Well, as I write this late in the Kyoto afternoon, Donald Trump has just made…
The British government does not have to appease the financial markets
Sometimes one journalistic piece captures the problem facing those who are trying to change the economics narrative and promote an alternative framing that is ground in the reality of the system rather than one that serves to reinforce the dominant ideology of the elites. The opinion article by Larry Elliot in yesterday’s UK Guardian (October 13, 2024) – Labour’s challenge is complicated by the triumph of finance. That’s bad news for UK plc – is one such article. It summarises how far the progressive debate and the British Labour Party has become trapped by fiction. It demonstrates clearly how if we start off assuming that there is a rigid constraint on decision-making then the bind will lead, invariably, to poor decision making because the opportunity set is so artificially limited by the starting assumption. I am amazed really that progressives in Britain (and everywhere by the way) still adopt this flawed framework for debate and decision-making. So let’s work it out properly.
The essence of the article is this:
1. British Labour has promised to obey the Tory fiscal rules which means it has tied itself in a straitjacket, which is likely to derail any effective shift in policy.
2. It is promising to match all recurrent spending with taxation revenue (at least), which means it will aim to run at least a primary fiscal balance but preferably a primary surplus.
3. It realises that if it wants to actually do anything constructive, then it will have facilitate large-scale investment in its capital accounts.
4. It also has inherited a private sector that has failed to adequately invest in capital infrastructure, which means, as the article notes that ” the government needs to invest – and invest big – to mend, grow and future-proof the economy”.
5. But the other fiscal rule that it has promised to reduce the public debt ratio over five years then looms as a further constraint.
6. Its solution is to ensure GDP growth outstrips the growth in debt issuance and the question then is how can an economy that has been on its knees after 14 years of Tory austerity and mismanagement actually grow fast enough to satisfy that promise.
7. But then the fiction begins:
To get the necessary investment, Labour must bring the financial sector onboard while diluting its often malign influence … It may be desirable for Britain to have shiny new hospitals and a modern power network to bring renewable energy to the cities, but only if the financial markets give any plan the thumbs up.
So the readers are assailed with the regular claim that the real constraint on government is the financial markets.
British Labour started pushing that line in the mid-1970s when Denis Healey was the Chancellor in the second Wilson government then under James Callaghan, when he took over from Wilson as Prime Minister.
Remember then that Healey entered a bailout agreement with the IMF pretending that the Government did not have sufficient funds to continue.
Of course it was a lie but it conned the trade unions into believing that the austerity that Healey wanted to inflict was inevitable, which preserved the ‘Social Contract’ between the Government and the Unions for a little longer.
Since then, the Labour Party has been completely besotted and paralysed by the myth that it has to first appease the ‘City’ before it can do anything and the parameters they assume apply in that appeasement are so restrictive that there is not much that they can do anyway that is progressive.
Which leads them to adopt ridiculous fiscal rules, further deregulate and privatise, reduce prudential oversight to the level where there is little oversight (remember Gordon Brown’s ‘light touch’ regulation), and end up pursuing fiscal austerity when exactly the opposite is required if Britain is to move beyond the dark Tory years and actually deal with the challenges ahead.
The article repeats the rumours that:
… the City could go on strike in the event that investors don’t approve of what Rachel Reeves comes up with on 30 October. If the budget involves too big an increase in borrowing to fund infrastructure projects, then the markets may refuse to buy UK bonds and this will lead to higher interest rates. This discipline will force the government to come up with plans based on what the markets will accept, not on what the UK might need.
That statement is just pushed out to the readers with no scrutiny as to what the mechanisms are or what the alternative might be.
It is just a continuation of the TINA – myth that Margaret Thatcher made popular in her – Speech to Conservative Women’s Conference – on May 21, 1980.
She told the audience, during a part in the speech discussing inflation, that:
We have to get our production and our earnings into balance. There’s no easy popularity in what we are proposing but it is fundamentally sound. Yet I believe people accept there’s no real alternative …
If the bills are met by borrowing or printing money it feeds through as inflation. We all pay in the end.
I added that last sentence to the usual ‘TINA’ source quote because it shows how closely related the narratives promoted by the British Labour Party are to the dogma spewed out by Thatcher to her Conservative audience.
Larry Elliot’s assertion in the citation avoids mentioning the pre-conditions that have to follow for there to be even a grain of truth in the causality he rehearses.
First, the ‘strike’ speculation he notes assumes that the financial markets can actually do something to stop the government from spending.
That something is apparently that they will stop buying UK government bonds.
Second, he uncritically then asserts that that ‘strike’ will lead to higher interest rates, which he leaves it to the reader to implicitly conclude will undermine the initial strategy of the Government to invest in infrastructure.
Third, that ‘strike’ will be binding on government.
The ‘market’ rules and he leads the reader to assume that what satisfies the ‘markets’ will not be in the best interests of the nation.
But, TINA, the financial markets rule not the democratically elected government.
We have been hearing that narrative for decades now from the progressive side of politics such that it is now hard to tell the difference between the Conservatives and the Labour interests – in jurisdictions around the world and especially Britain.
So, reflect a little on the underlying but unstated conditions that Larry Elliot declines to entertain for the benefit of his readers – perhaps out of ignorance perhaps for other reasons.
What would happen if the primary bond dealers who ‘make the market’ in the primary issue by the Government went on strike?
It must be understood that the whole gilt bond market – structure, operations, etc – is a legislative creation – that is, it is a creature of the elected government, which can change the rules any time it wants.
You might like to consult this briefing (March 28, 2024) – Official Operations in the Gilt Market An Operational Notice – that was published by the UK Debt Management Office (DMO) and which outlines how the UK bond market is structured through legislative fiat.
Another DMO document issued in 2004 but retains relevance – A guide to the roles of the DMO and Primary Dealers in the UK Government bond market – is also helpful if you want to understand what I am writing here.
It will help you understand that the claim that the bond dealers will go on ‘strike’ is highly misleading.
The so-called ‘Gilt-edged Market Makers (GEMMs)’ are selected financial institutions (or ‘desks’ within an institution) who are required by law to ensure that there is liquidity in the primary and secondary bond markets.
As background, government bonds are issued in the so-called ‘primary market’, which is simply the institutional machinery via which the government sells debt to the authorised non-government bond dealers, the GEMMS in the UK context.
Once bonds are issued via an auction in the ‘primary market’ they are traded in the ‘secondary market’ between interested parties (investors) on the basis of demand and supply.
Trading in the secondary market is just about shuffling wealth.
The primary auction process allows the GEMMS to place bids (for themselves or as agents) in terms of volume and yield required.
Eventually, the resolution of all the bids sets the relevant yield for that issue.
From the DMO, we learn that:
Firms endorsed by the DMO as GEMMs agree to meet a number of obligations on a continuous basis. The aims of these obligations are to ensure that primary dealers contribute to the liquidity of the secondary market and provide appropriate support to the primary issuance of Government debt.
Further:
GEMMs are the only institutions able to bid directly by telephone to the DMO in gilt auctions, and, as such, are expected to play an active role in the issuance, sale and marketing of UK government debt.
Further:
The DMO recognises that it is neither possible, nor desirable, to set minimum allocation targets for individual GEMMs at every auction. Nevertheless, GEMMs should aim to purchase at auctions amounts at least broadly equivalent to their secondary market share …
So that should put a different slant on the concept of a bond market ‘strike’, which on the face of it means – just as Larry Elliot’s words say – “the markets may refuse to buy UK bonds”.
Which, in turn, suggests that the government would run out of the funds necessary to run a fiscal deficit (that is, spend beyond the tax revenue), given the inference is that the bond sales provide that funding source.
However, the GEMMS could not feasibly stop bidding at the auctions if they wanted to retain their GEMM status, which confers on them a range of privileges that boost their capacity to make profits from the bond market.
So the only meaning a ‘strike’ could have in the reality of the segment of the British bond market that pertains to ‘funding’ (that is, the primary market) is that the bids the GEMMs place could require higher yields on the gilt than before.
This is why Larry Elliot claims that interest rates would rise, given that the yields in the bond market are related to interest rates in the money market through competitive processes.
The next question then is would that be binding on the Government, as the UK Guardian article implies.
If so, then the bond markets can dictate terms of government spending.
Clearly, that is not the case.
The Government can, via the central bank, dominate the bond market dealers whenever they choose to.
How?
First, the central bank can drive the yields on government bonds down via its purchasing power in the secondary bond markets – this is what quantitative easing demonstrated.
So if there was a GEMM strike – meaning they decided to bid at higher yields only then the central bank could just deal them out of the equation by ensuring that such yields would be irrelevant given yields in the secondary market.
Across the array of financial assets – type, maturity etc – arbitrage and competitive trading means that the yields and loan rates have to stay in kilter with each other, adjusted for risk etc.
Second, what about an uncovered auction outcome – that is, where the bids do not exhaust the volume the Government wishes to issue?
Well, the central bank could just buy up unbid for volume.
This might require some change in administrative regulations or legislative changes, which are, of course, in the hands of the government of the day.
However, if the central bank is bidding up the price of government bonds in the secondary market and holding yields down as a consequence (remember price and yields move inversely given the fixed income nature of the bond instrument), then the GEMMs will know that they can offload any primary issue purchases immediately in the secondary market and record a tidy profit in doing so.
Which means the likelihood of an uncovered auction is pretty small.
Even if the technicalities of the above escape you, the message is clear – the bond dealers have obligations that ensure they have to participate in the bond issuing process.
If that participation generates outcomes (yields) that the government considered unfavourable, then the central bank can dominate the auction in a variety of ways as above.
Short story – Larry Elliots scare mongering is not based on any intrinsic characteristics of the monetary system.
The only way the bond market can dominate the government in this way is if the government allows them to.
Only a stupid government would seek to ‘appease’ the City based on this unfounded paranoia.
Further, what of Margaret Thatcher’s claim that issuing debt – “borrowing … feeds through as inflation”?
Ask yourself, how can that be?
The government spending carries an inflation risk, just like any spending (consumption, investment, exports).
The bond issuance just provides an extra portfolio choice for wealth holders – another financial asset to park their accumulated saving.
The funds used to buy the bonds were not going to be spent by the non-government sector anyway.
So the act of issuing the bonds has no bearing – positive or negative – on the possibility that there will be excessive spending in the economy.
To be fair to Larry Elliot, he recognises that “(t)he risk of a buyers’ strike is exaggerated.”
In appraising the plan by Reeves to borrow to invest while cutting recurrent spending and increasing taxes, the UK Guardian article correctly notes that:
The risk, therefore, is not that the budget is too generous but that it is too restrictive, sucking demand out of the economy at a time when it is already showing signs of slowing down.
He also notes that the constant doom and gloom that Starmer and Reeves pump out “about the dire state of the public finances” has killed household and business confidence at a time when the reverse was necessary to underpin a high growth performance.
However, he cannot help himself when he concludes that:
In July, the public voted to end austerity and for higher public investment, yet the government’s ability to fulfil its mandate relies on securing approval from the financial markets … Finance is the master not the servant. It decides what governments are free to do; it sets the terms of the debate; it shapes and dominates the economy.
The first part of that sentence is correct – the rejection of austerity by the voters.
The rest of the citation is the fiction that the progressive side of politics has been seduced into believing so that the demands on government will not crowd out the needs for government to fund the profit ambitions of the top-end-of-town and their corporate mates.
How might Larry Elliot explain the Japanese situation using that logic?
Mainstream economists predicted that the Japanese government would go broke – using that logic – in the 1990s.
And more.
None of the predictions that flow from that logic have been realised.
Conclusion
The paranoia about the power of the ‘City’ has dominated progressive politics in Britain for decades and has perverted the policy set that the politicians think is available to them.
Not much will change while the Labour supporters and the advisors continually pump out the message of appeasement.
Ultimately, the financial markets can be dominated via the capacity of government both financially and legislatively.
No appeasement is necessary.
That is enough for today!
(c) Copyright 2024 William Mitchell. All Rights Reserved.
It’s important to remember that the ‘gilt auctions’ in the UK are the *secondary* mechanism for ‘sterlising’ government spending.
The first ‘bond swap’ is done at the cash management level via repos and Treasury Bills. The ‘gilt auctions’ are actually a short to long swap.
Short gilts are issued to the DMO from the National Loans Fund for use in repo trading. The DMO then swaps those gilts for whatever is required to zero the Net Exchequer Position over a weekly time frame, with the difference swept up by the weekly Treasury Bill sale.
However in the UK all this is a policy position, because our National Loans Act has the line “The Bank of England may lend any sums which the Treasury have power to borrow”. Therefore our ‘full funding rule’ is entirely a political choice rather than a legal necessity. “Strikes” can have no material effect.
The DMO points this out every year in their annual review.
The question is “Do we want to be like Argentina”?
If so, then we just need to follow the advice from the media.
Fortunately, nobody gives a d*** about the media and its mouthpieces.
In Portugal, the media are all bankrupted.
Incredible really. The world is on the brink of destruction, driven primarily by the human economic model – and we’re still arguing over terminology over money creation and distribution. The real problem is even if all governments adopted a transparent, enlightened model based on MMT principles – what would they do with this magic money tree? More of the same I would opine. Funnel money into the new green deal – to what exactly? Drive growth in that sector perhaps, but to what end? Last week, the UK government announced a £22billion investment into green tech, primarily in carbon capture and storage. Meanwhile, in the real world, our increased emissions and global temperatures have exhausted the planet’s natural carbon capture storage mechanisms. No amount of money will fix this, whereas no money might fix it.
Sorry – links for the above post:
Guardian: https://www.theguardian.com/environment/2024/oct/14/nature-carbon-sink-collapse-global-heating-models-emissions-targets-evidence-aoe
Low latency carbon budget analysis reveals a large decline of the land carbon sink in 2023.
https://arxiv.org/pdf/2407.12447
Sorry…not the most astute financial reader… But, is there something missing here..?
“Ultimately, under the financial markets can be dominated via the capacity of government both financially and legislatively.”
There seem to be two types of Larry Elliott article. Occasional ones where he seems to get it, but much more often, ones like this, whether by his own volition or as a result of being sat on by a Guardian of the newspaper. Hard to square such articles with the Larry Elliott telling a LEXIT meeting that the GFC should have led to a radical attack on the fundamentals of capitalism (YouTube: Larry Elliott- Corbyn, the Labour Movement and a People’s Brexit). He ends this article by saying ‘without curbs on finance, governments are severely constrained’. This shouldn’t be the conclusion of course. It should follow, that being the case, that the government needs to enforce such curbs, or rather that it simply needs to stop pandering to the financial markets. Japan of course is never to be mentioned, except as a moribund economy (though one meeting the needs of its people rather better than in the UK).
@Mark Russell One has to hope that a government that would discard the neo-liberal nonsense would also be able to show short shrift to the fossil fuel industry lobby. Re the carbon capture investment, the somewhat maligned (here) George Monbiot recently penned an interesting article https://www.theguardian.com/commentisfree/2024/oct/11/labour-carbon-capture-climate-breakdown
Hi Patrick – but it’s not going to happen. People are too heavily invested in the current FF economic model and are willing to believe any fantasy that avoids the real issue: Overshoot -> Ecological, social and economic collapse -> Mass extinction.
The only alternative is impossible for the vast majority to consider. No oil, no cars, no air travel, no heavy industry, no emissions, no industrial agriculture, no weapons, no toxic chemicals, no plastics – a modest, humble lifestyle, living within our means (there’s an old fashioned concept!).
Politicians think they must do something big and spend vast sums of money on a futile and dangerous exercise, whereas in reality, we have to sit quietly for a few generations and allow the planet to recover – then see what we have in front of us. Stop doing harm.
The BBC has their own fiction about the “necessity” of fiscal rules:
“Liz Truss’s 2022 mini-Budget was a prime example of the price of lost credibility. Her failure to provide plans for how her government would fund the biggest tax cuts in half a century, and a lack of independent vetting of those plans, caused borrowing costs to soar. And so too did the cost of new fixed-rate mortgage deals – which are also linked to those markets.”
Full article: https://www.bbc.co.uk/news/articles/c981me1qn43o
Utterly ridiculous. The borrowing rates did spike briefly but why does the BBC ignore the Bank of England’s role?
Bond sales are a relic of gold convertible money, when bond sales protected the Treasury’s gold supply by precluding the presentation of the currency used to buy the bonds for conversion. Under a fiat regime, there is no longer a compelling reason to sell bonds.
I see Andrew Griffith MP has trotted out the ‘coming back as the bond market’ quote from James Carville again.
It’s pretty clear now we’re not going to get anywhere unless we say we are going to shutter the gilt market permanently and go to ZIRP. It’s all been set up specifically to play this game. Any change in government policy is ‘expected’ to cause inflation in the models the Bank of England use, which will cause them to raise interest rates. Gilt paths react accordingly. That is then used as ‘proof’ the gods of the markets are looking unfavourably on the change. The heralds then announce that in endless articles in the press.
The Bank of England reaction policy has to be changed and the full funding rule scrapped.
Of course to go ZIRP effectively will require a JG putting in place – shifting the stabilisation policy from the market for money to the market for labour.
Spending cannot overcome biophysical limits.
There’s an even bigger problem than progressives believing that currency-issuing central governments face a mythical fiscal constraint.
The global Ecological Footprint (EF) is currently 1.75 times global Biocapacity (BC); three-quarters of all nations have an EF in excess of their BC; and almost all high per capita GDP countries have an EF that exceeds their BC by a factor of at least two. That is, most progressives have no knowledge of the real resource constraint we face, and I’m including a lot of MMT economists (Bill Mitchell, who is aware of what the real resource constraint really is, is one exception). I know this because when a question was asked about ecological constraints to a panel of esteemed MMT economists at the first International MMT conference at UMKC in 2017, which included Bill Mitchell, it was met, at first, with prolonged silence, until Bill was left to respond by himself. Other panel members seemed disinterested, as if ecological constraints are a matter easily dealt with by a bit of tinkering here and there. To be fair, one other panelist has recognised a personal shortcoming and has since done something to try to overcome it. All the panelists are upstanding, well-intentioned people.
If you think the neoliberal needless obsession with fiscal austerity is inflicting pain on a lot of people, imagine how difficult it is going to be for progressives (policy-wise) if and when they finally learn what the relevant constraint is, and how constraining it will be.
The USA needs to halve its EF for its economy to be ecologically sustainable, which, without any other changes, means a halving of its GDP. It has taken the last fifty years for the USA to halve the EF-intensity of its GDP, and it is likely that a lot of the reduction has been due to the change in the mix of goods it produces because legislation, such as the Clean Air Act, has driven ‘dirty’ production to China and the like. And the claim that we can shift away from physical goods to services simply reveals a misunderstanding of the trophic structure of economic systems (the output of the secondary trophic level (manufacturing) becomes the input of the tertiary trophic level (services)), which means services cannot substitute for physical goods (although goods can be better designed to yield more services), and ignorance of the facts. As the percentage of GDP from services of high per capita GDP countries has shifted from around 55% to around 80% over the past fifty years (a change in their product mix – rich countries import poor countries’ secondary trophic level output to serve as inputs of their own tertiary trophic level), the level of resource use, GHG emissions, etc. has risen. For all you believers in the dematerialisation of GDP, shouldn’t it be falling? And the per capita EFs of rich countries is larger than that of poor countries where the percentage of GDP from services is still stuck at 50-55%. Shouldn’t it be lower?
Distribution is never going to be more important than it will in the future should we ever start reducing EF so that it is again within BC (note: EF no greater than BC is coming our way in any case – we either do it by design or it eventually happens by ecological disaster). Given the importance of work, a Job Guarantee is going to be an essential part of the just transition because achieving and maintaining full employment is going to be even more difficult in a world with smaller national economies (albeit they can be economies comprising better stuff). Efficiency will also be important – we will have to get the most out of the natural resources we can extract on an ecologically sustainable basis. No more throw-away coffee cups, etc.