Drive The Money Changers From The Temple

NeilW writes:

The bond market has long been hailed as a vital cog in the machinery of modern economies, a sentinel ensuring fiscal discipline, and a barometer of economic stability. But is this reputation deserved? Recent turmoil in the UK gilt market following Rachel Reeves’s maiden Budget has brought this question into sharp focus. A sell-off in gilts has been framed as the righteous judgment of the “bond vigilantes” sniffing out fiscal imprudence. Yet, this narrative is built on misunderstandings and misplaced reverence for an institution that is neither necessary nor productive.

The Myths of Market Discipline

Let’s break down the received wisdom. We are told that government borrowing is constrained by the willingness of investors to lend. When spending and borrowing exceed some implicit threshold of acceptability, markets “strike back,” driving up yields and demanding fiscal rectitude. According to this view, the UK government’s plans to issue £300bn of gilts this tax year—to cover a deficit augmented by £32.3bn annually over the next five years—represents a breach of that threshold. Bond investors, alarmed by a perceived lack of discipline, have sold off.

None of this is true.

The UK government does not need to “borrow” in any conventional sense. Spending by the government is an act of money creation. When the government credits a bank account, the Bank of England records a corresponding credit and debit on its balance sheet. Taxes operate in reverse, debiting bank accounts along with a corresponding debit and credit recorded on the Bank of England balance sheet. The result is a balancing item in the accounts, which is all ‘government borrowing’ really is - occurring as a natural function of double-entry accounting, not the rapacious whims of financial brigands.

Gilts are not a necessity but a political choice stemming from the outdated “full funding rule.” This policy requires the issuance of bonds to cover deficits, a remnant of an older economic orthodoxy linked to the long-defunct gold standard. In reality, these bonds merely offer investors the option to exchange overnight reserves (which pay the Bank of England’s Bank Rate) for longer-term instruments with a fixed yield.

The Economics of Parasitism

What function, then, do bond investors serve? Advocates might argue they provide discipline, ensuring governments use public funds wisely. Yet this discipline is illusory. The bond yield is simply the market’s expectation of future Bank of England policy rates. Investors do not “set” borrowing costs; they predict them. The entire bond market’s existence rests on the unnecessary act of swapping one type of government liability (reserves) for another (gilts).

Far from being the guardians of fiscal virtue, bond investors resemble the money changers of biblical lore—skimming off the system while adding no value. Their profits are a deadweight loss to the economy. The intricate dance of issuance, trading, and yield curve management consumes resources and employs talent that could be deployed in more productive sectors. Financial engineers who might design systems to combat climate change or improve healthcare instead spend their days shaving basis points off gilt portfolios.

A Political Choice, Not an Economic Necessity

Ending the bond market is not a radical idea but a logical step toward modernising public finance. If the UK government were to eliminate the ‘full funding’ rule, it would continue to settle its obligations just as it has been doing since the 1860s—by directly crediting bank accounts. Private banks would receive the Bank Rate on their deposits held at the Bank of England, and the costly bond issuance process would end.

Critics may raise concerns about inflationary risks or a potential loss of market discipline, but these fears are unfounded. Inflation is determined by the balance between aggregate demand and real economic capacity, not by the actions of bond traders. Ultimately, fiscal “discipline” is a political choice best exercised through democratic means rather than being delegated to unelected financial elites.

Reclaiming Public Purpose

The bond market, far from being an essential institution, is a parasitic appendage—one that has outlived whatever utility it might once have had. By continuing to issue gilts, the UK government perpetuates a system that benefits a narrow class of financial intermediaries at the expense of the broader public. The talents of those currently employed in the bond market could be better used in sectors that address real-world challenges.

It is time to euthanise the bond market—not with malice but with a clear-eyed understanding that its continued existence serves no public purpose. Just as the money changers were driven from the Temple, so must we clear out this vestige of an outdated economic paradigm. The myth of the vigilantes must be dispelled. Only then can we create a monetary system that serves the needs of everyday people.

As Larry Elliott, the best thing in The Guardian, writes:

There are plenty of tough jobs in politics but none tougher than the one just handed to Sébastien Lecornu, the third French prime minister to be appointed by Emmanuel Macron in a year.

Lecornu has been given the nigh-on impossible task of getting an austerity budget through parliament at the head of a minority government facing implacable opposition from parties of the hard right and hard left. Talk about poisoned chalices.

The conventional wisdom is that Macron and his succession of premiers are the only ones prepared to face up to reality, which is that France’s unwillingness to get serious about reducing its budget deficit leaves it at the mercy of the financial markets.

Sooner or later, the bond market vigilantes – the collective term for traders in government bonds – will force the French political class to act. Eventually, the warring political parties will accept the truth of what Margaret Thatcher said in the 1980s. You can’t buck the market.

Britain, so the story goes, also needs to wake up, or else the markets will be coming for us next. There is still a chance to avoid a meltdown, but it requires the sort of action that French MPs have so far resisted. Raise taxes. Cut welfare. Take the axe to spending programmes.

The reason France and Britain have no choice but to do this is because states are weak and markets are all powerful. The bond markets exert their power through their role in buying and selling government bonds. If they sell en masse, the interest rates governments pay to borrow goes up and they can be forced to change policy even when they are reluctant to do so. It has been the received wisdom for the past 50 years that governments should do what bond traders and speculators demand, or risk being crushed by the global financial juggernaut.

There is an alternative narrative, which goes like this. Britain has its own currency and a central bank with the ability to set interest rates. It is not France – and the idea that contagion will spread across the Channel is an attempt by the political right to dragoon the UK chancellor, Rachel Reeves, into actions that will be unpopular as well as pointless.

It is also worth saying that markets are powerful, but not all-powerful. They operate within the legal and institutional frameworks created by governments – and when the going gets tough, they rely on governments to dig them out of a hole.

During the global financial crisis of 2008 and the Covid pandemic of 2020, the markets were only bailed out thanks to the willingness of governments to print money and run big budget deficits. There was no talk of the need for the bond market vigilantes to impose financial discipline back then.

Just as the power of markets is exaggerated, so the power of states is underestimated. What happened in the 1970s and 1980s was that states were shaped by a rightwing ideology which meant, among other things, the removal of curbs on the movement of capital. These restrictions had been put in place for a reason: so that governments could go for full employment, build up welfare states and reduce inequality.

Removing capital controls has been good for big finance and multinational corporations, but has made it harder for governments to pursue domestic economic strategies. States have not grown weaker during the past half century, they have merely served a different class interest.

To be sure, there are times when the markets get it right and governments are clearly wrong. Black Wednesday – the day in September 1992 when George Soros forced Britain out of the European exchange rate mechanism – was an example of that. While a humiliation for John Major’s Conservative government, Black Wednesday allowed interest rates to fall and proved to be the catalyst for a powerful economic recovery.

But the markets are not always right. The idea that austerity measures were needed to keep bond markets happy and thereby create the conditions for growth proved to be a fantasy in the aftermath of the financial crash, and is no more plausible in the France or Britain of today.

Nobody could accuse Macron of being anything other than a market-friendly president. He has cut corporate taxes and raised France’s retirement age. And a fat lot of good it has done him. Under his presidency, the French economy has continued to struggle. All of which means the real lesson for Britain from France is somewhat different from the one trumpeted by the political right.

Reeves is correct to make faster growth her priority, because it will lead to higher tax revenues and fewer people claiming benefits. But sucking demand out of the economy through tax increases and spending cuts will lead to weaker growth and a higher deficit, prompting further demands from the markets for remedial action. Speculation about which taxes are going to rise in November’s budget will probably sap business and consumer confidence.

Labour, like other centre-left parties, faces a choice. It can argue that financial markets are often capricious and destructive. It can argue that uncaging finance has not produced the improvement in economic performance promised by the Thatcherites. It can argue that the whims of the markets should not be allowed to prevent the need for a generously funded industrial strategy. It can argue that by raising tariffs and taking a stake in the US chipmaker Intel, Donald Trump has made the unthinkable thinkable. It can make the case for targeted and transparent controls to prevent short-term capital movements blowing the economy off course.

Alternatively, it can use “you can’t buck the markets” as a justification for passivity and, by doing so, chart a course for eventual defeat. As the parlous state of centre-left parties across Europe shows, timidity will have economic and political consequences.