Someone else's problem

It's early days, but Darling's midweek budget is starting to look like a disaster for New Labour.

Although a majority seems happy with the idea of taxing the rich, most people see through New Labour's cynicism. Their sudden discovery of income inequality comes too late to save them.

If the tax hike was meant to be a trap for the Conservatives, Cameron and Osborne have inconveniently stepped aside. They know that the next election is in the bag. New Labour have comprehensively wrecked the UK economy and therefore a undemanding strategy of saying little and waiting should be sufficient to see a Conservative government safely established by June next year.

As an electoral tactic, the budget has failed. However, as Brown contemptuously focused on trying to embarrass the Conservatives, he neglected the core issue that now confronts the UK. Simply put, the question is fiscal sustainability. Brown and Darling are planning for two straight years of deficits in excess of 12 percent of GDP? Can they get away with it?

It all depends on what we mean by "get away with it". Many newspapers today, most notably the Wall Street Journal and the Telegraph, openly questioned whether the UK government can sell the huge quantities of debt required to finance the Darling’s deficits.

There is a strong implication that the UK could be heading for a sudden disaster. Investors may go on strike and refuse to buy government paper. It has happened before, most notably in the 1970s, when an earlier Labour government tried to run up large deficits, which were ironically, significantly smaller than the ones that Brown and Darling are proposing today.

It is of course always exciting to contemplate catastrophe. Moreover, economists and journalists are particularly prone to apocalyptic visions. Personally, I shouldn't be too critical here. I, too, have been known to dabble with colourful language to describe the future.

A more serious and probable risk comes from interest rates. Investors, at least in the short run, will be willing to buy government debt so long as they are adequately compensated. This means if the yield is high enough, the investors will come.

Government debt yields do not live in isolation from other interest rates in the economy. If the government has to pay more on its new debt, this will pull up rates on corporate bonds, mortgages and even personal borrowing.

As a tsunami of government debt hits UK capital markets, the high yields required to finance the government's huge deficits will squeeze out public sector investment and consumption. This is known as crowding out. It was something very familiar to Brown's predecessors - Callaghan and Wilson.

None of this will matter to Brown. By the time government yields start to rise, and bring down the private sector, he will be blissfully drawing his pension and waiting for his knighthood. It will be some else's problem.