ECONOMICS AGENDA BY LIAM HALLIGAN

The debate on UK public spending is now moving fast. But not nearly fast enough.

David Cameron warns we face "an age of austerity" and that an incoming Tory government would implement "what could be one of the most painful round of cuts since Sir Geoffrey Howe's Budget in 1981".

By harking back to the "tough choices" of the Thatcher years, Cameron is starting to sound like a leader. But he's not yet even close to showing he understands the scale of the problem we face. Unless he corrects that fast, and his words reflect reality, Cameron's caution, his political cowardice, will make this country's predicament so much worse.

The UK will soon have a budget deficit of 15pc of GDP. The government will be selling gilts equivalent to 20pc of our national income - for at least 3 successive years. To say this is the worst fiscal crisis in this country's peace-time history is to understate the problem. We're now in banana republic territory.

For many years, this column has warned about Brown's excessive borrowing and the billions of off-balance-sheet liabilities.  The importance to our tax base of financial services and housing meant the bursting of the credit bubble was bound to hammer government revenues. Combine that with the retirement of millions of baby-boomers and 2010-14 was always going to be difficult. Yet until quite recently, Cameron's Tories were pledging to "match Labour's spending plans". Rather than showing they understood the need to tame the state, the Cameroons tried to have it both ways by "sharing the proceeds of growth".  It's because the current Tory leadership spouted such vapid nonsense on the public finances for so long that Cameron now needs to demonstrate he "gets it".  Repeat after me, David: "the Tories WILL implement a painful round of cuts GOING WAY BEYOND Sir Geoffrey Howe's Budget in 1981".

If Cameron doesn't say this, or something similar, the UK will soon lose its Triple-A credit rating. Big institutions will then be forced to dump UK gilts - leading to a disastrous spike in yields.  Interest rates right across the economy will balloon, whatever the Bank of England does.

For international debt markets, the name of the game is supply - how many gilts will be issued, and when. So if the Tories don't show how they'll issue fewer gilts, the government will have to pay much more for credit, leading to even deeper spending cuts.

Unless Cameron starts building the political consensus now, getting the country squarely behind the need to spend less, the markets simply won't believe he'll actually will cut spending when he gets into office - given the distinct lack of backbone he's shown in his comments on the public finances to date.

The political classes will say I'm bonkers. They said I was "bonkers" several months ago when I went on the BBC's Today programme to warn the UK could face a gilts strike. Yet the markets are now warning the game could be up. "Treasury projections are definitely a cause for concern", says Arnaud Mares of Moody's ratings agency. "The government faces the high probability of a serious buyers' strike," says Don Smith, Chief Economist at ICAP, one of the world's leading brokerages. The stark truth is that the UK's ability to rollover its debts is in grave danger.

For now, lenders judge that UK deflation is around the corner - making non-indexed gilts (the vast majority of those issued) seem a better bet. But fears are growing that "quantitative easing" - printing money - will soon push inflation up. When that happens, gilts will look much less attractive. As sterling keeps falling, that's also weakening the demand for UK government debt.

Cameron's advisors tell him to say nothing, and he'll soon be Prime Minister. Voters don't want to hear about cuts. That shows just how out of touch the political classes are. The country knows full well we've long lived beyond our means. The public is screaming for someone to take control.

Last week, David Davis, the former Tory Leadership candidate, wrote a newspaper article calling for "the debate to start on how to cut public spending". He mentioned some "unmentionables" - including Trident, public sector pensions and the renegotiation of PFI contracts. This was a valuable contribution - and Cameron reacted by toughening his rhetoric a smidgeon, before his spin-doctors reassured the interest groups involved by reining the language back in.

Politics is tough. During the coming few years, our fiscal meltdown will make it tougher than under Thatcher, tougher than the IMF debacle of the mid-1970s. Cameron has the chutzpah to be Prime Minister but has he got the stomach to lead? That's what the public wants to know - and what the all-important debt markets are waiting to find out.

CHINA REGAINING MOMENTUM

While the UK and US are on their knees, a slew of new data suggests China isn't doing badly.

In April, China's purchasing managers' index hit 53.5, its second month above the crucial 50-level and fifth successive monthly rise. Loan growth is running at 25pc annually - with banks extending $280bn of new credit in March. What a contrast with the Eurozone, where credit is still shrinking.

Chinese car sales spiked 30pc last month and house prices were up 9pc. More homes were sold in Shanghai than in any month since late 2007. From mid-2009, China's economy will regain its rapid momentum, says the World Bank. Annual growth will "slow" to 6.8pc, but China remains the "bright spot in the global economy".

No wonder Shanghai is the world's top-performing stock market - up 30pc since the start of the year, with the main Western share indices down 5-10pc. China seems determined to capitalise on this stellar performance.

Last week, China Mobile bought 12pc of Far EasTone - the first Taiwanese investment by a state-owned Chinese company in six years. Signs that foreign firms can soon list on Shanghai's stock exchange also show the Peoples' Republic is opening-up to the outside world. China is far less "levered" than its Western counterparts. Total household, corporate and state debts amount to 120pc of GDP - less than half the debt-burden of the big Western economies.

Just like India, Russia and the other "emerging giants", China will prosper during this era of "deleveraging" because its people, firms and government can channel resources into growth, rather than debt-service. Consider Beijing's $585bn stimulus package announced last November.

Financed with no extra borrowing, it can be easily expanded if the economy lurches. Compare that with the ill-conceived, debt-addled "bail-out" packages contrived in Western capitals. America still accounts for 20pc of global imports, while China and India combined take only 12pc.

So the US still makes the world economic weather. But consider that China imported a 51 tonnes of iron ore in March - a record high. The country's huge energy demand is also rising fast - as the blast furnaces are switched back on and the building-boom re-ignited. So as Chinese growth cranks back up, the Western world won't only face the trauma of watching its economic hegemony slip further. It will also have to deal with rising oil prices, as the Eastern economies surge.

Liam Halligan is Chief Economist at Prosperity Capital Management