Tony Blair has hit back at claims a corruption probe into a Saudi arms deal with BAE Systems was dropped after commercial and political pressure.
The Lib Dems believe the Serious Fraud Office was told to drop the case, owing to concerns that another multi-million pound Saudi deal would be lost.
Lib Dem leader Sir Menzies Campbell said it was deeply damaging to the rule of law and set a dangerous precedent.
Mr Blair has said the probe was dropped because of national security concerns.
The SFO was investigating claims that Britain's biggest defence firm BAE had paid bribes to secure an arms deal with Saudi Arabia in the 1980s. BAE has always denied the claims.
But on Thursday the attorney general said the investigation was to be stopped, because of doubts over a potential prosecution and on grounds of national security.
It came weeks after reports that the Saudis were threatening to pull out of a deal to buy 72 Eurofighter jets from BAE and deal with France instead.
The Lib Dems argue it was "effectively blackmail" by the Saudis and the SFO decision "came from the top".
Speaking at an EU summit in Brussels, Mr Blair said he had put to one side the effect on "thousands of British jobs and billions worth of pounds for British industry" - basing a decision on this would have potentially put Britain in conflict with international law.
He said his role as prime minister was to advise on what was in the best interests of the country.
"Our relationship with Saudi Arabia is vitally important for our country in terms of counter-terrorism, in terms of the broader Middle East, in terms of helping in respect of Israel and Palestine. That strategic interest comes first."
He said the probe would have led to months or years of "ill feeling between us and a key partner and ally and probably to no purpose" and he was certain the right decision had been taken.
Speaking later on the BBC's World At One programme, Lord Goldsmith said the decision had to be made on the merits of the case.
"There were some very big problems with this and my judgement was it [a prosecution] wouldn't succeed," he said.
The prime minister's spokesman also said the impact on jobs had been a "consideration", but was not the reason the probe was dropped.
But Sir Menzies Campbell told the BBC the government could not "have it both ways" and has demanded to see the attorney general's legal advice on the decision.
He said it had been a political decision, but any decision into whether a prosecution is pursued should be done "entirely independently".
"We are entitled, I think, to a much clearer exposition of how this decision was taken. It creates a very damaging precedent which Britain will come to regret."
Mr Blair also denied accusations he had tried to "bury bad news" by deliberately timing his police interview on the cash for honours allegations to coincide with the SFO announcement, and the publication of Lord Stevens' report into the death of Princess Diana.
On Thursday, Mr Blair became the first sitting prime minister to be interviewed as part of a criminal investigation - but Downing Street stressed he spoke to police as a witness and not a suspect.
On Friday he repeated Downing Street's claim that he was within his rights as Labour leader to nominate a number of working peers every year.
The rows threaten to overshadow his planned trip to the Middle East in which he hopes to make progress on the stalled Israeli-Palestinian peace process.