If Dave doesn’t win, it’s open season

If Cameron delivers only a small win, many Tories will consider him exposed as a charlatan.

Long-Term Capital Management (LTCM) had mythic status as a bond trader in the 1990s. It had a supposedly unbeatable formula for calculating risk - an algorithm based on past market performance. But on 17 August 1998, Russia unexpectedly defaulted on its sovereign debt. LTCM lost $4.6bn and folded shortly thereafter. The fund chiefs had committed an elementary error. The data they fed into their formula went back only a few years, a period that happened to cover stable, rising markets. They had mistaken what was recent for what was normal.

What does this parable of hedge-fund hubris have to do with British politics? For one thing, it is worth keeping in mind whenever market opinion is cited in connection with the election. Traders do not have supernatural powers of perception. They have short memories and are terrible at measuring political risk.

Yet this campaign, more than any before, will be conducted in deference to financial indices. That is because the next parliament will have to oversee a process of fiscal tightening - tax rises and spending cuts. As politicians aren't always in a hurry to inflict that sort of pain, there is an incentive for everyone to see markets as the force majeure, demanding austerity as the price of servicing British debt.

First cut is the deepest

The Tories have a particular need to talk up the exigences of the market. They want to cut deeper and earlier than Labour - but that approach isn't selling well on the doorstep. People hear "cuts" and imagine nurses being herded to the guillotine. So if people aren't seduced by austerity, they have to be scared by bankruptcy. The market gods are displeased, the tribal Tory drums will beat; they demand blood sacrifice. George Osborne recently claimed that if Gordon Brown were re-elected, international investors would be "heading for the exits".

That is questionable. It is, however, clear that investors would prefer a decisive victory for one side or the other. "In the event of a hung parliament," a note from the Japanese financial services group Nomura said this week, "we believe that the inevitable uncertainty over the shape and sustainability of the next government would be such that markets would see it as a negative." In other words, sell Cleggs. Markets see a hung parliament as something negative because on paper it sounds like a situation in which the country has no government. Besides, the last time an election produced one was February 1974, when most of the people now passing judgement on the viability of UK gilts weren't even trading football stickers in the playground.

But you don't need a hung parliament to have legislative deadlock. In 1992, John Major was elected with a majority of 21. Rebellions, defections and by-elections left him barely able to govern. By coincidence, the forces that produced both of the last two bouts of administrative paralysis in British politics - industrial action in the 1970s and swivel-eyed Europhobia in the 1990s - are poised for a comeback.

The raw political aggression that has recently been on display over British Airways's dispute with the Unite union is not just electioneering; it is a harbinger. BA is unusual in the private sector for the power wielded by its unionised workforce. Most companies have been free to inflict whatever cost-cutting measures the recession has demanded without fear of their workers walking out. Most public-sector bodies, however, haven't even started that process. After the election, they will have to start implementing pay freezes, taking away pension privileges and sacking people.

The Tories could win with a workable majority and find that, while the Commons offers no obstacle to a deficit-reduction plan, thousands of striking public-sector workers marching on Parliament Square are less compliant.

I doubt David Cameron is anxious about crossing a picket line. But around the time that the Tory leader is getting into a fight with the unions, his Euro-woes will start kicking in. In opposition, Cameron's EU policy has been simple. He opposed the Lisbon Treaty until it came into force, then he sullenly accepted it as a fait accompli and promised to negotiate some symbolic "repatriation" of power from Brussels. It won't happen. Most other European governments see the ratification of the Lisbon Treaty as a blessed relief, clearing the way for serious continental business. Tory ministers will soon find themselves having conversations with their EU counterparts - about tax and financial regulation, for example - that their MPs will deem borderline treasonous.

It is possible that Tory backbenchers will be as meek as novice monks and not rebel. But Cameron's leadership style has made that unlikely. The whole "modernisation" project is really a putsch by a small junta: Dave, George and a handful of their closest friends and advisers. They have not given the rest of the party much love. "They just don't make an effort to talk to many people, regardless of their political stripe," says one disgruntled adviser. "Even the shadow cabinet feels left out."

Backbench stabbing

On top of that, Cameron himself has acquired a reputation for aloofness that verges on being plain rude. Chatter about how he doesn't smile at his MPs in the lift, and other such injuries, wouldn't matter if the Tories were cruising to a comfortable win, but they aren't. A victory with a slim majority holds a double danger for Cameron. The backbenchers he has snubbed will have numerical leverage over him. But they will also assume a reactionary moral high ground. There are many Tories who have temporarily suspended their mistrust of Cameron in the hope that he will deliver a big win. If he delivers only a small one, they will consider him exposed as a charlatan.

It is true that a hung parliament might be unstable. But not much less stable than a parliament with a small Tory majority. There has been much discussion in recent weeks of the "kingmaker" role that Nick Clegg could assume if no party has an overall majority, but there hasn't yet been much attention paid to the "king-wrecker" role that backbench Tory MPs could play. Their relative obedience in the past few years has been motivated by anticipation of an election victory. It is no guide to what will happen afterwards. Remember LTCM. It is a mistake in politics, as it is in markets, to take what is recent as a guide to what is normal.