Too clever for their own good?

Up they loomed on the screen. Charlie Whelan, the Treasury press supremo, smoking like a fiend, grinning like a devil. Ed Balls, the Treasury economic adviser, intelligence beaming like a laser, emotions packed away behind clear, unblinking eyes. And the rest of Gordon Brown's Treasury team.

Then the Chancellor of the Exchequer himself - a dour Clydeside union boss with a wintry smile facing, not shipbuilders, but the massed ranks of young traders in the trillions-a-day global financial markets.

Broadcast on Tuesday night on ITV, We Are The Treasury was a fly-on-the- wall look at how the new Labour Government is making economic policy, meshing the classic levers of interest rates, taxes and public spending.

The programme was most controversial when it revealed the importance the new team attaches to spin. Image after image flashed up: Brown's team on the phone to reporters, Brown's team chuffed at the way reporters were covering stories, Brown's team talking to Brown about handling the media.

Since the programme, the Treasury has dismissed the charge that it manipulates the media. "The media is obsessed with spin doctors," Treasury press chief Whelan had wailed on the TV documentary.

Privately, Brown & Co make a far more sophisticated argument. Keynes is now dead; his notion that governments can smooth the business cycle through "pump priming" and other such quaint interventions in the economy is out of date.

In the 1980s deregulated, globalised financial markets overpowered governments and wiped the floor with Keynes - or so the argument goes. Today we see a further evolution in economic history: with money flowing round the world, the nation that tells the best story to international investors gets the biggest slice of funds. The nations attracting the most international funds enjoy the greatest latitude to pursue economic policies.

"You do not manage the economy by talking about it," says Merrill Lynch UK analyst Paul Turnbull, "but, yes, sending signals is important." UBS Securities UK analyst Andrew Roberts puts it this way: "Markets are all powerful now. Markets move on the expectation of what is going to happen. It makes sense to manage those expectations."

Between May and mid-September Brown & Co did not put a foot wrong in managing market expectations. When it came to fighting other nations for international funds, the new Treasury team out-Thatchered Thatcher. Even the head of research at Nikko Securities , Simon Briscoe - a stinging and brave Treasury critic - concedes: "The Treasury's message has worked very well on overseas investors."

Within hours of occupying 11 Downing Street, Brown sprang the kind of surprise the markets love. He announced he would pursue a long-term inflation goal - subsequently set at 2.5 per cent - but that with immediate effect authority to set interest rates designed to achieve that goal would shift from the Treasury to the Bank of England.

A week later the Chancellor pleased the markets again. He published a tough Budget - although some thought it should be even tougher to take the pressure off interest rates. "This laid to rest any idea that the Blair Government was going to be a traditional Labour tax-and-spend government," says Roberts. "The markets view Brown as an unreconstructed Conservative."

As a result of these two signals to the markets, and others that followed, Britain under Blair is now seen by traders and investors as Europe's counterpart to the US under Bill Clinton.

Sending signals to the financial markets is nothing new. All governments do it. To a fair degree, it's what central bankers do for a living - which is why, in their bashful, unprepossessing way, they are more image-conscious than Hollywood stars.

Leaking as a form of sending signals is not new, either. In the 1980s, as the soaring yen scared the wits out of Japanese exporters, there were persistent rumours that the Bank of Japan's international vice-minister, Makoto Utsumi, sometimes gave information to currency consultants in Washington in hope of nudging down the yen.

What is new about Brown & Co is their recognition that spin is more than just publicity. It is an integral part of economic management. What follows from this is an unprecedented degree of discipline and ruthlessness on the part of the Brown team, which includes advisers Sue Nye and Ed Milliband, in handling information.

One veteran Treasury watcher notes: "Economic correspondents have been cut off. The Treasury deals only with political reporters. The careers of lobby reporters depend on scoops. This gives the Treasury greater leverage than they would have over economics correspondents."

Market analysts who in the past could talk to the Treasury press office are also cut off, according to Nikko's Briscoe. "On 2 May we all rang the Treasury to find out when the Chancellor would be meeting the Governor of the Bank of England. We got a recorded message telling us we would no longer have access."

Traders and investors soon cottoned on to the new approach. They identified the Treasury's favoured reporters - one at the Financial Times in particular - and began reading their stories as quasi-official policy statements. "It was very efficient," says Roberts. "The Government could speak to the markets through this conduit. The markets understood. And there were no political repercussions. Only the markets were getting the message."

Then on Friday 25 September the FT published a front page story about the Blair-Brown approach to the single European currency. This story was different from those signalling the Government's determination to be tough on interest rates, taxes and public spending. It was about an explosive political issue - one fundamentally affecting the prices of sterling, UK shares and government bonds.

The story was built on anonymous Government sources and suggested that Britain would enter the European Monetary Union during Tony Blair's first term in office - sooner than the markets were anticipating. This news was crucial, because traders and investors are making and losing large sums in the run-up to EMU by playing European currencies, shares, and bonds off against each other. It altered market thinking about the value of UK financial assets compared to those of other EU states.

On 25 September, as a result of the FT story, the markets concluded that British interest rates would now come down more quickly than they had thought. This sent gilts and shares soaring and the pound plummeting. So sharp was the market's move that it threatened to overshadow the Labour Party conference beginning that Monday.

All this focused the attention of the man in the street on a game the Government had been playing with the markets that had previously gone on unnoticed to all but an inner circle. This threatened to make Treasury spin a political issue, so over the weekend the Chancellor and the Foreign Secretary, Robin Cook, issued carefully worded rebuttals of the story, characterising it as speculation.

The FT stood by its report. In the face of this standoff the markets settled down. But the memory remains, and no one is sure how that memory will affect Government signals to the financial markets in future.

A straw poll of analysts suggests that, despite the Government's distancing statements, the market still believes the FT story was an official leak. "Ten days before the Labour party conference our political analyst canvassed his contacts to find out what was going to happen at the conference," says Roberts of UBS. "He came back and said the big rumour was that on the eve of the Labour Party conference there was going to be a leak about EMU."

A second analyst adds: "On the day before the FT story one City economist had drinks with a Labour press person. When the story came out, it went round the City like wildfire that the press person had said what was going to be in the FT, and where."

In retrospect, some City analysts see the FT story as confirmation of the new Treasury team's mastery of spin. "It was brilliant," says UBS Securities' Roberts. "The news was for the markets. The denials were for domestic political consumption."

But other City analysts see the story as a spin too far. Signalling the markets that the Blair Government would be different from previous Labour governments was straightforward. But sending signals about the single currency - while speaking in a different language to voters at home - will be far more fraught.

Brown & Co have a choice. They can get even better at spin and use the same methods as the EMU story runs. Or they can take the view that the single currency issue is inappropriate for spin, where voters and investors will best be served by an undoctored view of government thinking as it evolves.

"The basic thrust of economic policy making in recent years has been toward transparency," says Salomon Brothers UK analyst, Michael Saunders. "The FT story and the denials that followed were a move away from that transparency."

What happens next will be clear to all who look - no matter what spin Brown & Co put on the facts.

What the City says about Treasury spin

Brendan Brown, Tokyo Mitsubishi International: "Washington does it. Other countries do it. But I am disappointed with the slowness of the Government to follow through on its promise for greater freedom of information."

Colin Harte, Gartmore Investment Management: "The FT story was a kite. Now the government has to go public on its policy about EMU."

Andrew Roberts, UBS Securities: "The Brown team understand that they are not managing the old-fashioned business cycle. They are managing market expectations. Their success is all part of the success of the Blair government, part of the President Blair thing."

Michael Saunders, Salomon Brothers: "If rumours become a dominant feature in markets, then investors shy away. They feel they are not on a level playing field."

Simon Briscoe, Nikko Securities: "I think there's more spin than substance to this government's economic policy in a number of areas. I think the potency of spin as a tool of economic management is going to fade."

Paul Turnbull, Merrill Lynch: "You can say what you want. But ultimately you have to get your policies right."