Add some noughts, Mr Sunak

UK bond market turmoil signals need for urgent fiscal stimulus

In a crisis, the most important thing the authorities can do is get ahead of the chaos. Yesterday (Thursday) we saw the Bank of England scrambling to do just that — but in a way unprecedented even in the 2008 meltdown. And we still don’t know if it will work.

Having cut interest rates to 0.25% last week, and launched a scheme to help banks lend to small and medium-sized businesses, the Bank then faced “deteriorating conditions” in the market for UK government debt.

Normally, in a crisis, investors move their money from risky assets to safe ones; shares are risky, government debt is safer, with the safest ones of all being those with the longest maturities. But in the past week, investors have been clamouring instead for government bonds with the shortest lifespan because these are a close substitute for cash.

So at an emergency meeting, the Monetary Policy Committee not only slashed interest rates again, to 0.1%, but restarted its quantitative easing programme (QE), to the tune of an extra £200bn.

The normal aim of QE is to simulate the effect of cutting interest rates below zero — ie pump money into the banks — while forcing investors to move their money out of bonds and back into shares, property etc, where they can help fuel growth.

Yesterday’s move had a more urgent objective: to stop investors pulling their money out of the UK financial system altogether. In the past month the pound has fallen 13% against the dollar and 10% against the Euro, despite the fact that the Eurozone is more badly affected by the coronavirus, and that the USA has screwed up its own crisis response.

There is a global flight to safety and the UK, with its poor growth because of damaging austerity programmes, and with high uncertainty around Brexit, looks vulnerable.

The strategic question facing global investors is: which governments will do fiscal stimulus hardest, fastest and most successfully. Up to now the UK has done too little. Rishi Sunak’s budget contained, effectively, just £12bn of extra spending for coronavirus. Today he needs to start adding some noughts to the amount spent.

The £330bn soft loan facility to firms, and the £190bn release of bank reserves for lending to small companies were welcome — but this is going to need borrowing and spending by government on a vast scale: to pay people’s wages, to bail out failing airlines, and to force-march the manufacturing sector into producing ventilators.

I have argued before that, like Japan, the Treasury should be prepared to issue debt that is bought direct by the central bank — so-called monetisation. The orthodox view is that this, itself, would undermine sterling and thus fuel inflation, but given we’re about to experience the worst economic slump in history, deflation is the bigger danger.

If it won’t allow the bank to buy its debts direct, the government in any case needs to borrow at scale: a full emergency basic income scheme for six months would cost around £300bn. That’s a massive sum but would still leave UK debt below 90% of GDP (Japan’s debt is 196% of GDP) .

As the Systemic Risk Council warns, the Treasury should be wary of relying on globalised financial markets for this newly issued debt, and instead “prioritize distribution to domestic long-term investors”.

In practice, this means an element of what economists call “financial repression”. You have to be able to prevent money flowing out of the country, and coerce domestic savers to lend to the government by giving them nowhere else to go.

This is exactly what post-war governments did — and combined with sharp inflation in the 1940s and 50s it quickly eroded the debts they had piled up during the Second World War. But if Britain and other major states did this, the highly globalised financial market would — just as it did in the 1930s — retreat to a series of closed, regional and national markets.

Marx used to say that all economic crises are a memento mori for capitalism: this week’s turmoil on the bond market is a memento mori for globalised finance.

Whatever happens in the long term, the growing turmoil must force Chancellor Sunak to take unleash a decisive fiscal stimulus — borrowing hundreds of billions — today.