The crisis that broke out in the British bond markets is one of the first signs of the new kind of crises that we will see in developed economies.
Until now we have been dealing with the current economic situation in terms that have mostly come from the past, such as trying to see inflation rising based on the stagflation experience of the 1970s.
Little effort has been made to see the emerging landscape as a new landscape, part of the era that remains uncharted, with crises that capture the contradictions that emerged from the economic policies implemented from the 1980s onwards: privatisation, liberalization and internationalization of banking systems, the skyrocketing of global debt, the unprecedented “financialization” of the global economy, and the development of highly complex financial products and transactions.
These features have been combined with the globalization of production, the formation of highly complex and interdependent supply chains and new forms of international division of labour.
At the time of first the pandemic and then the war in Ukraine and the new divisions of the modern world – divisions that also have to do with the economy, if we consider the US economic war against China in high technology – all these features have led to the emergence of crisis trends: from the burst of inflation (which cannot be attributed to “wages and unions” or the “rigidity” of the economy), to new recessionary dynamics.
At the same time, the thinking of economic policymakers is still marked by the characteristics of a previous era: the perception that taxes are an obstacle to growth, tackling inflation through interest rate policy, limiting government intervention to “Banking Keynesianism” of “quantitative easing” programs. All of these can just cause problems.
The British experiment
Britain’s new government has simultaneously decided to spend up to £60 billion to help households and businesses cope with energy costs, while also making cuts to income tax and business tax. In this way, Liz Truss believed, she could put her special financial plan into practice.
But the combination of increased spending and reduced revenue means increased borrowing and thus an increase in Britain’s public debt of more than £400 billion, or almost 20% of GDP. Given that Great Britain’s debt is already at 100% of GDP, so Britain was entering a high debt phase, the markets responded by hitting British bond prices. Except that when bond prices fall, their yields rise, that is, their interest rates rise.
The de facto rise in interest rates based on the terms of the bond market was met with increases in key interest rates by the central bank as a means to tackle surging inflation. So all of this meant that relatively suddenly the cost of borrowing and also the cost of servicing the debt went up a lot.
Some investors such as Pension Funds that have a large volume of bonds in their portfolio have had a double whammy. And this is because such Funds tend to invest in long-term bonds by raising funds from the market with short-term borrowing. Now they have seen short-term interest rates rise significantly and bond prices in their portfolios collapse, in short the worst possible combination.
This was made worse by the constant attempt by such funds to buy bonds using them as collateral to borrow to buy even more bonds. But if the value of the bonds they use as collateral falls significantly, then they cannot borrow.
At the height of the crisis when long-term bond yields reached 7-8% from 4.5%, this meant that 90% of Pension Funds would run out of guarantees. And that would be a disaster since the mechanism by which they are constantly borrowing would collapse.
The Bank of England’s decision to buy 65 billion of these bonds was necessary in order not to collapse the system that had effectively reached a liquidity crisis.
An air of crisis in the markets
It is not only in Great Britain that we observe such trends. The yield on the ten-year US treasury, which is a benchmark for global borrowing costs, has passed 4%, while at the end of August it was 3.2%. But the traditionally more volatile two-year has also seen its return climb 3.55% this year.
In other markets this increase in borrowing costs and the restriction of liquidity has even more pronounced forms such as the collapse of bitcoin prices.
But all this has a wider impact on the economy. To a large extent, the high profitability throughout the post-crisis period of 2008, with the exception of the pandemic recession of course, was combined and to some extent supported by a sustained decline in interest rates and borrowing costs. This created liquidity but also opportunities for profits from investments in the financial sphere that became part of the strategy of all large groups.
If the estimates of declining profitability in combination with this rise in interest rates and borrowing costs are true, then we are likely to have the signs of a more comprehensive financial crisis, which this time will also coincide with the escalation of geopolitical tension.
