Plenty of pain - but in the end we may gain

Except that you hardly need to be a meteorologist to know that the barometer doesn't go on falling. It can plunge to hurricane levels and wreak terrible damage but it passes; painfully slowly, and however unlikely it seems while the wind is tearing the roof off, normal conditions eventually return.

The nationalisation of most of the British banking system shows how far we have to go. Royal Bank of Scotland alone is raising £20 billion, including preference shares which will pay 12 per cent. At £37 billion, the rescue cost of the four banks is far bigger than the biggest of Labour's post-war nationalisation programmes, covering coal, steel, and the railways. But however shocking the sight of our money disappearing into the balance sheets of such arrogant, self-satisfied institutions, there's no point complaining now. When the house is burning, you have to put the fire out first.

Several times recently, it has looked as if the world's central banks and finance ministries had done enough to smother the flames, and each time they've burst into life afresh, with paralysed credit markets and plunging stock prices. Now it looks as though the authorities have finally got the message.

This is not only a matter of banks running out of cash to meet their commitments (a liquidity crisis) but also one where lenders fear that the borrowing banks don't have enough assets to cover their liabilities (a solvency crisis). All the old rules have been consumed in the blaze and the new ones require the twin fire hoses of unlimited liquidity and sufficient permanent capital to allow the markets to start functioning again.

Even the fabulous sums now being pledged by governments across the world may not be enough finally to quench the flames; the International Monetary Fund is muttering about a further 20 per cent plunge in share prices, and in the current state of panic their doomsters may turn out to be right. Investors have been selling shares for whatever they will fetch, and if they had invested in bank shares, they are fetching a tiny fraction of what they cost to buy.

All bank shareholders, especially those in RBS, face the choice between throwing good money after bad or of seeing their holdings diluted by the Government's capital injection. The departure of chief executive Sir Fred Goodwin is scant comfort. After what he's done, many of them would prefer to see his head paraded around St Andrew's Square on a pike.

These extraordinary times provide some extraordinary opportunities, as well as the prospect of widespread misery. People will cut back and start saving or rather, they will start to make inroads into the debt mountains that so many have accumulated.

The correct policy response from the Government is so strange that Gordon Brown will be rubbing his good eye in disbelief. To cut back public spending now would risk turning the inevitable recession into a full-blown depression. To balance the new imperative for private-sector saving, the Government is going to have to spend more. Its golden rule on borrowing is no more operative than RBS's dividend policy. Suddenly, from being boxed in by forecasts of a burgeoning public-sector deficit, it seems the Government can run an even bigger one without scaring off the buyers of its debt.

In the depression of the Thirties, John Maynard Keynes advocated employing gangs of men to dig holes, followed by other gangs to fill them in again. He was exaggerating to make a point but the new world offers the prospect of government being able to afford worthwhile projects such as Crossrail, vanity ones such as aircraft carriers and downright daft ones such as ID cards.

It might even contemplate tax cuts. The money to pay for all this should be borrowed, and can be raised cheaply, because interest rates are coming down. It will be a long time before nervous savers prefer the prospect of returns from shares to the safety of government bonds, because the return may be low, but it's guaranteed. The spectre of inflation, that fraud on the British saver for the past half-century, is unlikely to appear soon. The commodity prices that have pushed it up are in full retreat, while (outside the public sector at least) people are grateful to have a job. They are in no mood to strike to maintain their real take-home pay.

The biggest risk now is to the currency. Britain has been bridging its chronic trade gap with earnings from the City, augmented by sales of assets and IOUs to oil producers and Far Eastern nations. Should these holders decide that sterling is too high, then even the 10 per cent fall we've seen over the past year would seem modest. But fall against what? Unlike shares, which can all collapse together all around the world, foreign exchange is a zero sum game.

To sell the pound, you have to buy something else, and for really big holders, the choice is effectively between the dollar, the yen and the euro. All three currencies have their own warts and carbuncles in the eyes of the money managers. Sterling is hardly the prettiest girl in the class but she's unlikely to have the holders fleeing in fright. Besides, if the pound did collapse, we would be unable to buy the goods that the Chinese make for us. In short, an orderly market is in everyone's best interest.

There is a lot more pain to come in the great unwind. Borrowers who thought debt was a badge of machismo will have to learn how to go about repaying it. Bankers will have to re-learn about knowing their customers, and to act more like providers of useful services rather than spivs with their eyes on the main chance. One day, when the financial weather has improved and the glass is rising, we may even conclude that we've gained something from the typhoon. One day