Flashback to the mid 1970s – the last time the British economy stared into the abyss. Iceland then made the news pages only because of cod. Even important foreign countries and markets attracted little more
attention. The behaviour of individual trade union leaders got more
play in our media than the US Presidential election.

Other important things were different in the 1970s. The British people still believed in saving. Throughout that turbulent decade, even with double-digit inflation, they never saved less than five per cent of their income. By the end, they were saving a whopping 11 per cent.

Today, the savings ratio has fallen to minus one per cent. The absence of savings is a huge threat not only to future investment and pensions
but to immediate recovery. Consumers have no spare cash to kick-start
the economy.

Financial institutions were tightly regulated in the 1970s and far more specialised. They were run not by hyperactive traders, but by stuffed shirts or amiable toffs who took three- hour lunches and long weekends.

Financial activity was far more closely connected to what the then Chancellor, Denis Healey, called "the real economy" – people making steel or shoes or building houses or setting up as plumbers or publicans. In general, financial services meant what they said – they facilitated everyday commerce.

Today, financial services have become an activity in themselves. One graphic illustration is the present volume of currency trading – 150 times greater than that needed to finance the whole of world trade in goods and services. Arising from the development of financial services as an independent activity are remuneration models which reward transactions and deal-making for their own sake, whether or not they add any long-term value.

Above all, in the 1970s financial institutions (and businesses generally) had balance sheets you could understand, with ascertainable assets and liabilities.

Today, thanks to increasingly arcane financial instruments, assets of gigantic nominal value have been turned into financial dogmeat – small nuggets of value ground up with gristle and sawdust. Consequently, there is now huge uncertainty about the value of major financial institutions throughout the world.

The 1970s were bad enough, but all of these great changes explain why the present crisis is much worse, why the recent domestic and international interventions are greater than anything ever undertaken before in peace time – and why they may not work.

Domestically, the Government's total rescue package for the banking system is worth £500bn – just under half of our GDP, and more than five times greater than spending on the NHS. Even if some is not used (or is finessed away by creative accounting), this is an unprecedented commitment of public resources.

Internationally, the co-ordinated interest rate cut (in which China, the new engine of the world economy, was a welcome partner) is the largest single expansionary move in global economic history.

But even these measures may not be enough to restore the indispensable ingredient of economic confidence. Indeed, after a brief rally the response of financial markets suggests that they have not. After years of optimistic exuberance, what Keynes called the "animal spirits" of the world economy have swung violently into desperate gloom.

Markets and policy-makers are anticipating more bank crashes and big company failures, or even entire countries following Iceland into insolvency. The new measures do not directly tackle the "dogmeat" problem – no one knows how much there is or where it is.

It is no use pouring money into the banks if they are still too frightened to lend it to each other, and if they are even more frightened to lend it to businesses and consumers out there in the "real economy".

To make the measures work, the world's governments will have to lean very hard on the bankers they have rescued. They should not waste their time on voter-pleasing gestures on executive pay. It is much more important to make those highly-paid executives do their job of lending out money where it is really needed. If they have lost the nerve to do this, they will have to be replaced. We will then have to go to full nationalisation of the banking system – as the Swedes did in the 1990s. The world's governments must also ensure that when this crisis is over we do not fall back into the bad habits which led us into it. Sadly, we cannot return our economy to Life On Mars, but there are some features worth restoring from the 1970s.

First, we need to start saving again, like our parents and grandparents. We need to clamp down on easy credit. And we must never again believe that property prices will rise for ever and ever and that we can always borrow against this to fund current spending.

Second, we need to restore the connection between the financial world and the "real economy" and end the culture of financial trading for its own sake. If that means a big shake-out of talent from the financial sector into manufacturing and everyday services, so much the better: fewer derivatives traders, more dry cleaners.

Third, we need to stop people trading in assets and liabilities they cannot value or even understand.

However, there may be one lasting benign effect of the crisis. To overcome it, we have discarded all the established rules and shibboleths about public borrowing – just as we did during the war, when we needed to. The Government has incurred immense new public borrowing overnight to bail out the banks. Perhaps it might now do the same for more popular causes.

The Government could pump new money into local authorities to build or acquire social housing and prevent home repossessions. Or into new energy sources and combating climate change. Or into renewing the human capital of our country, by education and training and (to greatest effect) by intervention in children's early years.

If we can borrow our way out of the present crisis we might, just possibly, discover how to invest in a better future.


Richard Heller is a former adviser to Denis Healey, who was Chancellor of the Exchequer from 1976-79.