Government bonds (or gilts) are like ‘the boy next door’. You know the type: sweet, dependable, honest. You know his morals and his market value. He won’t fluctuate dramatically – that is until his devilish ‘friend’ comes along, leading him astray and blurring the lines of a ‘committed relationship’.
Suddenly his price comes crashing down – you no longer see him in the same light. He’s not the delightful company you initially thought he was, and you need to break up as quickly as possible lest people begin to think less of you simply for associating with him. Now, I want you to imagine that ‘the boy next door’ is a gilt, you are his long-suffering partner, and the devilish friend is Chancellor Kwasi Kwarteng, who’s backed up by his buddies at the treasury.
Meanwhile, the IMF and other actors can be considered to be your group of friends. Oh, and the Bank of England (to be introduced imminently) is the boy next door’s ‘good friend’ – the guy trying to anchor him towards sensibility. He cares about everyone, including the Chancellor. Now that the main characters have been introduced, let me tell you a fable.
Once upon a time, there was a man called Dr. Kwasi Kwarteng. Dr. Kwarteng’s life was a continuous cycle of effortless achievement. From winning scholarships to Eton and Harvard, followed by a traditional Tory tour of duty at JP Morgan Chase, success was second nature to him. Classic ‘bad boy’.
Until he became a politician. It took him five years to be selected for a safe seat in leafy Surrey. Once in parliament, he had to wait seven years to win a junior position in government, and 4 more years after that to become a cabinet minister. He had been wronged by the timid One-nationers spearheading the Conservative Party.
The man needed to blow off some steam by dabbling in some neoliberal economics. Who cares if it’s not the budget season and only a few weeks after you’ve gained power? It’s always the right time to drop “the biggest package of tax cuts in 50 years”, especially when your dreams have been mercilessly crushed by the wimpy One-nationers at the top of the party. Who cares if we’re in the middle of a recession and stagflation beckons like a grey cloud? It’s payback time.
Budget day started with a promise to alleviate soaring energy costs through the “Energy Price Guarantee'”. That was to be expected. Then, the bad boy decided to unleash his intellectual road rage and introduced cuts to corporation tax and personal investments worth £43 billion.
Nice. The purpose of these tax cuts is to grow the economy in times of uncertainty – if tax rates decrease, people will spend more, keeping businesses afloat and money circulating through the economy. This creates employment, opportunity, and prosperity. Road rage over.
Here’s the snag. The Bank of England (the people in charge of supplying money) had decided to focus its attention on inflation, and the main way to curb inflation is to limit the circulation of money in the economy. This means interest rate hikes. To put it simply, the mini-budget places the Bank of England at war with the Chancellor. The good friend was in a knife fight with the bad friend over the gilt.
This war has wreaked havoc on the markets, with traders and pension fund managers (you – the owner of a gilt) reacting negatively to Kwarteng’s policies, with escalated arguments and the threat of a breakup with the gilt. As the good friend fights for control with the bad friend, demand for gilts fell dramatically. Bad friend one, good friend nil.
This was deeply problematic – the government’s only tool for borrowing money is the sale of bonds, and if they can’t sell bonds, they can’t borrow the money to pay for our energy bills and other necessary public services. To combat this, the Bank of England threatened to raise interest rates further to deal with the mini-budget. This caused the pound to fall to record lows against the dollar.
The next day, the International Monetary Fund (IMF) flexed its scimitar at Kwarteng, stating that they “do not recommend” fiscal packages that contradict central bank monetary policy. Moreover, the rating agency Moody’s has stated that treasury policy will “weaken the UK’s debt affordability”. Ouch. The friend circle has arrived at their verdict, and they want the boyfriend out.
The day after that, the Bank of England was forced to intervene. To restore bond prices (and save investors with significant bond possession), the Bank of England announced a £65 billion bond-buying scheme. In other words, the treasury’s control over the economy was weak enough for the Bank of England to justify spending £65 billion to restore a vestige of trust in the economy and stimulate demand.
Since then, the pound restored its value against the dollar and gilt yields started returning to normal levels. The actions of the ‘good friend’ have helped to restore facets of human decency in the boy next door, enabling a return to normalcy in the relationship.
The end.
Most fables end with relatively simple morals. This fable ends with a wake-up call. The role of the Bank of England is to protect the British economy and control the supply of cash. The purpose of the treasury is to devise policies that grow the British economy. Clearly, the two are at loggerheads with one another, with the Bank of England placed in the position to respond to the idiocy of turbulent politicians, who act out of a need to shock and win political support over a desire to protect the public.
The protection of people and the stability of employment has to be the principal focus of any public sector body, necessitating the primacy of the Bank of England. However, the treasury has won out, with the Bank lacking the necessary powers to effectively limit and control instability in the market caused by ineffective fiscal policy. Evidently, the Bank of England needs greater power to ensure that fiscal policy is in tune with monetary policy – auditing powers, perhaps? If not the Bank of England, the Financial Conduct Authority?
Some of you might think this unnecessary – after all, we already have the Office for Budget Responsibility (OBR) to issue judgements on the effectiveness of budgets. They critique budgets and act as objective voices on the budget’s potency to solve the varying economic crises our country appears to face.
Whilst the above may be accurate, the OBR’s actions are constricted by their position as a glorified quango. Arguably, such an observation may be too generous, given that Liz Truss was able to prevent them from offering their thoughts on the budget. As long as the OBR continues to be run by treasury officials, it remains under the spell of the treasury and the influence of politicians addled with hero complexes. An external organisation with more independence needs to step in and ensure sound fiscal policy.
Ultimately, it comes down to this: market stability is best enabled when fiscal and monetary policies are aligned. Without harmony, we are forced to expect tumultuous markets, rising bond yields, and poorer pensions. Bureaucracy might seem like a strange solution, but it’s the best way to ensure sound economic policy.
