favours and care little about the welfare of politicians. Four weeks ago Brown gave them £50bn of our money on the understanding that this would free up lending and bring down mortgage rates. Instead, they put them up.

Last week, Mervyn King, the governor of the Bank of England shot a bolt through the prime minister’s heart by delivering the grimmest assessment of Britain’s economic prospects since the ERM debacle sixteen years ago. He suggested that interest rates would not be cut until 2010, that a housing correction was underway and should not be interfered with, and that the British economy was probably going into recession - or as he put it “the odd quarter or two of negative growth” which just happens to be the definition of recession.

This bald assessment of the state of the national economy shocked Number Ten and the entire Labour party. It was the economic defeatism that hurt most. Most Labour MPs assumed that a deal had been struck during the boom years that, if house prices fell, the bank would cut interest rates and all would be well. Not any more.
There is now complete confusion in government. They just don't know what to do next.

This has been a hard lesson. The banks are in flight from risk, willing to take any handouts from government, on the strict understanding that it won’t make a blind bit of difference. They are acting to save themselves from the consequences of their own folly, leaving the government to flounder like overextended home-owners. But there are no two year fixes available to keep this government from repossession.

It could soon be black bin bag time in Number Ten. But I suspect Gordon, like his predcessor, is already considering a lucrative sinecure in one of the big banks that will cushion the blow of his political retirementr.