Vigilantes are the problem, not the solution

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It must have been sometime in the 1950s that I used to watch Mr Pastry on the television, and I’m sure that I remember one episode in which he wanted to be a ‘village auntie’; but my memory also told me that Mr Pastry was Clive Dunn rather than Richard Hearne, so maybe it was a different programme. Anyway, the plot line was that our hero had completely failed to understand what a vigilante was. The media and commentators seem to be suffering from a similar lack of understanding every time that they refer to the dreaded ‘bond vigilantes’ who are apparently forcing interest rates up because they’re worried that the Labour government might in any way deviate from the Tory financial straightjacket rectitude to which they’ve been stupid enough to commit themselves.

It’s not true; the participants in the bond markets really don’t give a damn about what government policy is, and are not trying (as true vigilantes would) to exercise extra-judicial powers over perceived miscreants. They care only about extracting maximum benefit for themselves, and see the widespread belief that a change in government policy might make UK bonds a riskier prospect as an opportunity to line their own pockets. It’s a form of self-fulfilling prophecy. Those paying the interest might well want a stable low level, but that isn't necessarily true of those receiving it.

That doesn’t mean that paying higher interest rates on government ‘debt’ isn’t a potential problem for the public finances. The extent of that problem is somewhat exaggerated though: part of the ‘debt’ is held by the government-owned Bank of England, so the government is paying interest to itself in an exercise which is more about book-keeping than debt management, and the higher interest rates only apply to new ‘debt’, not to the money which has been ‘borrowed’ previously. It’s also true that around 30% of the 'debt' is owed to banks, financial institutions and governments outside the UK, but that is offset by the fact that governments outside the UK also owe large amounts (almost £900 billion in the case of the US alone) to UK banks and financial institutions, and to the UK government itself, and interest comes into the UK as well as flowing out.

The bigger problem with the conventional analysis is that it looks at only one side of the equation, to wit the financial impact on government finances. But we need to look at the other side of the equation – after all, if one body is paying interest, someone else is receiving it, and those recipients are the holders of those bonds, and they are mostly based in the UK. They include a small number of wealthy individuals who directly buy bonds and a much larger number of indirect holders, mostly current and future pensioners. And since the benefit received through interest payments is proportional to the amount of bonds held, the benefits will flow disproportionately to the most well-off. In short, government bonds are a mechanism by which wealth is transferred from the many to the few (Richard Murphy has a fuller explanation of that here), and it is the few (or their representatives) who are manipulating the markets to maximise that flow.

Bowing to the perceived pressure from ‘the markets’ is outsourcing financial policy to those to whom wealth is being transferred. Understanding that is a key first step to debating alternatives – but not one that the political representatives of the few, whether Tory, Labour, Reform UK or whatever, are keen on promoting.

We shouldn't be driven by speculators

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The market for government bonds works in what looks to most of us a very strange way. Despite the newspaper headlines about rising interest rates, the interest rate is actually fixed for the whole term of the bond. What appears to make the interest rate change is that the bonds can be traded, and the price at which they are traded doesn’t necessarily bear any relationship to the amount which the government accepted into savings when it issued the bond or the amount which it is obliged to return to the saver when the bond matures. So a £100 bond issued at 3% for 30 years will cost the government £3 a year in interest, and the government will refund £100 at the end of the term. In the meantime, that bond may have been bought and sold many times at varying prices: for anyone buying at less than £100, the interest rate will look higher than 3% and for anyone buying at more than £100, it will look lower than 3%. But, to the government, it is always £3 per year. For any new bonds, the government might need to match the apparent interest rate being paid on existing bonds, but changes in the bond market price do not and cannot affect the cost of existing commitments.

It means that headlines about rises in the rate of interest increasing the cost of ‘borrowing’ and putting huge additional pressure on the government can be misleading. They only increase the cost of ‘borrowing’ on any new bonds issued, not on all bonds currently in existence, although one wouldn’t necessarily understand that from the headlines. There are a number of factors which have pushed the rate for new bonds upwards, not all of which are in the control of the Chancellor. Many of them are part of global rather than local trends. The extent of the impact of the required higher rates depends on whether, and to what extent, the government is obliged to issue new bonds to cover its spending. The Chancellor and government choose to believe that they have no choice in the matter, a conclusion which pushes them inevitably in the direction of austerity and/or tax rises, which just happens to suit their own ideological view. It isn’t the only view, though. As Professor Richard Murphy points out, the government could simply stop issuing bonds and wait for the price to fall, as it inevitably will.

Murphy isn’t alone in challenging the tyranny of the bond markets. There was a letter from another professor in Wednesday’s Guardian addressing the question of bond markets very succinctly. To quote Professor Kushner, bond traders “…strive to reduce long-term stability to short-term volatility in order to multiply transactional opportunities”; in other words the price (and therefore the headline interest rate) is very largely being driven by gamblers and speculators out to make a quick buck rather than by investors making long term decisions. A half-decent Chancellor would seek to isolate us from, rather than fall into line with, the interests of such casino capitalism. It really is time to challenge and smash the hold which these people have on economic policy rather than allow them to cripple the ‘real’ economy in which most of us live in order to satisfy their greed and selfish interests.

Blatant bribery

Tweet The UK Government’s new Pensioners’ Bonds seem to be popular amongst those pensioners who can afford to buy them.  There seems little doubt that the whole of the £10bn issue will be sold, and a million or more pensioners will be very happy with the above-average return on their investment.  There are, though, two sides to any investment.  As anyone who’s ever had anything to do with accounting will realise, one person’s savings are another person’s debt.  And in this case, the debt is the government’s – and therefore ultimately ours.

What has been presented as ‘selling’ £10bn worth of bonds to pensioners is in effect borrowing £10bn from pensioners.  There’s nothing wrong with that of course; governments borrow all the time, and most of their money is borrowed from citizens.  As an alternative to simply taking our money away in taxes, paying us a guaranteed rate of interest to loan them money is not without its attractions to many.

There are, however, two special factors about this particular bond issue.

The first is the generous rate of interest.  A government which has spent most of the past five years telling us that we must cut the deficit because continued borrowing commits the taxpayers to paying interest in future has decided, in effect, to pay over the odds to borrow £10bn which it could easily have borrowed on the bond markets at a lower rate of interest.

And the second is that it has restricted access to this generous rate of interest to a small section of the population, namely those pensioners who have spare cash to invest.  To put it another way, they have decided to commit all those of us who pay tax to paying interest at above the going rate to the most well-off pensioners. 

I don’t know how anyone can see this as anything other than a blatant bribe to a targeted section of the population – wealthier pensioners – in advance of the UK General Election in May.  And a bribe paid for by the rest of us at that – which is spun as a safe and well-rewarded investment to help our elderly.

But there’s another little lesson that we should learn as well.  When they say that we can’t afford to go on borrowing because of the future interest payments, what they actually mean is that we can afford to borrow as long as it helps them to win an election.  The worst of it is that it might actually work, and the irony is that many of those benefiting are probably amongst those whose support for cutting borrowing is strongest.

When is a debt not a debt?

Tweet The Chancellor proudly told us last week that the UK was finally going to pay off the debts incurred in order to pay for the First World War.  But it was, in reality, more of a headline than a fact.

It’s certainly true that the particular bonds issued retrospectively to pay for the war are to be repaid.  But the money to repay them is coming from new loans, and taking out a new loan to pay off an old one isn’t exactly what most of us mean by “paying off debts”.  It may not even involve switching lenders; it’s perfectly possible that at least some of those lending the ‘new’ money to the government will be the same people to whom the government has ‘repaid’ the old debt.

That doesn’t mean that it’s necessarily a bad move.  Taking out a new loan at a lower rate of interest to pay off an old loan at a higher rate is a very sensible approach.  And with interest rates at record lows, it makes a great deal of sense for the government to borrow while it can, even if that isn’t what they say.  And it’s worth noting one small point which the Chancellor somehow omitted – interest rates remain at a record low precisely because the economy is in poor health.  He’s merely taking advantage of the silver cloud.

It’s also worth noting that accountancy rules being what they are, for someone to benefit from switching from a high interest loan to a low interest one, someone else has to be the loser.  In this case, that would be the holders of the bonds which are being repaid.  To the extent that those holders are fat cats and foreign governments, most people will not be unduly concerned.  We shouldn’t forget, though, than an awful lot of bonds are held as the ‘safe’ part of the investments made by life insurance and pensions funds in which most of us have a stake.

“We” through the UK government may well owe a vast sum of money, but much of it is owed to “us” as current or future pensioners.  The debate about government debt isn’t as simple as it sometimes appears.