"Voldemort" in the City of London

BarcelonaIf in a country the central bank governor has to publicly deny having carried out a covert coup d'état to overthrow a democratic government, it is logical to think that the country may have a problem with its central bank – and with the governor in question–. This is exactly what Andrew Bailey, governor of the Bank of England, had to do in November 2022, following Liz Truss's resignation as Prime Minister of the United Kingdom just 44 days after taking office. As if Truss's bad luck were not enough, during her brief tenure, Queen Elizabeth II died.

"We did not bring down the government", Bailey said a month after Truss's departure from Downing Street. "We carried out a limited operation for financial stability purposes and we did exactly the right thing and finished it quickly", he explained. If Bailey and the institution he presides did "the right thing", why was he accused of bringing down the government? And why are some British commentators now – especially those on the left – warning that he could do the same to the executive of the current Prime Minister, the Labour leader Keir Starmer? The reason is the peculiar pressure of the debt markets on British government bonds – popularly known as gilts–, which ties the country's administration hand and foot.

The fall of Truss's government four years ago occurred following the presentation of a budget described, even within her own Conservative Party, as "irresponsible", because it provided for a tax cut of 45 billion pounds sterling (about 52 billion euros) without specifying where the money would come from; that is, whether it would cut spending or maintain it through more borrowing. The markets' response was immediate and the interest rate paid by the British government on gilts skyrocketed.

The theory is that investors clearly saw Truss's fiscal irresponsibility and the risk it posed to public finances, so they punished the United Kingdom with a higher cost of its debt. That case, moreover, brought a set of pension funds that had borrowed to buy gilts to the brink of collapse.

Bailey's response, however, was not what was expected, and this is where the accusations against him arise. Former Federal Reserve official Narayana Kocherlakota published an article in Bloomberg at the time with a very clear headline: "The markets did not bring down Truss, it was the Bank of England".

Lack of intervention

Normally, in Western countries, when the interest rates governments pay for their debt rise too much, central banks intervene in the markets to lower them with massive bond purchases. That is, despite being independent of the government, since they are public entities, they act as lenders of last resort for the state and prevent the cost of borrowing from being so high that it deprives administrations of the ability to carry out the policies for which they were elected by citizens.

However, in 2022, the Bank of England only bought bonds for two weeks. "At that crucial moment, the Bank of England shirked its commitment to safeguarding gilts", wrote a month ago in The Guardian, Daniela Gabor, a professor of economics at the prestigious SOAS, the school of oriental and African studies at the University of London, and one of the most critical voices of Bailey.

In 2020, Bailey replaced Mark Carney as governor (now Prime Minister of Canada). Both during the 2008 financial crisis and with Brexit, the Bank of England had opted for the so-called quantitative easing (quantitative expansion), a massive public debt purchase program to prevent that, despite the crises, the British government could finance its debt without excessive suffering. When he arrived at the institution, however, Bailey did the opposite: quantitative tightening

(quantitative contraction), that is, selling bonds massively.

These sales have not only increased the interest rate that the British government pays each time it has to issue new debt, but they also send a message to the markets that the central bank has no intention of being a support, for the moment, for the executive's policies. It should also be taken into account that, when public debt interest rises, the government and citizens lose out, as a larger portion of their taxes is dedicated to financing debt instead of social programs or investments, but investors gain, especially those who speculate with bonds.

Bailey has been particularly aggressive in his desire to divest his bond portfolio – between 2022 and the present, he has sold around £134 billion in securities – especially when compared to other nearby central banks, such as the European one, which have stopped buying debt, but have not sold it as aggressively. Currently, the United Kingdom pays approximately 4.9% annual interest on its 10-year bond, while Spain pays 3.5%; the US, 4.5%; France, 3.6%; and Germany, 3%.

Starmer, like Truss

Now Starmer finds himself in a similar situation to Truss. After his party lost local elections last May, he has less room for manoeuvre to implement spending and investment policies that would help the British economy recover, because the cost of borrowing is much higher than in other similar countries where public debt is a cause for concern, but not governmental paralysis. "It is not the bond market that, after Liz Truss's disastrous administration, has become an object of great fear for left-wing politicians, but rather Voldemort, He WhoMust Not Be Named, that is, the Bank of England and Andrew Bailey, its governor, who are really the key figures," assured Adam Tooze, professor of economic history at Columbia University in New York and a columnist for the Financial Times, on his podcast with Foreign Policy magazine.

The comparisons made by Tooze between Bailey and the evil wizard from the Harry Potter books are no coincidence: "There is no reason why a state like Great Britain should be subject to blackmail by bond markets if the central bank does its job properly," added the Columbia economist. "If we are concerned about the bond market, we should also talk about the central bank," he opined.

Despite the growing insistence among some media commentators that the Bank of England has shirked its duties, Starmer and no other politician in his party have ever dared to point the finger at Bailey. Truss did so at the time, accusing the deep state (the group of unelected public officials and agencies) of bringing her down. Bailey's response was simple: "I don't know what that means".