Jeremy Warner on the economic crisis...

To act as Labour urges and abandon the cornerstone of the Coalition’s economic strategy, namely getting the public finances back under control, would be to risk another catastrophe in the banking system – and, by raising interest rates, a similarly destructive meltdown in household and corporate finances. That is no kind of alternative strategy. Writes Jeremy Warner.

With the benefit of hindsight, it is abundantly clear how the mess we are in came about. For many years now, a number of advanced economies – including Britain’s – have been living in a kind of fool’s paradise. The balance of economic and productive advantage moved decisively from West to East, yet apparently limitless credit allowed living standards to continue rising, even as competitiveness was being eroded. There’s now been a rude awakening – and the adjustment, which is responsible for most of the stresses in the world economy today, is proving long and painful. Debtors are still not properly reconciled to having to live within their means, while creditors won’t accept the inevitability of writedowns. The result is a stand-off that is causing economic activity to seize up.

Repeated bail-outs are as repugnant to the eurozone’s surplus nations – such as Slovakia or Germany – as externally imposed austerity is to its debtors. The Slovak government has already fallen; on the other side of the fence, endless rounds of austerity look as if they might bring the Italian government down as well. In attempting to make the euro work, politicians are riding roughshod over their own electorates. It is as unsustainable as it is insulting to the principle of democracy.

With public sector demand shrinking almost everywhere, governments need the private sector to step up to the plate and provide the jobs and growth they can no longer deliver. For that to happen, a strong financial sector is required, one ready and willing to meet the economy’s credit needs. Yet instead, the reverse is happening. Ever more stringent capital and liquidity requirements, designed to make banks safer, are causing further balance sheet contraction and adding to the atmosphere of extreme risk aversion. As long as banks and businesses remain stuck in this mindset, there will be no sustainable return to growth.