So what will happen to the economy during the next couple of years? If the recession is shallow and short, then we might just about scramble through. But if not, then we will be in a huge mess, having to tighten policy while we're still in recession.
Most of us are still reeling from those dreadful borrowing figures revealed by the Chancellor in his pre-Budget report last week. I had been among the most gloomy in my calculations, but these numbers were even worse than I had expected, and that was before the additional borrowing he announced.
But digging into the figures, what worries me almost as much as the actual borrowing projection is the premise on which it is based.
According to the new Treasury forecast, the recession that began in the middle of this year will continue until the middle of next year. Then the recovery will begin, which would imply a shorter and shallower recession than in the early 1990s. This remains possible. Indeed, until a week or two ago, I thought the balance of probability was still that this recession would be less serious than then. But in the past few days, there has been mounting evidence that this one may be as bad. If so, then the Treasury's borrowing forecasts will also be wrong.
But first let's accept the official figures at face value. The independent Institute for Fiscal Studies (IFS) does an excellent analysis. The message is very simple: net debt will rise to the highest level for 40 years. The mesage is reinforced with: the deficit as a percentage of GDP will be the highest since 1946-47 when we had just started to recover from the Second World War.
I find that shocking. Indeed, I find it outrageous. On the Government's own figures, this is not likely to be a particularly serious recession, and less serious than those of the 1970s, 1980s or 1990s.
Yet it has managed our national finances so badly that the country's fiscal position is the worst it has been for a generation. And this without an apology. At least the chiefs at Royal Bank of Scotland eventually said sorry.
The saddest thing of all is that this is just what the Government sought to avoid with Gordon Brown's fiscal rules. Labour has made exactly the same error as the Tories, though on a slightly larger scale. If you compare Labour's record with that of the Tories, the structural deficit – ie, the deficit allowing for the economic cycle – and there is a remarkable similarity between the two. Both Geoffrey Howe and Gordon Brown started out as Chancellors by being restrictive, maybe too restrictive. Then policy became too expansionary and finally both governments went mad, with the main difference being that Labour has lost the plot a little earlier than the Tories did. The Tories, however, got another term in which they had to correct their own mistakes.
So on the Treasury's own numbers, things are pretty bad. Suppose, however, that the recovery is delayed until 2010, or that the recovery is a very slow and uncertain one, rather than the quick bounce that the forecasts imply. What then?
The answer is: spending cuts. The IFS notes that there will have to be reductions in the planned growth for current spending, but it adds there will have to be real cuts in planned capital spending. There is no precise limit to the deficit that the government of a Western democracy can run. Going back to 1946-47, I would have thought we are pretty much there on those projections. If you cannot borrow more and you cannot raise more in tax, you have to cut what you spend. The only issue is how savage this process will turn out to be.
And what can we say about the probable shape of the cycle? My own best guess is that a slow recovery will start some time in 2010, some six months to a year later than the Treasury expects. That would be the pattern of the 1990s cycle.
In the past few days, a number of new bits of data have pointed to continued contraction for some time to come. The first is that US house prices have started to fall even faster than before. There will eventually be a bottom – there always is – but until then it will be hard to put any valuation on all the mortgage-backed securities. The financial crisis has rolled on far beyond the US sub-prime market, but I suspect that just as US housing was where the trouble started, it will be where it ends. Once house prices hit bottom, that will be a signal for the other markets to turn around. There will then be a lag of perhaps a year before the economy responds.
The second point is what is happening in Europe. Goldman Sachs has now revised its forecast for eurozone growth for next year down to minus 1.3 per cent. As this is our biggest export market, that's bad news for us too. Goldman does not expect Europe to be back to its trend growth rate until "well into 2010 at the earliest".
The third is the growing evidence that the Chinese slowdown is very sharp. Its government has loosened credit and brought in a fiscal stimulus that makes our own seem very modest, but there is no doubt the economy is slowing much more sharply than the authorities expected.
But the thing I find most troubling is the evidence here in the UK (but actually pretty much everywhere) that businesses are trying to pay suppliers later. There has been a lot of attention given to the financing problems of companies – big ones that cannot refinance debts becoming due next year, and small ones that have their overdraft limits cut. And there has been a certain amount given to the difficulties faced by smaller companies in getting paid – being forced to wait three months for their money and so on. But less attention has been paid to the development that some suppliers now don't trust their customers and won't ship goods until they are paid. I don't know how widespread this is now, but supplier credit is the very core of commerce. If trust in it goes, that's bad news indeed.
Then there is the issue of trust in government itself, in particular our Government. After that speech last week, the UK found that the cost of insuring against a British government default had shot up. Meanwhile, I found myself chatting to a friend, a former top international banker. We talked about what assets were completely safe and he confessed that for the first time in his life he had bought gold; he was slightly sheepish about it.
"What about UK government index-linked securities?" I asked.
"Do you think they will honour them?" he replied.
If only Gordon Brown had been less arrogant and abided by his own rules, we would not have got ourselves into this mess.
Keynes and the bons mots they wouldn't want to quote
There has been a great revival of interest in John Maynard Keynes in the past few days. Thus the Governor of the Bank of England used his quote: "When the facts change, I change my mind; what do you do, sir?" And more substantively, the whole borrowing package was justified on the grounds of Keynes' ideas, though I suspect he would be aghast if he realised what was being done in his name.
In his life, however, Keynes was also famous for something else: his investment acumen. Not only did he successfully manage the finances of his college in Cambridge, King's, but he also built up a personal fortune almost entirely from investment. After his death in 1946, his estate was valued at £480,000 – equivalent to about £20m in today's money. This causes astonishment, for he had not inherited any great wealth and although he had some directorships, he had spent most of the previous six years working unpaid for the government. So how did he do it?
The tale of how he made his fortune, after some disastrous early mistakes, is told in a book, Keynes and the Market, by Justyn Walsh, published by Wiley this month. This is not a quick-fix, how-to-do-it book, but rather a series of snap-shots of different aspects of his approach, which the author notes have been subsequently adopted by other noted investors, notably Warren Buffett. It was basically a mix of value investing and spotting when prices were clearly out of line with normal valuations. You have to believe, as Keynes did, that markets can make huge mistakes of mis-pricing. He also believed in income rather than capital valuations.
Applying that to current markets, you would, I suppose, note that there are very high dividend yields available at the moment, the highest for a generation. So maybe another aspect of "Keynesianism" is as relevant as the King quote. Quite what our political masters would say about a second of his aphorisms is another matter. It was: "The avoidance of taxes is the only intellectual pursuit that still carries any reward."