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.
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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).<\/p>\n
Nor did it tell us that governments have financial limits on spending beyond which the financial markets will destroy a currency.<\/p>\n
If you thought that it did then I think your evaluation of the situation is defective.<\/p>\n
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.<\/p>\n
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.<\/p>\n
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.<\/p>\n
The economic circumstances made it impossible for Britain to pursue suitable domestic policies while still maintaining the agreed exchange parities under the ERM.<\/p>\n
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.<\/p>\n
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.<\/p>\n
In entering the ERM, British ‘pride’ was on show and the initial sterling parity was overvalued in relation to the structure of the economy.<\/p>\n
Britain has never got over the fact that their colonial empire has gone.<\/p>\n
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.<\/p>\n
So they could make profits by selling the pound short.<\/p>\n
It was only a matter of time.<\/p>\n
On Spetember 16, 1992, the so-called – Black Wednesday<\/a> – the folly of the Major government’s decision to join the ERM in the first place came to fruition and the speculators won.<\/p>\n 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.<\/p>\n 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.<\/p>\n The boss of the Bundesbank fuelled the fire by stating publicly that the pound was overvalued and would need “a more comprehensive realignment”.<\/p>\n 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.<\/p>\n Did this event tell us anything about the sovereignty of the British government?<\/p>\n Yes, but not in the way most people have concluded.<\/p>\n It didn’t say that the financial markets have all the power and can destroy a currency if they want.<\/p>\n 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.<\/p>\n 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.<\/p>\n