Labour’s biggest opponent is no longer the Conservative Party. It is the bond market: a 150-pound XL Bully that Chancellor Jeremy Hunt currently keeps on a lead. It ripped apart the Truss government in 49 days. It is the underlying reason why Keir Starmer abandoned his £28bn green pledge last week.
What Labour seems to miss is the fact that finance is as much a piece of theatre as politics. On the surface, bond prices might seem rational, driven by hard-headed 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.
At present the Tories are in charge of the narrative. They have turned the collapse of the Truss government to their advantage: as a warning to the world of what might happen if Labour was to finance its spending plans through increased debt. Since Labour has also pledged to avoid major tax rises, Starmer has found himself scaling back his ambitions for Britain with every tax cut the Conservatives consider. All he can do is retreat and complain that the Tories have “maxed out the UK credit card”.
If he had been paying more attention on 7 February, the day before he dropped his green pledge, he might have seen an opportunity to offer a better story on the bond market. That was when the Treasury Select Committee published its report on “quantitative tightening” (QT). It sounds an arcane subject but it has huge importance for 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). There were two objectives: staving off financial meltdown and ensuring that economic demand did not collapse.
The strategy worked, but the Bank of England now holds £738bn of government bonds. It wants to sell them back to the bond market through QT. The Treasury Select Committee is alarmed, describing the strategy as a “leap in the dark”. Between £50bn and £130bn could be lost as a result of the exercise “with potentially significant impacts for HM Treasury’s spending power for the next decade”, its report said.
Hunt clearly isn’t worried by this. Less money in the Treasury means less money for Labour to promise in its manifesto. The rest of us should care a lot about this: the money saved by abandoning QT could pay for Starmer’s original £28bn green pledge four times over.
The losses the select committee is troubled by reflect the difference between the price the Bank bought the bonds for and the price at which they now might be sold. Bond prices go down when interest rates go up and they also go down when the market is flooded with bonds for sale. But that is not the only cost of the Bank’s bond holdings. Each month the Treasury has to pay interest on the bonds to the Bank and when the bonds become due, the Treasury has to find the money to repay the full value of the principal to the Bank. The Bank doesn’t keep the money it receives from the Treasury in this way – it cancels it. We are quite literally paying taxes for nothing.
The total amount of income tax, national insurance contributions and capital gains tax revenue the Treasury received in the last tax year was £788.6bn. If the Bank chooses to hold its portfolio of government bonds to maturity, the taxpayer will have to hand over around £800bn in interest and principal payments to the Bank for destruction over the next decade or so. If the Bank sells its bond portfolio to private investors, the taxpayer remains liable for this amount plus capital losses of up to £130bn.
The opportunity for Labour is to find a better way of managing the Bank’s bond portfolio. This could not only help Starmer win the current “borrow to invest” debate that he seems to be losing; it could also be used to further destroy the Tories’ reputation for prudence.
The first step towards seizing this opportunity is to recognise that the £741bn of government debt currently held by the Bank isn’t real. It is the by-product of a piece of financial alchemy that has long since served its economic purpose. It can be made to disappear as easily as it was made to appear. It cannot be allowed to burden British taxpayers for decades to come.
Of course, Starmer and his shadow chancellor Rachel Reeves can’t say this in so many words. They have to use the language and rituals of financial alchemy.
The financial world likes to speak in opaque, bureaucratic prose. Talk about printing money scares it but an obscure acronym such as QE is calming. Similarly, we should not talk of making the debt disappear. We should talk about the Bank reducing its balance sheet by transferring the outstanding bonds into a special dividend to the Treasury for cancellation. We could call it something soothing such as “quantitative neutralisation” (QN). Cancelling it would have a neutral impact on the money supply. The money created under QE originally has long since been spent. It can’t come back to life and create more inflation.
The bond market should find QN reassuring compared to the alternative, which is 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 that Labour would need to manage through soothing language. It could talk about binding itself to a public spending framework that ensures any rise in prices is productivity-led. It could reassert its commitment to not borrowing for day-to-day spending and to reducing debt over the business cycle. It could also talk about the paramount importance of the Bank’s independence, just in case anyone fears that Labour would seek to take control of its printing presses.
Besides the language, the rituals of financial alchemy also have to be respected. The idea of quantitative neutralisation can’t be seen to come from Labour: that would make it immediately suspect. It has to be first proposed and discussed by the priesthood of economists and bankers. This will help QN seem stale rather than dangerous. Then, at some point, the arch-mage of financial alchemy must give his opinion: Gordon Brown must pronounce that QN was always the way he envisioned QE ending. Only then can Starmer use this magic to wrest the lead of the XL Bully from the Tories’ grasp.
And what a bite it will have. The Tories will look like dangerous chancers prepared to spend £130bn of taxpayers’ money to win an election, while Labour will look like the party that has opened the secret door to the future.
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[See also: Bankers’ bonuses are good for the economy]
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