It's the bond markets, stupid

If they can trash a right wing Tory government, what would they do to a left wing Labour one?

Like everyone, I heaved a sigh of relief when Liz Truss left office. She united the nation as never before - in wanting her gone. And I felt a twinge of optimism too – come on you felt it too, even though he seems to have adopted Liz Truss's 1000 yard stare. The former Chancellor at least seemed to know what he was doing during the pandemic. He doesn't do parties and seems focused on the job in hand in a way his predecessors were not. 

But there is another rather more disturbing aspect to this recent crisis which we need to think about.

As George Osborne, the former Tory Chancellor, remarked it wasn't the Tory party that elected this new government but the financial markets. Never before has it been so clear who calls the shots, who exercises real political power. By selling the pound short and trashing UK government bonds, financiers made it impossible for the Truss government to continue. Borrowing costs were rising so fast the public finances were becoming unsustainable. She had to go. 

Now, don't get me wrong. I was glad to see the back of Liz Truss and her doolally libertarians, but you don't need to be a hard-boiled Brexiteer to worry that the political choices open to British voters are now severely circumscribed by what unelected financiers think is acceptable. If they can do this to a pro-capitalist Tory government, just think what the markets would do to a left wing Labour one.

Jeremy Corbyn came within 2% of beating the Conservatives in the 2017 general election in voting share, but you have to wonder what would have been the point of his entering Number Ten if he had won. The bond markets would have revolted. Labour's big spending plans would have collapsed, as would nationalising the utilities. The pound would have tanked as government borrowing costs shot up. John McDonnell would have had to fall on his sword or whatever sharp implement came to hand. Within days the government would have been in ruins. 

Now, I'm not a supporter of Jeremy Corbyn either, but you get my meaning. Bill Clinton'spolitical adviser, James Carville, famously said that he didn't want to be reincarnated as a president or pope but the bond markets because “you can intimidate everybody”. He was joking. But this is serious. 

So who are these financial markets and what makes them so savvy? They are a motley bunch of financial creatures. Vast quantities of government debt is consumed by large lumbering beasts like pension funds and foreign sovereign wealth funds. They rarely rise from their financial ruminations except when there is rapid fluctuations in bond prices in which case they panic like a herd of wildebeest and the Bank of England has to step in to round them up.

Then there are the commercial banks, hedge funds and others who buy and sell government debt and currencies on a regular basis making large amounts of money along the way essentially from thin air. They are led by the people sometimes called “bond vigilantes” who speculate on government debt and were heavily involved in selling sterling a fortnight ago. They are shadowy figures mostly. The currency trader, George Soros, is the big daddy of financial speculators. He made a billion out of betting against the pound in 1992 forcing the UK to leave the Exchange Rate Mechanism. And thirty years ago a billion was serious money. 

So if these people are now in charge, and decide who is and who is not suitable to be in government, can we trust them? Well, I'm not sure we can. After all these financial institutions and speculators are the very people that gave us the 2008 financial crash – the greatest economic catastrophe since the Great Depression. They did it by speculating massively on bonds that turned out to be worthless: Collateralised Debt Obligations made up of bundles of frankly fraudulent mortgages. The government, you and me, had to mobilise over a trillion pounds in liquidity to prevent the entire financial system crashing. 

We also had to nationalise some of the biggest banks in the world, like Royal Bank of Scotland who'd got so big on funny money that its balance sheet was larger than Britain's GDP. We still own a nearly half of that bank. Moreover, that financial crisis was only resolved by laying the ground for a future one.

After 2010, the Bank of England started buying up government debt on an epic scale through Quantitative Easing, effectively printing money. This, as the former Bank of England Governor, Mervyn King, said at the weekend, has contributed massively to inflation. “Too much money chasing too few goods”.

But more importantly even than price inflation, zero interest rates led to a vast inflation in asset prices, most obviously house prices. People owning shares and property have made a killing in the past decade. The greatest increase in wealth inequality since the Edwardian age is a direct result of the Bank of England's policy of cheap money. This is not OK.

So, welcome to the new world. These are the people who now get to decide who is going to be in government. And welcome to what is called “sound money”. The financial markets dictate that governments must now “balance the books”, the crudest form of budgetary accounting. We'll see what that means next month when the Chancellor, Jeremy Hunt, informs us of the “eye watering” public spending cuts that are necessary to keep the markets sweet. It's back to austerity folks. After a decade in the doghouse, the bankers are back in charge.