Poor Alistair Darling. Only seven weeks since Gordon Brown handed him the keys to No 11, the new Chancellor is enduring perhaps the worst nightmare of any novice taking over at the Treasury: a bout of global market turmoil with the potential to spiral into a full-blown financial crisis.

Mr Darling must be reflecting ruefully on one of his predecessor’s mantras: that there were only two kinds of chancellor: “Those who fail and those who get out in time.” Even the ruthless Mr Brown must marvel at just how close he came to being ensnared in the fate now inflicted on his successor. His move next door may have come just in the nick of time - even if he will know that his fortunes remain bound up with his neighbour’s.

That will be scant comfort for Mr Darling, however, as he watches markets plunge. What, he must wonder in his darker moments, if it gets really bad?

Mr Darling will not have to flick back too far in Treasury annals to find a precedent, for Mr Brown faced just such a testing moment when he was forced to grapple with the fallout from the dot-com crash that hit most of the West at the turn of the millennium.

BACKGROUND

• Elephant slumps in wake of crunch

• Heads on the block, investors call for change

• Credit crunch forces Delek to leave property deal

• US rate cut looks certain after new data

• Bank of America to axe 3,000 after 'our errors'

BACKGROUND

• More pain for private equity industry

• Russian state bank poised to boost liquidity

• House prices‘to stay flat for years’

• Will soaring oil pump up inflation?

• US bank slump goes on

Black clouds loom on horizon

For the first time in 15 years, I am seriously worried about the outlook for the economy, the housing market and sterling

Float on the job market

Don't believe the scary headlines. It's not the worst time to consider a career in banking

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“Phew,” the new Chancellor might think. “Gordon came through that all right.” Indeed he did: Mr Brown has often boasted that Britain was alone among its leading competitors in avoiding recession. In fact, the episode could be a textbook case of policymaking, were it not that Mr Brown’s good show was as much down to luck as judgment.

Having inherited a hefty budget deficit of 3.5 per cent of GDP in 1997, his early years saw Gordon Brown take up with his famous friend Prudence and stick by tough Tory spending plans, so that by 1999 he had built up an annual surplus of 1.7 per cent of GDP. He then embarked on his big push to transform public services, with lavish spending increases averaging 4 per cent a year in real terms from 2000 onwards.

As much by accident as design, this bumper cash injection came just in time to offset the impact of the dot-com bust, boosting growth so that Britain did, indeed, avoid recession. Between 1999 and 2002, the public finances moved from a surplus of 1.7 per cent of GDP to a deficit of 2.3 per cent - a swing of a massive 4 per cent of national income. It was a classic case of what economists call “counter-cyclical” fiscal policy - leaning against winds rocking the economy.

Yet any sense of relief that Mr Darling might take from this optimistic lesson from recent hisory will evaporate swiftly as he examines his scope to follow a similar strategy. While Mr Brown had the time to build up a fiscal cushion for the tough times at the turn of the decade, his legacy to Mr Darling is one of multibillion-pound deficits. This year, the Treasury expects to be in the red by £34 billion, or 2.4 per cent of GDP.

The new Chancellor has none of the ready fiscal firepower to respond to a downturn with the sort of spending boost that saw his predecessor through or to pursue the alternative tactic of tax cuts.

The problem is that, defying advice from the International Monetary Fund, Mr Brown failed to rebuild the Treasury war chest during the economy’s boom years. Instead, as the spending pipe gushed and tax revenues fell short of hopes, he let borrowing take the strain and stay high. Now, he and his Chancellor may live to regret that choice.

The predicament is compounded by two further factors. First, despite its finances still being mired in the red, the Treasury’s forecasts are predicated on Mr Darling delivering the impending squeeze on spending that Mr Brown preprogrammed into its plans. In October, the Chancellor is due to detail which departments will bear the brunt of cuts in spending growth to about only 2 per cent year in real terms for the next three years - half the pace in the years after the dot-com bust.

Secondly, the public finances will look in still worse shape if market conditions further deteriorate. The rapid growth of the City has made it the economy’s most dynamic sector. It is thus even more important now to Treasury revenues than in 2000, with the Government raking in tax from the vast profits of institutions, the salaries and bonuses of their staff and stamp duty on share-dealing. As recently as March, the IMF sounded a warning that the Government’s finances may be being flattered by a “temporarily high” contribution from a City boom.

In the same month, the Treasury’s Budget forecasts assumed that the FTSE all-share index would reach 3,400 by the end of the year, yet London shares are presently 11 per cent below that level.

If the markets do not stabilise soon and the economy wilts, the Prime Minister and Chancellor will face a big political – as well as economic – dilemma. Ahead of an imminent general election, the pair could rely solely on a hawkish Bank of England that is still fretting over inflation risks to respond to any weakening of growth with interest-rate cuts to buoy the economy.

Alternatively, they could allow borrowing to resume its slide ever deeper into the red to pay for more generous spending, or lower taxes, to underpin growth ahead of going to the polls. Mr Brown and Mr Darling will know that the price of still more borrowing will ultimately be higher taxes but that these could wait until after the nation votes.

It is not hard to imagine which course a Prime Minister who has never won an election will want to follow – and to hell with Prudence.

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