With Keir Starmer expected to fall on his sword shortly, here is my take on the conundrum facing Andy Burnham, indeed any and every British PM. The true nature of Britain’s ‘special relationship’ with the United States has far more to do with American financiers’ willingness to keep borrowing to purchase British government debt than with history, culture or Britain’s defence needs. This is the burden under which every UK Prime Minister must labour.
Mike Tyson famously said, “Everyone has a plan until they get hit”. The same could be said of prospective British prime ministers, especially after Liz Truss’s spectacular defenestration. They all have a plan until the guilt market hits them. Andy Burnham, Nigel Farage, my friend Zack Polanski will have to face this, if they ever move into 10 Downing Street. I think they know it. But I doubt whether they appreciate the true magnitude or nature of their predicament.
Conventional wisdom has it that the bond market comprises people looking to invest their savings in a government’s debt. They seek the right balance between a higher interest rate and the increased risk this implies. For example, higher bond yields may signal that the market expects future inflation to reduce the value of the fixed interest payments that their bonds will yield. Worse still, it may foreshadow a risk of government default, as occurred in Argentina and Greece.
That’s more or less what first year economics and finance students are taught. And it’s all true. Except that, in the case of the United Kingdom, this story misses the most fascinating and worrying aspect of its government bond or gilt market: The British government’s ability to refinance its public debt of almost 3 trillion pounds does not depend on savers choosing to invest in gilts. In fact, the British government’s ability to sell gilts hinges heavily on the willingness of numerous US-based financial institutions to borrow substantial sums of dollars to purchase British gilts, which they then use as collateral to borrow for their own purposes within the US.
And there’s the rub. There is a world of difference between needing to borrow from savers and from relying on speculators who borrow themselves to lend you. Savers who lend to you focus on your long-term ability to repay them. They may tolerate your desire to make infrastructural investments that could increase your debt in the short term, in return for future profits that will help you repay them when their bonds expire. However, speculators who borrow in order to lend are a different beast entirely. They are much jumpier and prone to margin calls: situations where, if the bonds they purchased from you begin to lose value, fearing they will not be able to repay their own creditors, they dump your bonds thus turning their decline into a crash.
The question arises: Why are British bonds, or gilts, so much more reliant on American speculators borrowing money to buy them than German bunds, Japanese bonds, Italian bonds or Greek bonds? Why does every British government rely so heavily on American leveraged capital inflows?
It all started in the 1950s when the City of London discovered how to avoid following the British Empire down the road to oblivion. The trick was to carve out a niche for the City within the emerging dollar empire, which was institutionalised within the Bretton Woods system. American financiers faced rigid capital controls within that system, but the City of London was able to alleviate these due to three invaluable features.
First, London’s trading expertise and legal system offered American financiers efficiency with immunity from all sort of interventions, including democratic accountability. Secondly, Britain’s network of offshore jurisdictions offered fabulous tax-minimisation opportunities. And, thirdly, London quickly became the holding depository of a torrent of petrodollars and eurodollars, not to mention the shadowy dollars created outside the United States by foreign bankers.
Thus, the Great British paradox: while the UK’s real economy was in decline, the City of London was flourishing. When the Bretton Woods system collapsed in the 1970s, American financiers discovered another use for the City: they borrowed dollars in the US short-term to buy long-term UK government gilts, which they then sold quickly to repay their loans. They would then repeat this process again and again to profit handsomely. This is how the British government became reliant on leveraged US institutions. In order to continue operating as usual, London today requires American balance sheets that are willing to expand through borrowing and use British gilts as collateral in order to maintain liquidity in the US.
Put differently, the flipside of the City’s success story is that, even though it borrows in a currency that it prints, the UK is not financially sovereign. Yes, the City occupies a strategically important position within the global dollar system but the price for this is that the UK government’s sovereignty is circumscribed by its priority to maintain the City’s central position in American finance. While this remains the priority, the occupant of 10 Downing Street is like the captain whose powers are limited to re-arranging the deck chairs on the Titanic.
Is there an alternative to this peculiar form of financial subservience to US-based leveraged financiers? Yes, but it requires a willingness to accept a falling pound and falling house prices while increasing public investment through a new investment bank that issues bonds supported by the Bank of England.
Any Prime Minister who tries to maintain Britain’s financial servitude to US capital while also investing in public goods may well put Britain on a path towards the IMF, whose sole purpose, lest we forget, is to create the political leverage that will bring about – like it did in Greece – the permanent loss of sovereignty over tax and spending policy. The question is: Do the current contenders for Britain’s top job understand this?
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