Cooking the Books 1 – ‘Ignorant and mistaken’
The irony of it! A government with a free-marketeer Prime Minister and Chancellor punished by ‘the markets’. This normally happens to reformist governments that have promised to spend money on improving conditions for the workers. The 1929-31 Labour government was said to have been brought down by a ‘bankers’ ramp’. In France the term used was that such governments came up against a ‘wall of money’. Harold Wilson in the 1960s blamed ‘the gnomes of Zurich’.
The villains in question are international speculators – sometimes politely called ‘international investors’ – who buy and sell the bonds issued by different governments. Governments borrow money by selling bonds. These have a face-value and a rate of interest fixed as a percentage of this. Say, £100 at 5 percent. However, while the amount of interest payable remains the same (in the example, £5), the price at which the bonds are bought and sold on the bond market varies. So, if the price falls to £90 the interest is still £5, but 5/90 is 5.56 percent. If the price rises to £110, this ‘yield’ (interest/selling price) is 4.5 percent. When the government sells new bonds it has to take into account the yield on existing bonds and offer that as the rate of interest.
When on 23 September Kwarteng announced tax cuts to be funded by borrowing, the speculators perceived the new government as behaving like a reformist one. Cutting taxes without reducing government spending and covering the extra deficit by borrowing was seen as no different from increasing government spending by extra borrowing. So they sold UK government bonds. With more sellers than buyers, the price of these fell and the ‘yield’ went up, meaning that government has to pay a higher rate of interest to borrow.
This had an unintended side-effect. Some pension fund managers had been persuaded by clever City financiers to borrow money by effectively betting on the price of government bonds they hold not falling significantly. They lost the bet and were required to pay cash to settle. This they could only get by selling some of their bonds, so driving their price further down. To prevent the pension funds becoming insolvent and the risk of this leading to a wider financial crash, the Bank of England stepped in to buy bonds and keep their price up.
This was a classic case of how a central bank has to deal with a dash for cash – it makes more cash available to prevent the whole financial system clogging up. Marx came across this in his time. Under the 1844 Bank Charter Act, the Bank of England was allowed to issue money not backed by gold in its vaults only up to a certain amount. However, in the financial crises of 1857 and 1866 the Act had to be suspended to permit the Bank to make more cash available. Gordon Brown thought he had invented the wheel – and saved the world – when he followed this long-established practice during the Crash of 2008.
Marx’s comment was:
‘Ignorant and mistaken bank legislation, such as that of 1844-45, can intensify this money crisis. But no kind of bank legislation can eliminate a crisis’ (Capital, Vol 3, ch. 30).
Governments can’t make things better but they can make things worse, as we have just seen. Starmer tweeted that ‘the government has lost control of the economy’ (2.02pm, 28 September). But governments don’t control the economy. It’s the other way around, as he will find out if ever he gets the chance to have a go.