Stephen King: In the cold, clear light of the new year, lessons of the 1970s loom

Try as I might, I cannot offer you tidings of comfort and joy on the occasion of this festive season. Instead, I humbly suggest you should be careful with your Christmas spending because, at some point in the months ahead, you will be financially vulnerable. Over-use of plastic in the run-up to Christmas may bring some seasonal cheer to friends and family, but you will be regretting your actions as 2010 progresses.

It will be an austere, rather than prosperous, new year. The credit crunch may have eased. The stock market may be higher. The housing market has bottomed out, at least for the time being. Yet, despite this more cheerful picture, the unfortunate reality is that the British Government has run out of money. Many people are doubtless hoping that Father Christmas will deliver a sackful of presents over the next few days. Enjoy it while it lasts. Next year, a more likely intruder into your home will be the Chancellor of the Exchequer. He will be cutting your pay, reducing your public services and stealing your money from under your nose. "Bah, humbug," you might say.

The budgetary situation is a very sorry state of affairs. The Government likes to blame the world economic crisis (and greedy bankers) for the position it finds itself in. Yet the reality is that Gordon Brown was taking risks with our public finances long before the credit crunch began.

Having inherited an enviable fiscal position from the Tories in the late 1990s, Labour made three fatal mistakes. The first was to ignore hundreds of years of unstable capitalist endeavour and declare that there would be "no more boom and bust". The second was to ignore the increasingly lopsided nature of UK economic growth, which had left the Government overly dependent on revenues from the financial sector. The third was to redefine constantly the economic cycle to make the numbers on public spending add up, thereby undermining the fiscal rules which, at the beginning of Labour's time in office, had seemed perfectly reasonable.

We now have a gap between revenues and expenditure which takes us all the way back to the 1970s. It is hardly an encouraging comparison. The 1970s were, after all, the decade of the three-day week, the IMF bailout, a musical journey from the superficiality of the Bay City Rollers to the anger of punk, and a political system which became increasingly unable to cope with the hard choices facing society. It was a decade during which the old Keynesian view of economic policy was rejected.

Doubtless policymakers, in their Micawberish moments, hope that something will now turn up (as, indeed, they did through much of the 1970s). On the assumption that output is well below its long-term trend and that, as a result, there will be some kind of rebound in activity and tax revenues, it's likely there will be a cyclical improvement in the public finances at some point. That, however, isn't good enough. Other countries have seen equivalent output losses, but not many have seen a similarly vicious deterioration in the budgetary arithmetic. When it comes to public spending, we have been living beyond our means for far longer than most. And, as policymakers discovered in the 1970s, cyclical rebounds are never sufficient to make the fiscal numbers add up against a background of structural decline.

We are facing a "reality gap". With the Treasury admitting that the ratio of public-sector debt to GDP will continue to climb into the foreseeable future, there is absolutely no stability on offer in the public finances. The difficult decisions have been postponed until after the general election. In the meantime, we have an economy held together with sticky tape, where policymakers have yet to grapple with the harsh realities of our creaking public finances.

Other than the timing of the election, which is unfortunate from the perspective of Britain's budgetary position, there are other reasons for choosing not to take action on the public finances yet. The most obvious is the Keynesian belief that premature tightening could throw the UK economy back into recession. Another key reason is the already low level of interest rates. Earlier periods of fiscal austerity brought benefits in the form of a lower cost of borrowing for the private sector through so-called "crowding-in". That isn't going to happen now, because interest rates are already at rock-bottom levels despite the huge increase in government borrowing. The incentive to act is therefore low, because the countervailing benefits are likely to be small.

There is also a political calculus at work. Labour may not be very popular, and some within the party believe the forthcoming election is all but lost, but those Labour MPs who know their history will be aware that austerity governments tend not to survive. Is it possible that a Tory Government, faced with having to make a series of deeply unpopular decisions on tax and public spending, could find itself booted out of office after one term, replaced by even-Newer Labour? Might the Tories then find themselves in the political wilderness for years to come? This is the nightmare prospect for Messrs Cameron and Osborne. Winning a first term won't be easy, but it might prove to be an absolute doddle compared with winning a second term.

The incentives to delay, to obfuscate and to adopt a Micawberish philosophy are, therefore, rather hypnotic. But what are the dangers of such an approach? Most obviously, holders of UK government debt might become a little anxious, fearing the possibility of downgrades by the ratings agencies which would leave gilt prices lower than before. Then there's the risk of a sterling decline, particularly if investors begin to sense that the Government's excessive borrowing is being bailed out by the Bank of England through its quantitative easing policies.

There is also, however, a deeper concern, which relates to the failure to implement sustainable economic policies. If the public know that the public finances simply don't add up, or are unsure of the political commitment to act on stabilising them, their behaviour is likely to change. Some, worried about big tax increases, will postpone big-ticket purchases. Others might think twice before taking on a bigger mortgage, fearing a squeeze on public-sector pay. Public-sector employees will be thinking carefully about how they can oppose likely cuts in public spending: and, as obfuscation continues, they will have time to hone their tactics.

All this will eat away at the fabric of the economy. Just like an individual over-burdened with debt, the Government is unwilling to face up to the realities of economic life in the years ahead. The UK economy has been living beyond its means for far too long, initially supported by rising debts in the household sector but now, it seems, ever more dependent on rising public-sector debt. The tactics have merely delayed the inevitable. The inevitable is, however, heading your way. By all means enjoy yourselves over Christmas, but prepare for some major belt-tightening in the new year.

stephen.king@hsbcib.com