This comment was posted on the blog this morning by an occasional commenter called Dennis Buckley:
If we ever did get a government committed to managing public finances properly, how would they prevent the traders, the City, the hedge fund oligarchs from attempting to torpedo its efforts to ‘right' our systems. Would they not make a concerted effort to see interest rates skyrocket as the Tory ‘news'papers howled about financial mis-management?
This style of comment is happening quite often now and presumes that markets have power. I am not convinced. The comment I would have posted if I had not decided to write this post instead was as follows. Having decided to write here, I did not restrict my word count.
This argument about bond markets supposedly forcing interest rates upward has a very basic problem implicit within it.
To push the market interest rate on government bonds upwards, investors have to push the price of those bonds down. And there is only one way they can do that: they have to sell government bonds. Full stop.
But to have a significant effect, they have to sell enough of them. And, crucially, having sold them, they cannot then buy them back without reversing the very pressure they are supposedly trying to create.
So, if the City really wanted to conduct a sustained attack on a government by driving gilt yields upwards, it would have to keep selling gilts without buying new ones.
That immediately creates two problems.
First, somebody else has to buy every gilt that is sold. There is always another side to the transaction. The bonds do not disappear simply because a supposed bond vigilante sells them.
Second, if this is supposed to be a continuing attack, the sellers have to keep accepting progressively lower prices for their bonds. In other words, they have to deliberately realise losses. And then they have to assume another group of investors buys those bonds with the intention of selling them later at still lower prices if the attack is to continue.
That, then, requires a continual round of deliberate and coordinated loss-making.
In that case, an obvious question is why the City would want to keep losing money simply to attack the government. Financial institutions exist to make money, not to sacrifice their own balance sheets indefinitely in pursuit of an ideological campaign.
That does not mean gilt prices cannot fall. Investors can change their portfolios, expectations can change, and markets can become volatile. But that is very different from the mythology of all-powerful “bond vigilantes” who can indefinitely dictate terms to a currency-issuing government.
They cannot. Their supposed weapon requires them to keep selling assets at ever-lower prices while somebody else keeps buying them. That is not unlimited market power. It is a strategy of deliberate loss-making. And not many City players will do that for long.
In that case, how real is this threat? Not very, I would suggest. The government can weather any such storm, not least by refusing to issue any more bonds whilst activity of this sort is going on. By abandoning the supposed full-funding rule, which requires it to keep going to the markets for money it does not need, this cycle could always be broken.
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The truth remains however that our politicians don’t help by giving credence to these false claims of power by bond markets. Because they have been inducted or bought (both actually).
This is a really important post you know, because unlike too many others, you have thought through what the real logistics of the threat is and found it to be rather empty. A weak government just goes along with it. And did we not see some of this phenomenon in the crash of 2007/8 in selling MBS – offloading at loss – but they knew they would be bailed out? This is debate ammunition too, as well as deserving to be widely shared, though I know you are finite and it is the weekend!
Thanks.
This argument also applies to foreign exchange markets.
5th, if I thought there was going to be a coordinated sell-off, I’d short/borrow (& there would be plenty of others) .
Bond markets are populated by people that try to work the angles & make money that is their main interest.
(This is not a criticism of what you said – I agree – just an addition).
I thought about discussing hedging and shorting, and decided not to do so. I also ignore options. But you are right to raise the point.
The government needs to think outside the box if it wants to achieve meaningful change, there is little indication that it will. Unlike the Western neoliberal model, which rewards rent extraction while infrastructure deteriorates and productive capacity falls behind, China demonstrates that finance can be made to serve a long-term economic strategy rather than allowing financial markets to determine what the state can supposedly afford.
Bond yields don’t need a cartel of vigilantes selling in coordinated waves — they just need the marginal buyer to demand a higher yield on the next auction. No one has to sell existing gilts at a loss; buyers simply refuse to buy new issuance except at a discount. That’s not “deliberate loss-making,” it’s ordinary repricing of risk, done independently, once, by thousands of uncoordinated actors. And “just stop issuing bonds” isn’t free either — governments still run deficits, so the money gets printed instead, and that shows up in the currency and inflation, not gilts. You haven’t abolished the constraint; you’ve relocated it.
That was your last comment. You can’t even copy the name of a footballer correctly, and what you suggest does not solve the problem; it merely moves it to the auction.
If buyers demand a higher yield on newly issued gilts, they are demanding to buy those gilts at a lower price. The government is under no obligation to accept that price. It can simply decline to issue at those terms, as I keep saying.
More importantly, the government does not need the money from the bond sale in order to spend. Government spending creates the money first. Bond issuance is a subsequent operation offering holders of sterling an interest-bearing alternative to holding other sterling assets.
So “buyers refuse to fund the deficit” fundamentally misunderstands what is happening. They are not funding it.
Nor does stopping bond issuance mean that the government suddenly starts “printing money”. It was creating money when it spent anyway. Selling a gilt afterwards changes the form in which some of that government-created money is held; it does not finance the spending retrospectively.
You then make a second unsupported leap: that if the money remains as money rather than being exchanged for gilts, it must appear as currency depreciation or inflation.
Why?
Inflation results when aggregate demand exceeds the economy’s capacity to supply, not from whether a government liability is called a reserve, deposit or gilt. And sterling can only be driven down through selling. Someone must buy the pounds being sold.
There are real constraints on government spending: labour, skills, productive capacity, natural resources, imports and inflation.
But “the bond market might refuse to lend us the money” is not one of them, because the government never needed the bond market’s money in the first place.
Why doesnt the Government just grow a pair and say we are the democratically elected Government of the UK and if you attempt to prevent us Governing we will use our monopoly on the legal use of force, shut your operations down and imprison you as the law allows?
A slightly tangential comment here.
A vigilante is someone seeking to punish wrongdoing or criminal behaviour without legal authority to do so. The implied assumption being that bond buyers are correcting a government that has committed a crime by issuing too many bonds (or “borrowing” too much as most neoliberals would see it)! Kind of sums up the whole imbedded, biased narrative doesn’t it?
Yes, in a word.