It is only a matter of time

When the UK finally slips into a government borrowing crisis, what is the likelihood that we will be told that it was totally unforeseeable? "We never realized that government bond yields could increase to 10 percent overnight".

July's public finance numbers were truly awful. In a normal July, the government runs a surplus. The reason for this seasonality is straightforward. The corporate sector often pays its taxes on a three monthly basis, and July is a big tax month.

However, this July the government ran up a deficit of ₤5 billion. So far this year, the deficit is running at ₤43 billion. This number will soon start to rocket. Typically the government receives most of its revenues in the between January to April as the tax year ends. The last six months of the year, the government always runs a deficit.

The writing is now on the wall for government finances. The UK deficit is unsustainably large. The clock is ticking. Something big is going to happen within the next 12-18 months.

We are now looking at three scenarios. Under the first scenario, the government stops spending, raises taxes and reduces the deficit through an emergency budget. Under the current government this is extremely unlikely, but I still hold out hope that Cameron and Osbourne will do the patriotic thing when they are elected next summer.

In scenario two, the private sector call time on the deficit and refuse to lend more money. Interest rates on government debt will rise and the government will get the message and revert to option one. Be warned. This could happen quickly and may be linked to a sterling crisis.

In scenario three, the Bank of England continues to buy government debt with newly printed cash. The private sector gently exits from the UK bond market as King and the MPC monetize the deficit. This is basically the Zimbabwean economic model. It is likely to have the same devastating effects on growth and living standards here in the UK if the Bank of England and the government persist with quantitative easing.

However, there are precious few signs that the monkeys running monetary and fiscal policy are thinking beyond a nine month horizon. The UK economy is now drifting into some very dangerous territory, and when we do nosedive into a crisis, be ready for the "I didn't see it coming" excuses.