They're sharks, not vigilantes

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Talk of ‘bond vigilantes’ has risen again this week in the light of a significant sell-off of government bonds, not just in the UK but in other major economies as well. The term is one we should reject absolutely: the word vigilante makes them sound like some sort of irregular financial police, doing their bit to keep the politicians in line and on track. It’s a complete misnomer – they’re profit-hungry sharks seeing an opportunity to make more profit for themselves by extracting interest from governments.

The first thing that we need to understand is that for every bond which is sold, someone has to buy it. No buyer = no sale. Those selling bonds are deliberately selling at a loss; someone who sells £1,000 worth of bonds (which the government has committed to redeeming for £1,000 at maturity) for £800 is crystalising a loss of £200. If the rate of interest on the bond is 3%, they would expect to receive £30 a year in interest. Since that amount of interest is fixed, the person buying the bond will now receive £30 a year on a holding they bought for £800 – a rate of interest of 3.75% - and still expect to get £1,000 back at maturity. Not a bad deal for them. It’s worth noting, though, that for all the talk of increasing rates of interest on bonds, the amount being paid by the government each year hasn’t changed by a single penny. A fall in the price of traded bonds does not cause an increase in the cost of existing borrowing.

So why would someone sell a safe asset for less than its nominal value? Well, if they believe that the government will have to respond by paying that higher rate of 3.75% on any new bonds issued, they will end up with a better-paying asset. And in that case, for new bonds issued, the cost of government borrowing has indeed increased. Both seller and buyer have managed to increase their income from interest paid on their bonds as a result. They will have seen an opportunity to make money and taken it. In none of these transactions is there any moral or economic judgement about government fiscal policy, let alone any attempt to enforce a particular policy. Indeed, it’s almost the reverse – the impact of fiscal policy is merely to create a belief that interest rates will have to rise, and the consequent belief that ‘other people’ will seek to take advantage of that increase, causing the whole herd to move. The belief, based entirely on the notion that government funding is dependent on bond issues, becomes self-fulfilling. Far from enforcing stability and discipline, the profit-seekers positively benefit from instability and chaos.

The conventional neoliberal economists and pundits tell us that, in order to avoid those rises in interest rates, governments must never ‘upset the markets’. What they mean by that is that governments must never take any actions which might create an opportunity for the traders to push interest rates higher. That in turn is based entirely on the assumption that governments must always borrow, on the markets, any money that they do not raise in taxes – in short, the assumption that the household analogy for government finances is true. But what if it isn’t true? What if the government does not need to balance its budget and can simply run an overdraft with the central bank? That goes to the heart of the debate about what money is and how it works. What gives the bond markets their alleged power is the adherence of governments to the household analogy for government finance, not some universal law of nature. An approach to economics which recognises that the constraint isn’t the availability of money but the availability of resources which can usefully be deployed would strip that power away. Neoliberal ideology is artificially constraining governments – we should be asking who benefits.