Jeremy Warner: Britain starts to pay the price for fifteen years of boom

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Outlook: The spooky coincidence of yesterday's renewed meltdown in share prices with the 79th anniversary of the Great Crash of 1929 will do little to allay fears that we may now be heading into an economic contraction of severe and – in terms of its cost to livelihood – devastating proportions.

Technically, the UK economy is not yet in recession, for to meet the official definition requires two successive quarters of shrinkage. But the contraction announced yesterday for the third quarter was much worse than even the most bearish forecasters were predicting. Nobody believes that this marks the bottom. In the last few weeks in particular, activity has fallen off a cliff, and it now seems inevitable that economic output will continue to fall well into next year and possibly beyond.

This was the week in which both Mervyn King, Governor of the Bank of England, and Gordon Brown, the Prime Minister, admitted for the first time what everyone else has been saying for months – that Britain is facing a recession. Despite Mr Brown's often repeated claim to have abolished boom and bust, he must now reconcile himself to the fact that the economic cycle has not been bucked as promised.

Nor can he hide behind the claim that this is a global slowdown which began in America, factually true though this undoubtedly is. Regrettably, the downturn looks as if it will be worse here than in America and large parts of Europe. That this would be the case was always obvious to everyone other than the Government itself. High reliance on credit-fuelled consumption, the housing market and financial services has long made the British economy more vulnerable to a downturn that began in these sectors. What's more, the already high budget deficit makes it harder for the Government to spend its way to economic salvation.

There are two things that Britain is said to have going for it. One is its flexible labour market, which may make it easier to spread the pain of the downturn, and may also ensure that British companies survive it rather better than those in economies with more rigid fixed labour costs. The other is the floating exchange rate, which is able to adjust in a manner that makes British goods and services more competitive.

However, both these weapons are double-edged swords. Flexibility in the labour force makes it easier for companies to sack workers, which means that in the short term unemployment may grow more rapidly than otherwise. The adjustment to sterling may, moreover, turn into a fully blown rout, similar to what we are seeing with some emergingmarket economies. There were unnerving signs of that happening yesterday, with the pound experiencing its worst one-day fall against the dollar in 37 years.

A currency crisis is just what we don't need at the moment, for it makes it more difficult to cut interest rates, adds to inflation and increases the cost to the Government of borrow-ing. Once the skids are under a currency, it's hard to stop the slide. After a while, the flight of capital becomes self-fulfilling as foreign investors dash to get their money out.

This is already happening in a number of developing economies, necessitating outright rescue by the International Monetary Fund, always assuming that the Fund's managing director, Dominique Strauss-Kahn, isn't still too busy sorting out a pay-off for his lover.

How ludicrous that just as the IMF is called on to perform its duties, it should be making headlines for entirely different reasons – that its managing director has been having an affair with a subordinate. Until a month or two back, emerging markets were the one ray of hope in the gathering gloom.

Now they too are being hit by the doomsday machine of global capital markets. Shares in banks previously thought resilient to the mischief of the credit crunch because of their high exposure to still growing emerging markets – HSBC, Standard Chartered, Santander, and so on – are now bombing, along with everyone else. There's no justice in the world, for the main beneficiary of international capital's flight to safety is the greenback, the currency that gave us the credit crunch in the first place. Incircumstances where there is an outright run on the currency, as opposed to an adjustment that adds to competitiveness, Britain might even start to believe that membership of the euro has its benefits after all. Still, we are not there yet, and for the time being the floating pound is more of an advantage than a liability.

All the same, Britons need to prepare for a long, hard workout after all those years of living high on the hog. It still looks unlikely it will end in a humiliating flight to the IMF, as it did in the 1970s, but for an awful lot of people, it's going to be grim. Living standards will be impaired even for those who keep their jobs, while everyone, in the private sector at least, will have to work longer to earn a decent pension.

No more boom and bust? At the risk of sounding like a scratched record, let me again quote the late Sir John Templeton, investment guru: "'It's different this time' are the most expen-sive words in the English language".