Democratic Britain

A little over a year ago on 1st November 2010 I wrote what I called “…a little bit of scurrilous speculation.”  In it I speculated that an unintended consequence of QE had been to spur several countries to think very seriously of how they could replace the dollar as their settlement currency for international deals. The [...]

In a few weeks time, if Ron Paul gets swept aside by the GOP's machine, it may seem like just an interesting historical footnote that a man came within 4,000 votes of winning a Republican primary who is in favour of abolishing America's central bank. But probably it won't.

Right now, on the other side of the world, Hungary's government is staging a standoff with the European Union about the constitutional role of its central bank. And conservatives everywhere are relooking at the role of central banks as they morph from lenders of last resort to effectively underwriting - some say controlling - fiscal policy.

This new preparedness to question the role of central banks comes alongside a renewed interest in pure-form Austrian economics, which we covered on Radio 4's Analysis programme a year ago.

Ron Paul himself buys the full monty of Austrian-school positions on money and central banking. He is against fractional reserve banking - ie the practice of banks lending more than their deposits; he's against the "fiat money" that is the result of this; he believes central banks and the size and weight of the state within the economy are the cause of economic crisis; that the Fed is unconstitutional and that the US should return to - or as he puts it, go forward to a modern version of - the Gold Standard.

The mainstream media tends to treat this as lunacy or extremism. But once it was different. When the Fed was first created, in 1913, its Wall Street progenitors had to meet in secret at the exclusive Jekyll Island Club in Georgia, for fear that the new institution would be characterised as a "bankers' cabal".

For 20 years after the Jekyll Island conference, none of the participants would admit it had taken place. Only by compromising on the form of the Fed - it was created as an alliance of formally autonomous regional central banks - could its supporters get the new law through congress - and so the Fed was born amid much of the same opprobrium Mr Paul and his supporters now heap on it.

In an earlier phase of capitalism, Britain and the earlier European commercial powers (the Dutch Republic, Sweden) created central banks either to lend money to the government or to stabilise the convertibility of trading currencies into gold.

These then morphed into "banks for bankers" - clearing houses which would mop up liquidity among the middle and upper classes and spread it through the private banking system (in the lobby of the Bank of England there is a nice painting of the English bourgeoisie queuing up at Threadneedle Street on Dividend Day by George Elgar Hicks).

When the Bank of England set up in 1678 there was a similar hue and cry in parliament to the one that greeted the Fed in 1913:

"Both Tories and Whigs broke into a fury at the scheme. The goldsmiths and pawnbrokers, says Macaulay, set up a howl of rage. The Tories declared that banks were republican institutions; the Whigs predicted ruin and despotism. The whole wealth of the nation would be in the hands of the 'Tonnage Bank,' and the Bank would be in the hands of the Sovereign. It was worse than the Star Chamber, worse than Oliver's 50,000 soldiers. The power of the purse would be transferred from the House of Commons to the Governor and Directors of the new Company." 'The Bank of England', Old and New London: Volume 1 (1878), pp. 453-473.

The good burghers of restoration England, then, understood what many modern politicians do not, or purport not to: a central bank is part of the state.

Yes, independent or no, governed by a cabal of financiers or a collection of fools, its function has grown way beyond simply raising money for the government or clearing debts between banks. A modern central bank issues the currency; it controls the amount of money in the economy; it lends to the government and to other banks; it sets interest rates; it regulates the banking system - even now in the UK regulating macroeconomic policy - manages the foreign exchange reserves of the government and "owns" something called monetary policy.

But it is not elected. Indeed the attempt to place Hungary's central bank under parliamentary control is what has caused the EU to threaten to withdraw economic aid.

Nor is it much accountable. The Bank of England likes to claim it is accountable to the Treasury Select Committee, because it has to appear there quarterly. But in fact it is accountable to the Chancellor, who has signed away most of his rights to hold it to account.

Now, in the crisis, central banks are becoming all this and more: by issuing paper money on a giant scale they are affecting the ability of governments to make tax and spend policies - Chancellor George Osborne's ability to do £147bn of fiscal tightening is based entirely on the assumption that Bank of England Governor Mervyn King will go on doing £400bn of monetary easing.

There have been three crucial stages in the evolution of modern central banks. The first - well documented in the excellent Lords of Finance by Liaquat Ahamed - was when World War I threatened to crash the national banking systems of the combatants.

It was here that the unelected, largely unknown and unaccountable nabobs of central banking actually began to fix the global monetary system in a series of ad hoc and highly irregular deals with each other. This continued through Versailles and on to the second big crisis - 1931 - when the gold standard began to fall apart.

As capitalism moved in a statist direction, it became politically controversial for these private-style cross border loans to be made, and in some countries central banks became, for the first time overtly, a tool of the executive - Hitler controlled the Deutsche Reichsbank directly after 1937 proclaiming it was transformed "from an internationally controlled bankers' enterprise to the institution of monetary issue for the German Reich" - (Speech 21 January 1939). (Obviously with the Nazis this critique of central bankers as cosmopolitan internationalists drew on their general anti-Semitic critique of international finance).

This overt statism was reversed after 1945, but you do emerge in the post-war boom years with a clearer understanding of the central bank as an arm of the state, albeit a relatively independent arm; and the culture emerges that the central bank has to meld its activities with the national interest of states within a global system, rather than - as was sometimes the case in the era of Montagu Norman et al - a private club representing the supposed "interests" of the finance system.

The Fed, of course, as the bank of the dominant power, gains great power over the global monetary system.

The third stage in the development of central banks came in 1971 when the US abandoned the Bretton Woods arrangement of fixed exchange rates against the dollar. From this moment you get true fiat currencies, the takeoff of financialised capitalism and the emergence of the central bank in each country as money creator on behalf of the state, and thus a major centre of political power.

Once you understand that the central bank is really part of the state in modern capitalism, and that the crisis has made it the most important and powerful part, that allows you to understand almost everything else.

Right now, central banks are engaged in a major operation to stave off the Euro sovereign debt crisis by extending global unlimited short term credit to Europe's banking system. They are also printing money to support demand; and to export the crisis - and inflation - to the developing world.

One of the frustrations of being a journalist faced with this is where do you even begin to hold such institutions to account - not just for their tactical actions, as with my famous spat with Mervyn King in February last year - but over their strategic role, in both regulation, macro-stability and enabling (ie backing) certain fiscal policies over other ones (as again with Sir Mervyn and the Coalition).

Also for their role in diplomacy: Wikileaks released a cable last year showing the Chinese requesting Tim Geithner to lean on the Federal Reserve to speed through the partial acquisition of Morgan Stanley.

Given the central bank acts often in secret, and through informal contacts in networks like the Trilateral Commission (see membership list here) and Bilderberg it's hard to subject them to scrutiny. And this is not a new problem.

In my extensive collection of obscure books, there is one called "The Old Lady Unveiled" by J.R. Jarvie (Wishart 1933). Purporting to be a critique of the Bank of England, it contains an exchange of letters between Jarvie and the-then Secretary of the Bank, Ronald Dale, in which Dale unceremoniously tells Jarvie to get lost for requesting a list of stockholders in the bank.

"The bibliography of the bank is meagre and leads to nowhere in particular," Jarvie observed.

It sometimes feels that way today: for while there is much statistical information published by the central banks, and while some are now even putting themselves up for ritual grillings by journalists, it's very hard to find a hard-edged discussion of the economic, political, diplomatic and strategic role of central banks within the current system. Politicians meanwhile often simply shrug their shoulders: "The bank's independent, what's it to do with me?" they ask.

At least after Ron Paul, and after the Hungarian debacle, there will be more sensible questions to ask, even if we don't always know the answers.

As the economic crisis deepens, this is the moment to consider moving towards much shorter, more flexible paid working hours - sharing out jobs and unpaid time more fairly across the population.   nef's event About Time takes forward the ideas from its highly acclaimed report 21 Hours to examine how this could help to address a range of urgent social, economic and environmental problems we face.   On 11 January, the event brings together a panel of leading experts in partnership with the Centre for Analysis of Social Exclusion (CASE) at the London School of Economics:   Lord Robert Skidelsky, Emeritus Professor of Political Economy at the University of Warwick and biographer of J. M. Keynes, and Dr Edward Skidelsky, University of Exeter, and co-authors of the forthcoming book, How Much is Enough? Economics and the Good Life.   Juliet Schor, Professor of Sociology at Boston College, and author of Plenitude: The New Economics of True Wealth, and The Overworked American.   Tim Jackson, Professor of Sustainable Development at Surrey University, and author of Prosperity without Growth.   The evening will comprise of a public lecture followed by a drinks reception with the speakers.   If you are interested in attending please RSVP to Cam Ly (cam.ly@:neweconomics.org).   Save the date! This is an open conference, with places available to all on a first-come-first-served basis. Please arrive early to guarantee your place in the main theatre. Join us afterwards for a drinks reception at 7.30 pm.   Read more about the event at nef's website or at the LSE's public events page.  

I have a favour to ask. My friend Mark Tanner phoned me the other day to ask if I was going to enter the blog for the  Orwell Prize. I said I hadn’t thought about it. There was a tolerant silence followed by a gentle suggestion that I do think about it. I have and …well, [...]

In a normal year predicting economics is like predicting the outcome of a card game: there are too many variables and the only certainty being that the suckers will lose and the stealthily self-interested will win.

In 2012 however, the shape of the crisis is heavily predetermined: there are a series of crucial stages the eurocrisis has to go through and the way they're resolved will affect everything else.

Starting from where we are now, there are three big questions:

Right now my answers to these questions would be yes, yes and yes.

That is: yes, a liquidity splurge is going to be enough to prevent a credit crunch - though it will later have to be acknowledged as a massive and unconstitutional policy shift, forcing the ECB to become lender of last resort.

And yes, Greece will default. Its 50% haircut is proving hard to make stick; its coalition government is unstable and cannot collect enough tax; its people are increasingly destitute; its rich elite has, functionally, scarpered in anticipation of the pain to come. But given that the majority of Greeks still don't want to leave the Euro, and the eurozone leaders won't force them out, we will end up with a defaulted country using the Euro on sufferance, which is another de-facto step towards fiscal union.

And again yes: France will lose its AAA credit rating - causing problems for President Sarkozy and huge soul-searching in Germany, where those close to Chancellor Angela Merkel believe Franco-German apparent equality of status is crucial to selling any future fiscal union.

This, it will be seen, is not all bad. What's bad is that the indecision that scarred the months between June and December has already done enough damage to cause economists to predict a sharp recession focused around the first and second quarter of 2012 in the eurozone. Minus 1.5% economic growth for the year in the zone, says Standard Chartered's Gerard Lyons, and it's not the most pessimistic prediction I've seen.

The most likely outcome in pure economic terms is a moderately bad fiscal crisis, a survivable sovereign debt event and a sharp growth downturn, all in the first half of the year.

This then creates political problems that feed back into the economic loop. First, the frontrunner in the French presidential election, Francois Hollande, says he'll renegotiate the Treaty agreed in December. If he does, the prospect of a socialist victory in April will cause instability in the bond markets.

Second, there is Greece. New Democracy are looking likely to win - with 30% in the last three December opinion polls. Their parliamentary majority will be sealed by the Greek "augmented proportionality rule" which hands extra MPs to the largest party. But then the opposition will be the far left. Pasok is tanking at the polls - on 18%. But the combined vote of the Communists, the United Left and the Democratic Left is hovering around 28-29% in each of the last three polls. Of course these parties have severe ideological differences with each other, and have occasionally clashed in demonstrations - but Greek politics is polarising at the same time as its professional politicians are running out of answers. It is hard not to predict a social explosion in Greece. Should it be forced to exit the eurozone, then the exit plans I've seen do not look pretty. The one outlined by SOAS professor Costas Lapavitsas involves bank closures, current account freezes, import and capital controls and probably food rationing.

Then there is Italian politics. While the Eurocratic elite congratulate themselves on getting rid of a pantomime dame as prime minister, on the ground the technocratic government of Mario Monti is not that popular. Since there is no election scheduled, it remains to be seen how long he will be tolerated by the centre right majority in the Italian parliament, and the middle classes who have put them there.

Of the two political factors in Euro instability, the Greek and French elections come closely together: in mid and late April. By then a third political factor - renewed fighting in Washington over the 2013 US budget will be under way.

All this makes me think the first six months of 2012 will be marked by a containable fiscal and financial crisis, a double dip recession in Europe and some severe political shenanigans which bring non-mainstream politicians to the point where they are the official opposition, certainly in Greece and maybe also in France, where Marine Le Pen, of the National Front, could stand to gain from any anti-Sarkozy backlash.

Because of this, and the generally predicted slowdown in Asia and the BRICs [Brazil, Russia, India, China] as well as Europe, I think the other big thing we'll see in 2012 is a return to protectionism.

We already saw in December David Cameron walk away from a new Euro treaty on the grounds of defending Britain's national interest. On the same grounds Canada has walked away from Kyoto, and the Durban deal on Kyoto targets looks very meagre and subject to national flounce-outs.

China and America have continued their sparring over a tyres to poultry to luxury cars row at the World Trade Organization, with each imposing retaliatory taxes on the other; meanwhile Brazil's relationship with the USA is already couched in terms of trade war.

In 2012 the tendencies towards competitive exit routes from the crisis will increase, and they will do so along routes that are not obvious: direct trade battles may not be so important as battles over fishing rights, quotas, environmental damage and climate change. Access for tar-sand produced oil to Europe is worth watching.

By the time we get to the G20 summit in Los Cabos, Mexico, in June, we will be looking for global leadership: a global programme to stimulate growth - and to smooth out the relentlessly expanding imbalances in the world economy - and some calming words against trade war and currency manipulation. The worst thing would be is if we get another Cannes-style fiasco and the prospects do not look good.

In an election year President Obama is going to be domestically focused; there may be a new French president; the German Chancellor will be in pre-election mode herself by then and almost everybody else has not enough traction to make a difference.

I think the mid-year will be a clear inflection point. If the worst of the eurocrisis is over; if Greece is sterilised, and the ECB gets real about its role as a central bank; if America's budget cuts go onto autopilot and a non-extreme candidate is picked by the Republican party to run against Obama, then we may actually be entering the final 18 months of the post-Lehman crisis. The bottom of the US housing market is probably already behind us, and it will demonstrably pick up in 2012.

But beyond that it's hard to predict, because so many of the exit strategies from the crisis depend on exporting trouble to your neighbour or your rival. What's sure is that the politicians and central bankers have immense power of agency to make things go either right or wrong.

What's also clear is how much pressure they do actually feel from electorates - not directly, because most party machines and political systems are sewn up by elites - but indirectly through the various protest movements that have sprung up, and through social media and mass media participation in general. When I was at Cannes in November, what impressed me was the contrast between how sequestered the world leaders are from reality - the nearest shops are always Gucci and Swarovski themed - but how aware of the minutiae of what the occupy movement has just done, or what Ron Paul or Paul Krugman has just said.

So in addition to predicting a continued social upheaval in 2012 I will predict the further rise - not yet to power but to the edges of power - of the conviction politician. Ron Paul I think is still worth watching for the Republican presidential race; meanwhile Alexis Tsipras, leader of the Greek leftist coalition Syriza is also one to watch. And on the basis that even Churchill came back from abject catastrophe more than once, do not consign Silvio Berlusconi yet to the political waxworks.

Paul Mason joins Owen Bennett-Jones and a roundtable of BBC Correspondents tonight on BBC Radio Four at 2000 GMT

The lies which got us to the purgatory we are in, are being told all over again, right now, in every bank in the Western World. Not by accident, but on purpose, by men with calculators and degrees, in the full knowledge of what they are doing, why and for whose benefit. Every religion has [...]

To all of you who have made this blog what I hoped it might be: - a place where people think, question and converse in a community of their own making, -  where rancour and rudeness are not accepted, - and where people know they can ask for help and offer it in the knowledge [...]

The recent European Union summit was a disaster. Both Britain and Germany played the wrong game: British Prime Minister David Cameron isolated Britain from Europe, while German Chancellor Angela Merkel isolated the eurozone from reality.   Had Cameron brought an economic-growth agenda to the summit, he would have been fighting for something real, and would not have lacked allies. As it was, he fully accepted Merkel’s austerity agenda – which his own government is implementing independently – and chose to veto proposals for a new European treaty to protect the City of London. This cheered up the Euroskeptics in Cameron’s Conservative Party, but it offered nothing to counter the lethal medicine prescribed by Germany’s Iron Lady.   The agreement reached in Brussels forecloses any possibility of Keynesian demand management to fight recession. “Structural” budget deficits would be limited to 0.5% of GDP, with (as yet undisclosed) penalties for violators.   This is the wrong cure for the eurozone crisis. The Merkel doctrine holds that the crisis is the result of government profligacy, so only a “hard” balanced-budget rule can prevent such crises from recurring.   But Merkel’s analysis is utterly wrong. It was not deficit spending by governments that fueled the economic collapse of 2007-2008, but excessive lending by banks. Government’s mounting debts have been a response to the economic downturn, not its cause. What ought to have been hard-wired into the EU’s institutional structure was not permanent fiscal austerity, but provisions for economic stability.   More immediately important is the failure of the proposed “fiscal union” to do anything for European recovery. The figures are grim: before the summit, the European Central Bank slashed its eurozone GDP growth forecast for 2012 from 1.3% to 0.3%. That is almost certainly optimistic. In fact, the eurozone will contract in the first half of next year – and probably in the second half, because of the deficit-cutting policies now being pursued – placing further pressure on banks and sovereigns.   The reason why recovery from the crash of 2007-2008 has been so anemic is straightforward. When an economy shrinks, government debt grows automatically, because its revenues decline and its expenses rise. When it cuts spending, its debt grows even more, because its cuts cause the economy to shrink further. This makes the government more, not less, likely to default.   In the eurozone, most government debt is held by private banks. As this debt increases, the value of banks’ assets falls. So the crisis of the sovereigns engulfs the banks. To put weakened governments on iron rations, as Merkel did, was to make a financial crisis inevitable. To continue to preach salvation through austerity as the economy declines and banks collapse is to repeat the classic mistake of German Chancellor Heinrich Brüning in 1930-1932.   To be sure, the eurozone needs more than a bailout. The periphery needs to recover competitiveness, and some have taken heart from the Mediterranean countries’ shrinking trade deficits – the structural trade imbalances within the eurozone are correcting themselves, they say. Unfortunately, these corrections are not based on increased exports, but on declining imports, owing to depressed levels of economic activity. The idea that a country can achieve a trade surplus by importing nothing is as fanciful as the idea that a government can repay its debt by starving itself of revenue. One person’s spending is another person’s income. In insisting that its main trade partners cut their spending, Merkel is cutting Germany off from the main sources of its own growth.   So, will the single currency survive? Two policies that might, in combination, save it are off the agenda. The first is quantitative easing (printing money) on a heroic scale. The ECB should be empowered to buy any amount of Greek, Italian, Spanish, and Portuguese government bonds needed to drive down their yield to near the German rate. This might stimulate real growth through several channels: by reducing lending rates, by raising the nominal value of public and private assets, and by weakening the euro against the dollar and other currencies. But the effects of quantitative easing on economic activity are uncertain, and such an inflationary policy might well invite retaliation from Europe’s trading partners.   That is why quantitative easing should be run in conjunction with a eurozone-wide investment program designed to modernize the creaking infrastructure of eastern and southern Europe. Capital spending by governments, unlike current spending, can be self-financing through user charges. But, even if it is not, well-chosen public investment produces high returns: new roads reduce transportation costs, and new hospitals produce a healthier workforce.   An institution, the European Investment Bank (EIB), already exists to carry out such a program. It should be recapitalized on a sufficient scale to offset the contractionary effects of Europe’s national deficit-reduction programs.   Quantitative easing, combined with public investment, would impart the growth impetus that the eurozone sorely needs to bring about a gradual reduction in its aggregate debt burden. But it is almost certain that neither policy, much less both, will be implemented.   The ECB is stealthily buying government bonds on the secondary market, but its new governor, Mario Draghi, insists that such intervention is temporary, limited, and intended solely to “restore the functioning of monetary transmission channels.” No one at the recent EU summit suggested making the EIB an engine of growth. So the bleeding will go on.   This means that the eurozone is beyond saving; the euro will survive, but the zone will shrink. The only question is the scale, timing, and manner of its breakup. Greece, and probably other Mediterranean countries, will default and regain the freedom to print money and devalue their exchange rates.   This will send shock waves throughout the world. But sometimes shock waves are needed to break the ice and start the water flowing again.    

Is there a plan B? That question is usually asked of governments regarding their attempts to ‘save’ the banks domiciled in their country. But has anyone asked if the banks have a plan B? Does anyone think that if our governments fail to keep to their austerity targets and fail to keep bailing out the [...]

Robert appeared this week on the BBC World Service's Forum programme to talk about the financial crisis and ways towards recovery, along with two other economists - Far East specialist Danny Quah and Middle East specialist Timur Kuran.   You can listen to the programme or download it as a podcast at www.bbc.co.uk/programmes/p00lzhr8, or join the discussion at the Forum's Facebook page.

We had been kidding ourselves. It always felt, when you covered a Brussels summit, that Britain was there on sufferance, but the rules said otherwise: technically we were and are an equal member of a 27-nation union whose oft-explained "three pillars" of governance were applied for the common good.

Now, as is clear from Thursday night's summit statement, these common institutions are to oversee a selective "fiscal compact".

The European Commission (which the UK sits on) and the parliament (which it sits in) will adorn the architecture of a strategic economic compact which the UK is excluded from. That is the problem Prime Minister David Cameron had to confront last night.

Now there is a two-speed Europe and in order not to give up sovereignty Britain had to give up power. The long term impact is not calculable: it depends on whether the smaller, 17+ pact of euro countries, can save the single currency, avoid a slide into default and break-up, and find a way out of perpetual deflation, social unrest and poverty for the five peripheral countries.

Here is how they plan to do it:

The fiscal compact, then, is a step towards unleashing just over 1tn euros worth of lending. This should be enough to take Italy and Spain out of the bond market shooting gallery for a year.

Meanwhile, however, the fundamental problems of Europe are racing towards us like a tidal surge. Three French banks were downgraded on Friday, and it is possible some euro countries will now face downgrades. But the investors are not waiting for downgrades: they are dumping exposure to the south European countries who have just signed up for a decade of austerity - because they just don't think the whole plan is sustainable.

In summary, I think what was achieved for Europe last night was the buying of time. But time to do what? Opinion among the economists and business people I speak to is divided: some think the fiscally united eurozone can overcome the short-term dip that will now happen and emerge as a strong, globally competitive area. Others think it's set for catastrophic breakdown.

I can only add at this stage that, by enshrining in national and international law the need for balanced budgets and near-zero structural deficits, the eurozone has outlawed expansionary fiscal policy.

It has done what the US Republicans would like to do - and if you think about it, it has made what Gordon Brown did, and what Barack Obama (and indeed Wen Jia-bao) is doing illegal.

The result, if it works will be stability. It is hard to see how it promotes long-term growth.

The rumours are swirling.  Top of the list is “re-hypothecation”. Next is German bank re-capitalization. And last is an IMF Europe bail out fund. At the end of the US trading day came a report from the Japanese press that the G20 were going to set up a $600 billion rescue fund for Europe.  American [...]

“…nobody would claim that their own thinking was ideological, just as nobody would habitually refer to themselves as Fatso. Ideology, like halitosis, is in this sense what the other person has.” “Ideology” by Terry Eagleton. P.2 We all see the world through a lens of ideas and assumptions. The courageous man admits this to himself [...]

So as European leaders admit they can’t find the money to make the EFSF (Europe’s bank bail out fund) anything like the size they all said it had to be, but they are saying nevertheless that the EU gives itself 10 days to fix the crisis. The latest plan is to turn to the IMF [...]

Yesterday will be seen as a landmark in British economic history, and in British politics. It will relegate George Osborne's emergency budget of June 2010 to a footnote and elevate Robert Chote's happy-go-lucky assessment of our economic prospects in November 2010 to the status of a case study in predictive failure.

Because yesterday's Autumn Statement will set the political tone of the decade: it will tie the hands of future governments; and it has already brought a philosophical debate on the British right to an abrupt end.

Within six hours of their tight-lipped ordeal on the government benches, Lib Dem MPs heard Danny Alexander pledge them to go into the 2015 election fully committed to £30bn more austerity than they signed up for in the Coalition Agreement. "You've bagged a tiger there," a stunned editor of the FT told my stunned colleague Jeremy Paxman. And there are more tigers and more stunning events to come.

First, to recap the main points. The Office for Budget Responsibility tore to shreds the economic forecasts on which the Chancellor's original plans were laid.

Under what we now call Plan A, a total of £107bn discretionary fiscal tightening - tax rises but mainly spending cuts - would rapidly balance the books. He would meet his own target of eradicating the structural deficit a year early, in 2014-15, and as the state rapidly shrank, private sector growth would kick in. This "rebalancing" of the UK economy would be led by a sudden switch to net exports (after 10 years of net imports) and a surge of private-sector investment.

The rapidity was important, and clearly spelled out by the Policy Exchange think tank in numerous studies and notes. The theory says if you rapidly reduce the cost of government borrowing, this channels private investment into productive business; on top of that, by signalling a rapidly shrinking state, you signal lower future taxes and generate behaviour changes that stimulate growth. In addition, the government took tax measures designed to amplify the latter effect: lowering taxes on business, even as they raised taxes on income and consumption.

We did indeed get lower government interest rates (bond yields) - a combined effect of QE and the "safe haven" effect from the turmoil in the eurozone. But we didn't get rapid growth, mainly because the channel from low bond yields to low business interest rates is the banking system, and it doesn't work.

In fact, though the rest of the world is rapidly cooling now, in the last months of 2011, Britain's recovery began faltering a year ago. US growth - even with near 10% unemployment - was an annualized 2% in Q3 2011. Germany has grown by 2.1% in the first three quarters of this year. The UK is now set as follows:

Plan A, in short, failed. It failed because the eurozone did begin to slow, and confidence was hit, and so exports - having surged - will not surge much more. But also because the very survival mechanism adopted by the Bank of England - near-zero interest rates, QE and talking down the pound, which has produced and maintained a 20% fall of sterling against world currencies - led to imported inflation. This has hammered the spending power of a workforce whose wages have been pinned to the floor, even in the weak recovery phase.

The OBR last year expected strong growth, falling inflation and even posited the happy accident that in the event of rebalancing happening too slowly, this would mean the government hitting its fiscal target sooner. It could see "no plausible divergences" from the rate of recovery predicted but did identify the danger that statisticians had mis-estimated the long-term growth potential of the UK economy. Revise that down by 1.5% said Chote, and you would then raise the danger of missing the target.

Yesterday the OBR revised it down by 3.5%.

Plan A then was based on three, linked, wrong premises: that Britain could quickly switch to a private, export led model; that the economy is bigger than it actually is; and that consumption could survive the inflation surge imported by the Bank of England.

If you look at that dispassionately, there were two logical actions Osborne could have taken in the face of the new evidence. One was to reinforce the "slash the state, rapid rebalancing" strategy: this would have meant reaching for emergency tax cuts - either in the form of VAT or a 100% total exemption for business investment which employers have calculated would cost the Treasury up to £12bn.

Of course this would have meant even further slippage of the fiscal targets. But the IMF had already signalled its readiness to countenance a relaxation of the targets, and advised tax cuts as the way forward if growth faltered. At the time, June 2011, this was interpreted as something the government had discussed and explored with the IMF: a kind of ready-made "Plan A+".

However, rereading the IMF June statement in view of yesterday throws considerable light onto the option George Osborne actually took. The IMF stated in June:

"In the event of both persistent weak growth and high inflation, the appropriate response depends on the source of this condition: if it is due to further commodity price volatility, policies need not respond unless there is clear evidence of second-round effects (e.g., higher import prices feeding into higher wage growth). In the more difficult case in which weak growth and high inflation result from a much narrower-than-estimated output gap (which would be indicated by rapid wage growth), policies will have little choice but to tighten to re-anchor inflationary expectations. A narrower output gap would also imply a higher-than-currently-estimated structural deficit and therefore would require further fiscal tightening over the medium term."

It's clear from this that even the IMF could not see what was happening on the balmy June streets of barely-growing Britain. There was a mixture of inflation-driven slowdown and a narrower output gap. But neither fed through to higher wage growth: in fact both are feeding through to deflationary pressures on incomes.

So faced with this mixture in practice, George Osborne did a modicum of private growth-stimulation measures yesterday, paid for by taking money from families on tax credits; and severely tightened the public finances for two further years.

Once you understand this, you understand the scale of the scales - as it were - that are falling from the eyes of the government. The theory of "expansionary fiscal contraction" - eagerly adopted in the Treasury after May 2010 - would have told George Osborne to cut spending harder in the short term, and cut taxes to stimulate growth. Instead he has kept spending neutral and done very little on the tax cutting front.

Instead of a rapid rebalancing, with a sunny uplands populated by cheery manual workers, newly retrained from health or social work, we face a long, slow rebalancing and six more years of fiscal austerity. And the time it takes for the economy to recover to its 2008 level is now predicted to last until mid-2014. This is much longer than the actual depression of 1930-33 in the UK, and not much less deep.

So why did Osborne make the choice to deal with deficit first, growth second? The answer came from Fitch Ratings within hours of his speech:

"The capacity of UK public finances to absorb adverse economic and financial shocks that would result in yet higher public debt while retaining its 'AAA' status has largely been exhausted."

Let's unpack this: Fitch calculates - on its own definition - UK debt will peak at 95% of GDP - higher than Germany or France. If there is a financial shock - such as a bank crisis or a Euro sovereign default - which lowers growth further, pushing UK debt higher, that - says the agency - would likely lead to a rating downgrade. At that point, depending on how bad the rest of the world is performing, the UK would lose its current historic low cost of borrowing advantage.

Put plainly - there is a danger that a euro crisis would plunge Britain into the same vortex of downgrades, austerity and low growth that Europe is suffering.

Yesterday, then, allows us to look at the real structural problems and opportunities that face Britain. We are a country that was not able to enact "expansionary fiscal contraction" - because we had kidded ourselves about our basic economic potential, and because imported inflation hammers consumption, and because our export markets are no longer growing. Like America, we have an impoverished middle class whose spending power cannot survive a slump in house prices, and which has no pricing power in the workplace to raise its wages relative to profits.

The alternatives to this? Raise your economic potential through investment: in machines, research and better skilled people; re-orientate to different export markets; and disincentivise the importation of low-skilled operations. I.e. become a high-skill, high productivity economy oriented to the world, not Europe.

What the right learned yesterday is there is no swift route to this; what the left learned is the size of the fiscal overhang it will inherit should it ever get back into power. For yesterday will shape Labour's future as much as it will the Coalition's: markets are already pencilling in an attack of the vapours in late 2014 if it becomes possible that a Labour government committed to missing Osborne's new fiscal target will be elected.

And don't kid yourself that Britain is somehow immune, either, from the "government by technocrat" virus sweeping Europe. We saw last night the Lib Dems forced to effectively write their manifesto on the set of Newsnight; Labour too will now be wrenched from the leisurely world of blue-skies thinking, by boxfresh young frontbenchers in as yet unwrinkled suits. It will see its core electoral base - the public sector workforce and low-income families - subjected to four more years of demands for givebacks, job losses, service cuts, tax-credit cuts. But it cannot publicly support their protest actions. Those of us who've reported from the streets of Athens, and know what a leaderless mass of angry people looks like, know how disorienting a fiscal crisis can be for social democrats.

Osborne's original rebalancing plan had both a political and a fiscal advantage: it would kickstart a new kind of growth not based on property speculation and maxed out credit cards; and it would rapidly refill the Treasury's coffers with private sector tax revenues. At a stroke of the statistician's pen, this was made impossible yesterday - or at least impossible in the short term. And all this is premised on the non-implosion of the eurozone.

George Osborne revealed yesterday the Treasury is contingency planning for a euro breakup; the OBR revealed it was not part of that contingency planning. Maybe it should at the very least model what the options would be for a flatlining UK economy faced with a second credit crunch and a sharp slowdown in world growth. Economist Andrew Lilico on Newsnight last night predicted it would bring a 10% contraction in UK GDP.

"Contingency plan" sounds in a way safe, remote. We have to hope the actions of Mrs Merkel and President Sarkozy do not turn today's secret contingency plan into March 2012's Budget Statement.

Here's my snap assessment of the Autumn Statement. First the big analytical takeaways:

There is a fair bit of tentative dirigisme in there: a national infrastructure plan; transport links upgraded with macro-economic design; exemption from carbon targets for crucial industries; 100% capex tax exemption in the north of England.

It poses the old question in a new way: can we stimulate a new kind of growth, based on manufacturing and exported goods in time to rebalance the economy; and can we avoid a second recession by printing money for long enough so that the £111bn Osborne is taking out of demand does not tank the entire economy.

But none of this factors in the results of the euro crisis. As I write the evidence of a credit crunch in the European banking system is spilling out. Even if Merkozy get their act together and avoid Eurogeddon, it is going to hit growth in our biggest export market.

I think this changes the "Plan A vs. Plan B" debate as follows: Plan A is significantly amended - there will be a high chance of missing the fiscal target; but Labour's "Plan B" must take account of the OBR's damning judgement about what Labour did to the structural deficit.

We are now about to find if a bit of dirigisme, a lot of austerity, and swathes of printed money can a) prevent recession b) turn the economy around c) get a coalition of Conservatives and Lib Dems elected - should they wish to be so - in 2015.

I don't think this will provoke a wave of public sector strikes on top of the pensions unrest already under-way. What it does is tee up a much bigger electoral pitch by Labour to the public sector workforce.

There is now no chance of a sustained recovery, either in the real economy or the public finances, by the time we get to the pre-election period.

Where is the European Bond and Banking crisis going next? Well Europe has a simple problem – it can’t sell its debt, neither sovereign nor private bank debt – at an interest rate they can afford. Italy sold €7.5 billion in bonds but at rates that are completely unsustainable. To give you an idea of [...]

In his autumn statement today the chancellor claimed it was his deficit reduction plan that enabled the British government to borrow money even more cheaply than the Germans, thus saving the taxpayer £21bn in interest rate charges over five years. Ed Balls rejoined that "he still clings to the illiterate fantasy that low long-term interest rates in Britain are a sign of enhanced credibility and not, as they were in Japan in the 1990s or in America today, a sign of stagnant growth in our economy". The intellectual debate between George Osborne and his critics hinges on this single point: what is it that makes a deficit-reduction programme "credible"?   Let's start with the theory of the matter. "Look after unemployment," JM Keynes said, "and the budget will look after itself." This was a neat way of saying that a credible deficit reduction plan depends on growth. All governments have large deficits at present because their economies have shrunk. The deficits will decline automatically as their economies start growing.   But policies of deficit reduction will not in themselves produce growth. Nor will they eliminate the deficit. Trying to reduce the deficit by cutting spending and raising taxes means taking spending power out of the economy, when what a depressed economy needs is more spending. A government can always cut its own spending. But it cannot control its income. If cutting its spending leads to a fall in its revenue, it is little nearer "balancing the books" than before. One person's spending is another's income. If the government reduces the economy's spending, its own income will fall.   This grisly truth is at last starting to pierce the fog of rhetoric. The latest report of the Office for Budget Responsibility predicts that the government will miss its borrowing target this year because of reduced revenues. Even though it has cut spending by more than its goal, the fall in tax revenues – £15bn less than expected this year – has knocked it off target.   The economy has not grown for a year and, says the OECD, is now likely to contract. Lower growth over the next five years means the government will have to borrow £111bn more than planned. The brief recovery is over. The shrinkage in demand is becoming a collapse. Unemployment will still be rising in 2013, real wages will continue to decline and as households stop spending, company profits will suffer. The deficit will not be gone by 2015. Even to get rid of it by 2017 – the latest estimate – will require a further £23bn of cuts. But as these will reduce growth even further, the elimination of the deficit can safely be postponed to never-never land.   We come to the question of confidence. The chancellor has repeatedly claimed the deficit reduction programme was, and is, necessary to maintain investor confidence in government finances. Confidence is very important, but also mysterious: the bond markets can believe a dozen contradictory things before breakfast. The main point is that confidence cannot be separated from the economy's performance. As it stalls, the creditworthiness of governments declines as their debt increases, raising the likelihood of default.   A year ago bond traders, having forgotten what little economic theory they knew, were inclined to believe that deficit reduction would in itself generate recovery. For several months the Osbornites fed them the fantasy of "expansionary fiscal contraction", the idea that as the deficit falls the economy would expand. This story is now exploded. It's the economy that determines the size of the deficit, not the deficit that determines the size of the economy.   The chancellor is right to say that Britain is not at the "centre of the sovereign debt storm". But for how much longer? The eurozone financial crisis – on both its sovereign and commercial bank sides – is the direct result of policies which have brought about the slowdown of the European economies. From August to September industrial production turned sharply downwards in the EU, and especially the eurozone. But our government has been pursuing the same policies, with the same results. This suggests that, without a change of policy, the price of our own government debt will start to go up.   I agree, therefore, with Ed Balls. The government's debt-reduction strategy is not credible, either as theory, or in term's of maintaining the markets' confidence. The chancellor's plan would have looked good had it worked. It has fallen so far short of it that Osborne sees the need to introduce a subplot into the main narrative. This goes under the name of "credit easing".   He has authorised the Bank of England to buy an extra £75bn worth of government bonds – known as "quantitative easing" – to increase the reserves of the banking system. Then there is "credit easing": banks will be given government guarantees to raise money more cheaply provided they lend to small and medium-sized businesses. The government will offer to secure part of the loans taken out by first-time buyers of new-build homes, enabling them to get larger mortgages with a smaller deposit at lower interest rates. The government also intends to "mobilise the finance" for an infrastructure programme, though how it can get the pension funds on board without subsidised interest rates and/or guaranteed income streams is not clear. These are steps in the right direction. But, according to the OBR: "It is far from clear how much additional lending [credit easing] will create."   What the chancellor is trying to do is to increase the supply of credit. But the austerity side of his policy is choking off the demand for credit by reducing the market. The new policy is therefore incoherent. What we need is not a subplot but a new narrative, which recognises that the most important requirement for recovery is to increase total spending in the economy. In this story, increasing capital spending is the main plot, cutting current spending the subplot. The chancellor is edging towards this, but he has not arrived. Events may force the pace.  

It now looks like Chancellor George Osborne's growth strategy will have to be executed in a global environment of falling growth, more financial crisis and the breakup of old trans-national institutions.

That is not necessarily a disaster, as I explore below. But it changes the game.

Britain's politicians are trapped in a "Plan A versus Plan B" debate all the more intense for becoming less and less relevant to the issue of how we escape the crisis.

The short-term measures are obvious: George Osborne was given a pre-stamped exeat pass from his fiscal commitments by the International Monetary Fund in June. If it looks like you're going to miss your budget targets, said the IMF, go ahead and miss them; the detailed timetable of fiscal discipline was never as important as the general direction of travel for the markets, and by making a massive austerity gesture when everybody else was complacent, Britain successfully moved the markets' hostile attention onto the European mainland.

In addition, said the fund, cut taxes rather than spend more. We'll see what's signalled in the Autumn Statement but I would be surprised if, sometime in the next six months, we do not get a tax-based stimulus to the tune of £8bn or £12bn.

This, on top of the £20bn credit easing signalled on Sunday, might - I stress might - be enough to put a floor under collapsing lending to small businesses, falling consumption and falling confidence.

But Britain's real problems are long term. We have a structural deficit because we have a structural growth problem. For 30 years, successive governments stood by and allowed manufacturing to shrink rapidly, while boosting the financial services sector; they also progressively privatised the service economy, creating the illusion of "private sector job creation".

A recent study by economists at Manchester University's CRESC centre showed that "para-state" employment - that is private job creation with public money - accounted for about half the jobs created under Blair/Brown. (Ewald Engelen et al "After the Great Complacence" Oxford 2011)

In addition, the switch to a consumption-led economy was driven by two big spurts of equity withdrawal from mortgages, based on the two great house-price booms. The CRESC study shows that, under both Blair and Thatcher, the total amount created by equity withdrawal exceeded the value of GDP growth.

Now, the banking system is deflated, house-price inflation is only a problem where fleeing Greek and Russian millionaires wish to live, and state spending is destined to shrink by £113bn.

The old model is not going to drive growth so a new model must be found. But - and this is a problem for an essentially technocratic, managerial political class - there is no easy technical solution.

"Once the answer is not 'the market will solve things'," says CRESC Professor Karel Williams, "the answers are not easy". It is not easy just to decide to have an industrial policy, he says, and it is very easy to decide to have the wrong one.

In the OBR's first attempt to map out a rapid switch over of UK growth from "state plus consumption" to an "investment plus export" model, the OBR produced a set of figures which - in pie chart form - I've kept on my desktop ever since.

They show the intent - in fact the need - to switch growth rapidly from the way it was in the past 10 years, dominated by consumption, to a pattern dominated by investment - with exports replacing the shrinking state completely as a source of GDP growth. It's a useful comparator because in each case growth is supposed to be at the same rate: 2.6% average over the 10 years to 2008, and a projected 2.6% in 2014.

To make this happen, says Prof Williams, you would have to revive the manufacturing and trade-able goods sectors rapidly.

I have spent the week in the north of England trying to understand what it would take to make this happen. The North West is still Britain's most valuable manufacturing area, with pharmaceuticals, aerospace and materials long-standing specialisms. What you would need to do macro-economically is capture as much as possible of the global market for these and other sectors Britain is specialist in. That means focusing either on volume - still possible - or on the high-value end of these businesses.

This, it turns out, we are already doing - but there are micro-economic obstacles.

If we look at a company like Morson Projects, in Trafford Park, the issue that comes up immediately is skills: "We're about 200 people short across the whole group," says the Syd Carson, who runs the company's aerospace and defence division.

They need everything from technicians to engineering PhDs but, though they train between five and 10 each year, the overhead cost to the operations of doing anything more are prohibitive: "Our clients need us to be delivering perfect work from day one," he tells me.

Carson would like the UK government to, as in Germany, France and even ailing Spain, fund the training of engineering graduates to a standard where they are employable. "It saddens me to see people with engineering degrees driving cabs or stacking shelves," he says.

Like many of the other manufacturing sector bosses I have met, he's also passionate about where the opportunities are. Whole fleets of aircraft are to be replaced in the next 10 years, whole swathes of new nuclear technology are about to be built.

What Morson does is "manufacturing design" - that is they "build" each product - an airliner wing, a business jet body, a brand new factory - virtually on a computer screen, down to the chiselled cross in each Phillips screw. Then they simulate the manufacturing process - like building a model aircraft on a computer. And then they stress test the finished product on the computer. And then the maintenance team comes in and maintains the product, working out if you can get a spanner into a certain space - again still on the computer. These are well paid jobs and a high-value industry.

With politicians like Chuka Umunna now talking about "backing sectors", you would have to work out what it means to "back" a sector.

For many business people it comes down to offsetting the already hyper-competitive nature of policy in the successful exporting countries. China, Japan, Switzerland and - through the euro you could argue - Germany, "protect" their industries through manipulating their currencies; in much of continental Europe, they "protect" sectors by pooling the social costs of training. In countries like Ireland and Switzerland the attraction is also the tax regime.

Prof Williams believes that to turn things round we would have to go beyond the simple replication of the mercantilist policies of the exporting countries: you have to identify and build clusters, he says. "You need a new type of civil servant - one that does not worship 'enterprise' in general but understands state intervention to sustain high-value, exporting businesses." He believes very little of such expertise exists in Britain.

Actually the challenges go beyond even that. We are the oldest industrial economy in the world and have suffered the longest decline. Though we know a lot about how to industrialise countries, "re-industrialisation" has hardly been attempted in the past 200 years.

Probably the only country that has successfully done it is China, building low-tech industry from scratch in southern China, but less obviously rebuilding high-tech sectors on the ruins of the old, Mao-era factories in Manchuria. In other words, only states that can fire an entire work force, raze a whole area, jail people at will and override all kinds of local and national laws has ever tried it before.

But the prize is there: there is no shortage of examples of ailing economies bouncing back rapidly on the adoption of radical recovery policies in the 1930s. Again, before you rush out and celebrate, I will list them: Soviet Russia, Nazi Germany and Japan.

The fact is, in all the countries that are prospering during the global crisis, there are elites that have decided to ruthlessly pursue their national interest - often with the support of a middle-class electorate jealously defensive of its global privileges: the Japanese of their semi-closed market, the Chinese communists of their massive wealth, the Germans of their prudent and socially inclusive civil society.

Turning a country that's lived through a free market binge for 30 years into Stuttgart will not be easy. There is no chance of turning it into Shanghai. There is probably a right wing and a left wing version of state-driven, export-oriented rebalancing and this would be a more fruitful one to have than the one where right and left wing bloggers trade insults over "deficit denial".

But even once you've decided the strategy, and found some people to execute it, it will be hard. Everybody I've spoken to this week - from the bosses at Eden Biodesign, a huge biotech success story in Speke, to the scientists trying to commercialise Graphene at Manchester University - has one ever-present worry: that the rest of the world is capable of out competing us; that the global owners or the global clients can always go somewhere else; that maintaining global excellence is the first worry, long before you think about doubling or trebling your market share or your capacity.

The world business leaders live in is defensive; the obvious space for government is in commercial and industrial "offence" - the doing of stuff that ordinary firms cannot afford to do, nor can conceive of at an industry or sectoral level.

It's quite prosaic: it's about all the buzzwords politicians like to use - skill, tax-breaks, clusters, apprenticeships, seed-funding. But suddenly these tasks become things the state, or quasi-state, has to do, rather than attributes of an essentially market-driven, laissez faire, philosophy.

If you really want to achieve the change implied by the OBR's two pie charts (see below), the state would have to take ownership of creating the competitive conditions for an export-driven, high-skill service and manufacturing-led recovery.

The one reason for positivity amid the gloom spread by the euro crisis and the US' debt paralysis, is that - now that nearly all the big powers are engaged in a covert but perfectly obvious scramble to lump the costs of crisis onto other countries - it's become life or death for the politicians to work out how to do it.

But as the economists at CRESC remind us: when everybody else is doing it, and when it has been cross-party doctrine not to do it for 30 years, it might be quite hard to do it.

Sources of Growth 1999-2008

1= Consumption 2= Business investment 3= Housing 4= State spending (trade, not shown, is negative)

Sources of growth 2014 (OBR projection)

1= Consumption 2= Business investment 3= Housing 4= Exports (state spending, not shown, negative)

For those who might be interested I will be giving a talk in Edinburgh on Dec. 6th. There will also be what I hope will be another lively Q&A afterwards as well as a chance to meet in person and talk informally. I hope you can make it. It will be at 7.30 pm at [...]