So much for taking back control – Britain is tumbling into a full-blown sovereign debt crisis

When I was a small boy at school, Andrew Bailey was a prefect and, then as now, a distant figure of authority. We called this stout disciplinarian “Bastard Bailey” because he showed little mercy towards any pupil he discovered enjoying an illicit Rothmans behind the science labs. Entreaties for clemency based on fictional bereavements or medical conditions were routinely ignored. Names were obtained, noted and passed on for appropriate action.

Sean O’Grady

Seems he hasn’t changed that much. The distressed pension funds begging him to buy their devalued British government bonds have been met with that same stony resistance. He’s right, in the sense that propping up pension funds in trouble isn’t the role of the Bank of England. It’s not their fault that they’re in trouble – that’s because the panic-inducing effects of the mini-Budget are still being felt throughout the financial system and the economy.

Maintaining financial stability is the task of the Bank, which is why the Bank ended up buying the funds’s gilts, but it couldn’t do so endlessly or across the entire £1 trillion industry. It seems Bailey concluded that there’d be no “contagion” from his move. It’s up to the government and the pension fund trustees and regulators to order any rescues, and the Bank will no doubt advise on making them work.

In effect, like it did with the failed banks in the financial crisis of 2008, Britain may need to effectively nationalise some of these final salary funds, if the deficits become that large. If that happens, then final salary scheme pensioners will have some or all of their income guaranteed by the UK taxpayer, which some might find odd.

More to the point, the resulting debt taken on by the government will add to the national debt, along with the massive liabilities racked up over a couple of world wars, the global financial crisis, the Covid furloughs and Brexit.

There are hints that Bastard Bailey may, unusually, relent and carry on propping up these pension funds, but the dilemmas remain. It’s not financially sustainable for the Bank; and it’s not easily consistent (if at scale) with selling gilts to push interest rates higher to push inflation down.

It feels like the financial system is continuing to come under stress because investors do not trust the government to manage the economy and public finances responsibly. The solvency of pension funds and banks are intimately linked to UK plc, because these institutions rely on gilts as a “safe” asset – and now they’re not. That’s a systemic problem. A very big one.

Though as yet undeclared, the United Kingdom seems to be tumbling into a full-blown sovereign debt crisis. That is, of course, simply financial jargon for a country at risk of being insolvent – unable to honour its debts as they become due. Investors seem less and less willing to fund the activities of the British government, and less and less inclined to allow the nation, in colloquial terms, to roll over its overdraft or max out the credit card again. It could scarcely be more serious.

The Bank can try and keep liquidity up and interest rates down to save the pension funds; or it can restrain inflation by pushing interest rates up – but it hasn’t the means to do both. Britain may need a loan if the markets close to it. That is what the International Monetary Fund (IMF) is for – to restore order and confidence, as well as lend money.

It is astonishing. All investors want to know, in return for lending His Majesty’s government thousands of millions of pounds, is how sure they can be that they’ll get their interest paid and their money back. It is not too much to ask. They are not much interested in fairy tales about “unleashing potential” and Brexit opportunities.

At the moment, America seems the safest haven, and Britain the least safe among the major economies. It is not a good place to be. If things spiral downwards, because Liz Truss cannot get either tax increases or spending cuts, or both, through parliament, then the IMF will be needed to rescue the British from their own incompetence. There may be another change of prime minister, of chancellor, or a general election and a new government. In any case, we cannot go on as we are, because the money has run out. So much for “taking back control”. Trust is at a discount.

The storm that began on 23 September was and is a direct result of Kwasi Kwarteng’s disastrous mini-Budget. Mini-Budget; maxi trouble. Despite attempts to row back, the storm has blown up again. Having dismissed the permanent secrecy to the Treasury, Sir Tom Scholar, presumably because Sir Tom had the temerity to point out the flaws in the chancellor’s approach, Kwarteng has now appointed another civil service lifer, James Blower, to try and restore confidence. It has been to little avail.

Nor has his decision to bring his next mini-Budget forward to 31 October, and, at last, the appropriate forecasting from the Office for Budget Responsibility (OBR). And of course he has U-turned on the abolition of the 45 per cent additional rate of income tax. It settled things for a while, but it will take much more to get investors to invest in Britain. Ironically, that was the whole purpose of the mini-Budget as the driving force in Truss’s ill-fated dash for growth.

The UK has spent decades trying to improve its credibility as a destination for international investors. Part of that was building up a strong institutional framework whereby monetary and fiscal policy would be scrutinised and made transparent – an operationally independent Bank of England accountable to parliament on its performance; a strong independent Treasury with the ability to reevaluate politically motivated or vanity projects; the OBR; and a range of ratings agencies, think tanks and parliamentary committees able to raise legitimate questions and keep ministers “honest”. Successive chancellors worked within this system, aside from a brief hiatus when Rishi Sunak was supposed to turn the Treasury into an arm of No 10.

However, during the Tory leadership campaign, Truss, as candidate, and Kwarteng, as her campaign aide, and then again as prime minister and chancellor, systematically trashed this structure. They derided the “abacus” mentality of the Treasury and its “orthodoxy” and briefed how they’d love to break it up.

Kwarteng carelessly rubbished the Bank’s record, bullied its governor, Andrew Bailey, while Truss openly discussed changing its remit to make it more pro-growth (and thus weaker on inflation). The OBR was sidelined in the mini-Budget process. The civil service was ignored. All of these institutions were called a “blob”, and Truss implied they were part of some “anti-growth coalition”. It’s absurd, and the stuff of conspiracy theories. How did the Tory party end up here?

Such is their delusion that Truss and Kwarteng blithely assumed that the markets would take the vague “plan for growth” at face value, and that trend growth would soon be restored to 2.5 per cent per year. Investors were confidently thought to be willing to believe that the biggest tax cuts in half a century would pay for themselves before long. They didn’t, which was bad enough, but now Truss and Kwarteng are believed to be so untrustworthy, there is an additional risk premium being applied to Britain, due to it being led by such unimpressive figures.

Britain is not a basket case, even if its present incipient sovereign debt crisis bears an uncomfortable resemblance to the problems that Greece, Italy, Portugal and Spain suffered during the various euro crises around a decade ago. When the Callaghan government turned to the IMF for help in 1976, it did Britain some good, and the loan wasn’t needed until a year later. But, as in those cases, some outside intervention was needed to restore confidence.

An IMF team sitting in the Treasury and taming Kwarteng’s tendency to arrogance and restoring investor confidence would at least start the process of recovery. Our pension funds and banks will be all the safer if the present government is replaced by an IMF committee. So much for taking back control.