Labour’s greatest adversary is no longer the Conservative Party. This is the bond market: a 150 pound Bully XL that Chancellor Jeremy Hunt is currently holding. He destroyed the Truss government in 49 days. This is the underlying reason why Keir Starmer abandoned his £28 billion green pledge last week.
What Labor seems to forget is the fact that finance is as much a play as politics. On the surface, bond prices may appear rational, driven by sound decisions about inflation, interest rates, and credit risk. Underneath, however, they represent the same seething mass of human hopes and fears in search of a story that we see in politics.
Right now, conservatives are in charge of the narrative. They turned the collapse of the Truss government to their advantage: as a warning to the world of what could happen if Labor financed its spending plans with an increase in debt. Since Labor also pledged to avoid major tax rises, Starmer has found himself scaling back his ambitions for Britain with every tax cut the Tories consider. All he can do is retreat and complain that the Tories have “maxed out the British credit card”.
If he had been more attentive on February 7, the day before abandoning his green pledge, he might have seen the opportunity to present a better story to the bond market. It was at this time that the Treasury Select Committee published its report on “quantitative tightening” (QT). This seems like an obscure subject, but it is of vital importance to the future of our economy. Between 2009 and 2022, the Bank of England used electronically created money to buy UK government and corporate bonds (quantitative easing). The objective was twofold: to avoid the financial crisis and to ensure that economic demand did not collapse.
The strategy worked, but the Bank of England now holds £738 billion of government bonds. He wants to resell them on the bond market via QT. The Treasury Select Committee is alarmed, calling the strategy a “leap into the unknown”. Between £50 billion and £130 billion could be lost as a result of the exercise “with potentially significant impacts on the purchasing power of the UK Treasury for the next decade”, the report said.
Hunt is clearly not worried about that. Less money in the Treasury means less money Labor could promise in its programme. The rest of us should care a lot: the money saved by ditching QT could pay for four times as much as Starmer’s original £28bn green pledge.
The losses that worry the select committee reflect the difference between the price at which the Bank bought the bonds and the price at which they could now be sold. Bond prices fall when interest rates rise and also fall when the market is flooded with bonds for sale. But this is not the only cost of the Bank’s bond holdings. Each month, the Treasury must pay interest on the bonds to the Bank and when the bonds mature, the Treasury must find the money to repay the entire principal value to the Bank. The Bank does not keep the money it receives from the Treasury in this way: it cancels it. We literally pay taxes for nothing.
The total amount of income tax, national insurance contributions and capital gains tax revenue that the Treasury received in the last fiscal year was 788.6 billion pound sterling. This is less than the total amount of taxpayers’ money the Treasury will hand over to the Bank of England for destruction over the next decade.
The opportunity for Labor is to find a better way to manage the Bank’s bond portfolio. This could not only help Starmer win the current “borrowing to invest” debate that he appears to be losing; it could also be used to further destroy conservatives’ reputation for prudence.
The first step to seizing this opportunity is to recognize that the £741 billion of public debt currently held by the Bank is not real. It is the byproduct of a financial alchemy that has long since served its economic purpose. We can make it disappear as easily as we made it appear. This cannot be allowed to burden British taxpayers for decades.
Of course, Starmer and his shadow chancellor Rachel Reeves can’t say that in so many words. They must use the language and rituals of financial alchemy.
The financial world likes to speak in opaque and bureaucratic prose. Talking about printing money scares him, but an obscure acronym like QE is calming. Likewise, we should not talk about making the debt disappear. We should consider the Bank reducing its balance sheet by transferring outstanding bonds as a special dividend to the Treasury for cancellation. We could call this something calming like “quantitative neutralization” (QN). Its cancellation would have a neutral impact on the money supply. The money initially created under QE has long since been spent. It cannot come back to life and create more inflation.
The bond market should find QN reassuring that the alternative would be for the Bank to flood the market with government bonds worth 28 per cent of UK GDP. There would still be a risk of higher inflation which Labor would have to manage with calming language. This could include tying into a public spending framework that ensures that any price rises are driven by productivity. It could reaffirm its commitment not to borrow for daily expenses and to reduce its debt throughout the economic cycle. He could also talk about the overriding importance of the Bank’s independence, just in case anyone was concerned that Labor was seeking to take control of its money printing presses.
In addition to the language, the rituals of financial alchemy must also be respected. The idea of quantitative neutralization does not seem to come from Labour: that would immediately make it suspect. It must first be proposed and discussed by the priesthood of economists and bankers. This will help QN appear outdated rather than dangerous. Then, at some point, the archmage of financial alchemy must give his opinion: Gordon Brown must declare that QN was always the way he envisioned QE ending. Only then can Starmer use this magic to rip the head of the XL Bully out of the hands of the Tories.
And what a mouthful it will be. The Conservatives will look like dangerous chancellors willing to spend £130 billion of taxpayers’ money to win an election, while Labor will look like the party that opened the secret door to the future.
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[See also: Bankers’ bonuses are good for the economy]