Apparently the bond vigilantes are saddling up – on their ride to oblivion

When I was in London recently, I was repeatedly assailed with the idea that the Liz Truss debacle proves that the financial markets in Britain are more powerful than the government and can force the latter to comply with lower spending and lower taxes. It seems the progressives have a new historical marker which they can use to walk the plank into conservative, sound finance mediocrity. For decades it was the alleged ‘IMF bailout of the Callaghan government in 1976’ when Chancellor Dennis Healey lied to the British people about running out of money and needing IMF loans to stay afloat. They, of course, never needed any loans but Healey and Callaghan knew the people wouldn’t know that and they used the fiction as a vehicle to keep the trade unions in a subjugated position. That lie has resonated for years and has been a principle vehicle for those advocating smaller government, more privatisation, and more handouts to the top-end-of-town while at the same time cutting welfare payments to the poor, killing the national health system, degrading public utilities, transport and education and all the rest of it. Well now that gang, which now rules the Labour Party in Britain has a new fiction – the ‘Truss surrender to the markets’. And the logic is spreading elsewhere with lurid claims emerging that the so-called bond vigilantes are saddling up to force the US government broke.

The Liz Truss debacle – and it was a debacle – told us nothing about the relative capacities of the financial markets and the consolidated government sector (treasury and central bank).

Nor did it tell us that governments have financial limits on spending beyond which the financial markets will destroy a currency.

If you thought that it did then I think your evaluation of the situation is defective.

And then you would have to explain why the years of speculative attempts by financial markets to force the Japanese government including the Bank of Japan to change policies to reward the speculative bets against the yen and the bond market are not successful.

I have argued before that when the ‘markets’ assess that the government is weak – for whatever reason – and will fold under pressure to the financial bets, then they will be able to force the issue in their favour.

In the early 1990s, it was clear that Britain’s membership of the European exchange rate mechanism – the fixed exchange rate system that the Europeans roped John Major into joining was untenable.

The economic circumstances made it impossible for Britain to pursue suitable domestic policies while still maintaining the agreed exchange parities under the ERM.

From the day they joined in October 1990, the sterling was under pressure from currency speculators who knew that the external deficits were continually pushing the sterling down and that the Bank of England could not push interest rates up sufficiently or maintain foreign currency reserves at levels necessary to defend the parity.

And in trying to stay in the system, the British government was forced to adopt policies that guaranteed a deep recession and that was highly damaging to the political popularity of the Major government.

In entering the ERM, British ‘pride’ was on show and the initial sterling parity was overvalued in relation to the structure of the economy.

Britain has never got over the fact that their colonial empire has gone.

It was also clear that the speculators knew that the pound was overvalued and that the trade situation was such that it was highly probable that the pound would struggle to stay within the lower band of the parity agreement.

So they could make profits by selling the pound short.

It was only a matter of time.

On Spetember 16, 1992, the so-called – Black Wednesday – the folly of the Major government’s decision to join the ERM in the first place came to fruition and the speculators won.

Their victory was made more so by the desperate actions of the government and the Bank of England to remain in the ERM despite the facts they were facing that it would be impossible to do so.

Major approved the massive sale of foreign currency reserves to buy up sterling to avoid a devaluation – which they claimed would be inflationary but was also about British pride.

The boss of the Bundesbank fuelled the fire by stating publicly that the pound was overvalued and would need “a more comprehensive realignment”.

By the evening of the 16th, Britain was forced out of the ERM after a day of turmoil which saw the interest rate skyrocket and the currency being sold off in large volumes.

Did this event tell us anything about the sovereignty of the British government?

Yes, but not in the way most people have concluded.

It didn’t say that the financial markets have all the power and can destroy a currency if they want.

What it told us was that if the government enters unworkable fixed exchange rate arrangements with other countries that have very different trading strengths, then speculators will be able to force the government into submission.

There wouldn’t have been the 1992 sterling crisis if Major hadn’t bulldozed the nation into the ERM which was unworkable from the start.

I discuss this in great detail in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015).

Fast track to Truss.

Her command on power was tenuous to say the least.

She was a sort of accidental Prime Minister overseeing a party that was in chaos and the knives were drawn for her from the start.

It was obvious that she was way out of her depth and her first Chancellor Kwasi Kwarteng was no better.

It was like a fool’s gallery in Britain.

Given the instability within the Tory Party and her obvious lack of resolve, it was obvious that the speculators would test her nerve.

They did and she folded.

Had she been more astute and more confident of her position as PM, her government could have stared down the short-seller in the financial markets and forced losses on to them.

That was the lesson.

Her fiscal plans might have been ridiculous – or not – but that is beside the point.

Speculators will test any situation where they sense there is a lack of political resolve.

That is why they lose when they try to bet against the Japanese government.

Yes, the pound may have depreciated more than it did if Truss had held her ground.

But the yen has also depreciated and is now providing a massive boost.

Japanese exports rose significantly (11.9 per cent) in January and have been improving for some time.

Tourism (into Japan) also booming as a result of the lower yen.

Now, I would not want readers to think I support an exports-led growth strategy significantly weighted to creating a tourist economy.

Living in Kyoto part of the year has taught me that such a strategy is destructive of local amenity and needs to be contained.

But in terms of mainstream logic, the depreciation that would follow (and be finite) a showdown with the financial markets is nothing to be worried about.

Fast track to this week and the financial media is already giving platforms to the ‘bond vigilante’ narrative.

The Financial Times article (February 26, 2024) – Spiralling US public debt risks action from bond vigilantes – falsely marketed as “Markets Insight”, which would imply that there was knowledge being imparted, claims that:

Bond vigilantism is resurgent in the market for sovereign debt. That emerged with remorseless clarity from the brutal sell-off of UK gilts that toppled hapless British prime minister Liz Truss. Could the fiscal disciplinarians of the global investment community now turn their disruptive talents to the US Treasury market?

All manner of pestilence is then predicted – including devastation of the “US’s role as the world’s chief provider of safe assets during global crises”.

A counter is presented based on a series of features of the US bond market – such as being “the world’s biggest, most liquid market” – which really miss the point.

But then the key to why the bond markets will allegedly turn on the US government is presented and it has nothing to do with the Trump-Biden calamity or whatever:

Rather, it is a spiralling public debt now exceeding 97 per cent of gross domestic product, a level not seen since the second world war.

And allegedly, what makes matters worse is that in relation to the US Treasury debt “nearly a quarter is in foreign hands”.

And rising public deficits.

And the Milky Way, I suppose!!

The author concludes that Treasury debt is now “potentially unsafe”.

What could that mean?

Credit risk? It is unimaginable that the US government would ever reneg on its contractual obligations to pay the principle on the bond instrument upon maturity.

Credit risk refers to the fact that a debtor may run out of funds to repay their obligations.

That can never happen to the US government.

There is no credit risk pertaining to US Treasury bonds.

So what else could it mean?

Exchange rate risk?

Possibly. If the US dollar was to depreciate significantly then at the time of conversion of the bonds upon maturity into foreign currency the value would lower than before.

But imagine that the foreign holders of the debt get skittish (after reading this FT article) and flog off the debt in large volumes and try to convert then they would be ensuring that the conversion was lower than before.

Not a likely scenario.

What else could it mean?

Well the author then quotes a few mainstream economists (including Mr Spreadsheet Error Rogoff) who claim that:

… the demand for safe dollar debt risks overwhelming the US government’s capacity to back it when the tax base is diminishing. In which case we are in similar territory to the collapse of the Bretton Woods exchange rate regime in the early 1970s, which unleashed two decades of high inflation and enduring financial instability.


The US dollar floats.

The situation today is nothing like what happened in the early 1970s, when foreign holders of US dollar reserves demanded convertibility of their holdings into gold.

No such convertibility exists now.

And the US government does not need its tax base to honour any debt obligations denominated in US dollars that it might have.

It is true that while it has all the dollars its needs to honour any debt obligations, large scale spending in excess of the tax revenue it receives may not be appropriate in all circumstances – specifically, if all the productive resources for sale in US dollars are in full use.

But that is a separate problem and has no bearing on whether ‘bond vigilantes’ can destroy a currency or not.

The conclusion of the article is that:

It is thus safe to predict that the relative fiscal probity of sovereign borrowers will become a more pressing concern of official reserve managers.

First, what is fiscal probity?

Probity comes from the Latin term probus, which means according to the Oxford dictionary “the quality of having strong moral principles; honesty and decency.”

We all want our governments to abide by that benchmark.

But for the author, this is a term that is bandied around to imply fiscal deficits are bad.

They never really pin down what the level is beyond which badness manifests or when badness becomes too bad.

For them, it is enough to put out the scare and leave it to the politicians to fall for the pressure – and in doing so, reward the financial markets that have been placing bets against the public assets or the currency.


No such chaos is likely in the US bond markets because smart people know that the US government has the relative financial capacity against the financial markets.

Ultimately, the Federal Reserve Bank can ensure yields are stable and low if it wants to.

Just like the Bank of Japan demonstrates every day.

That is enough for today!

(c) Copyright 2024 William Mitchell. All Rights Reserved.

This Post Has 12 Comments

  1. ‘Britain has never got over the fact that their colonial empire has gone.’ Maybe that really does explain the perverse neediness to maintain/fix the value of the pound (and also ties into the neediness for cheap foreign holidays to places where Brits can feel wealthy for a fortnight). Perverse because the economy/society improves every time the pound loses international value, without ever going into the inflationary death spiral which is the adult economic equivalent of children’s scare stories.

  2. Mediocrity is the correct word for describing what is going on in the so called western world.
    Decadence is so prevailing in the UK and in the EU blob, that we can’t decide if we should laugh or cry.
    Now, there’s this French “genius” that thinks of himself as the next napoleon and, just like him, is planning on invanding Russia, all the while working to bankrupt French Farmers, so that vulture hedge funds can buy large stretchs of French farming land for cheap.

  3. ‘ Britain has never got over the fact that their colonial empire has gone.’- useless line more often used by remainers.All countries had a FX value prestige thing,but the British were probably more upset about Germans Deutsch Mark being overtaking the pound sterling.

    German GDP per capita over took UK in the. Late 60’s ; a lead which UK hasn’t caught up with.

    UK Government policy banned development/building
    The 1956 west midlands plan sought to reduce the population and block investment in building factories etc. Nimbyism in Britain has been very damaging and has been going on for ages, increasing costs for public investment and limiting private investment.

    Germany supported a regional diverse economy using a lot a targeted credit guidance to nurture a prosperous mittelstadt.

    Britain also spending a lot on maintaining a presence in West Germany which obviously pushed down pound sterling relative to the Deutsch mark.

  4. Re Mr Spreadsheet Error Rogoff:
    A year ago I was listening to BBC Radio 4 ‘More Or Less’ with mathmatician Hannah Fry explaining the disastrous Rogoff ‘Spreadsheet Error’. I can’t remember the details but it prompted me to write a complaint to the BBC about the misinformation on ‘public debt’ it purveyed – I think I mentioned that the only time I have heard an MMT economist on BBC was Stephanie Kelton on the World Service in the middle of the night. I eventually got a bland response. A search on Hannah Fry found that she had made a TikTok video about how the spreadsheet error had caused the Osborne austerity (which I haven’t watched). On her website there is an email address for her agent. Do you think someone should try to contact her?

  5. On Saturday I asked Yanis Varoufakis whether he thought MMT revealed a path to shared prosperity.

    Interestingly he said “no”, but then quickly added “only the US can (create money out of thin air in the nation’s treasury and central bank, to fund the public sector without taxing or borrowing from the private sector).

    So…..half way there……

    But the qiestion is: why does he believe only the US can do it? (I didn’t ask, because I didn’t want to detain him at the time). .

    My answer: because the US has the de facto global reserve currency…… (and I might add– a currency backed by the Pentagon which spends as much on the military as the rest of the world combined).

  6. “My answer: because the US has the de facto global reserve currency”

    Then why do I have 30% of UK Gilts held by entities external to the UK?

    The notion of a ‘global reserve currency’ is fixed exchange rate thinking. In a global floating exchange rate world, the consumer pays with the currency they have and the supplier ends up with the currency they want to hold. The finance industry *gets paid* to make that happen – so they find a way.

    Don’t confuse the cheap path for that exchange – which the dollar currency area provides – with the only path for that exchange. If there is anything to understand from the Russian situation it is that the global finance system interprets interventions as damage and routes around them.

  7. Varoufakis doesn’t get it any more than Pettifor or Meadway or Mazzucato. They stopped thinking when Positive Money hit the scene – it’s more than their job’s worth.

    On R4 news this morning the newsreader read out the TINA line which the Chancellor will roll out on Tuesday: “Borrowing now will pass on the bill to future generations”. And the shiny Ms Reeves will squeak her set piece: “We will only borrow to invest (except not as much as we said before).

    Great news that the eloquent George Galloway will be back to sock it to them in Parliament but, as someone pointed out on Facebook today, he’s a climate change denier – his party’s policy is for a referendum on tackling climate change – so I won’t be joining.

  8. Carol, I can’t discover the difference between MMT and ‘Positive Money’; whereas the mainstream “bill on future generations” meme is nonsense spurned by both.

    So Varoufakas’ point (ie, only the US can fund the public sector via a claim on resources not money) remains to be explained. Neil Wilson mentions floating currencies being the key to Varoufakas’ ‘error’, but obviously different natural resource allocations around the world causes conflict.

  9. ” I can’t discover the difference between MMT and ‘Positive Money’”

    The difference is that Positive Money ends up raising the cost of loans and mortgages, whereas the MMT view drives them down via ZIRP.

    The approach is to try to redefine what is ‘money’ and what isn’t ‘money’, but that doesn’t change the actual nature of the ‘money things’ in play, which as MMT explains are far more extensive. It’s another version of the ‘government bonds have special powers because we say so’ myth, just on the private side.

    None of this works because the finance industry gets paid to turn illiquid instruments into liquid instruments. If you try to ban liquidity, all that happens is the finance industry finds a more expensive path to create the demanded liquidity and makes more money. That’s the lesson of history – from Eurodollars to Russian sanctions.

    Additionally, Positive Money has no concept of the price anchor inherent in the buffer stock approach MMT uses to maintain price stability. It’s still stuck with the dead end idea that we can somehow manage an economy by controlling the private money supply by price.

  10. Thank you for the explanation, Neil: ZIRP and a JG.

    But the issue of differing natural resource allocations around the world which can cause conflict – how can MMT account for this reality in a floating currency scenario – with a goal of engendering shared prosperity for all nations (as Varoufakas is seeking)?

    I fear that’s what Varoufakas had in mind, with his “MMT (meaning public money created ex nihilo) can only apply to the US” comment.

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