I’m worried about Andy Burnham

The Makerfield by-election has been announced and Labour Mayor of Greater Manchester Andy Burnham is aiming to win the seat. Once in Parliament he intends to instigate a Labour leadership contest and become Prime Minister without having to trouble the wider electorate.

While I am unimpressed by Burnham as a leader —  his record as Mayor is flattered as a result of central government funding — what I am actually worried about is the tendency that Burnham represents, or has at least flirted with, when it comes to government borrowing.

Which is to say: he thinks you can tell the people lending you money to fuck off. 

But then, he’s never had to convince anyone to lend an organisation he leads money. He has increased Greater Manchester’s need to borrow by a billion pounds, but the £1.4bn the authority owes came direct from the Treasury.

The UK government spends money and raises tax to pay for it. However, the tax receipts never match the profile of spending exactly, so the government needs to meet the deficit. The deficit can be caused by a timing mismatch. For example, lots of spending in December but low tax receipts then lower spending in January and higher tax income, or it can be a case of the government spending more than it raises over the year.

In theory, the government could just print more money to cover the deficit, and that’s one of the things that advocates of “Modern Monetary Theory” would suggest. In very constrained terms, it also has its place in mainstream economics — it’s part of how Quantitative Easing works, and it is exactly how the Bank of England’s Ways and Means Facility provides the government overdraft which smooths out day-to-day cashflow.

However, printing money to pay for spending has had unintended consequences, namely very high inflation, so to avoid this the government borrows the money. (There are other reasons it can be useful to borrow money, such as providing safe assets for the economy, and lots of other reasons printing money is undesirable, but we’re keeping this simple.)

The main way the government borrows money is by issuing bonds known as Gilts. Gilts come in different forms, such as inflation linked or zero coupon, with varying durations, but most pay a fixed interest rate twice a year, with the original amount paid back at maturity. 

The great thing about Gilts is that they are a tradable instrument. This means you can lend money to the government for 20 years, but if you decide you want your money back early you can sell the right to the debt and remaining interest to someone else. This is great! It means you get to lend your money to someone who will almost definitely pay you back and that if you want your money back early you can get it. It’s also good for the government, the ability to trade its debt means people are willing to lend money to them for much longer than than otherwise.

All of this has led to the bond market you’ve read about; people who buy and sell government debt as a job. This is what people mean when they say “the bond markets” isn’t some mysterious shadowy group, it’s just a bunch of blokes (and some women, because of woke) buying and selling government debt. Some of them are traders, doing so purely to make a profit. But the majority are just looking to park money somewhere safe: pension funds, insurance companies, big companies and so forth. 

The Bond Market is only a “thing” the way a car boot sale is, not one thing, just people buying and selling.   

I promised to tell you why Burnham is bad, and we’re nearly there, but this is the important bit. The gilt market is like any market. It is made up of buyers and sellers. If there are more buyers than sellers then the price goes up, if there are more sellers than buyers the price goes down. As most gilts have a fixed coupon (interest rate) if the value of the bond falls then yield (the interest payment compared to the value of the Gilt) rises. When the government issues new Gilts, it does so at the current market rate. So:

1. Gilt yields (the market rate) rise when there are more sellers than buyers 
2. The cost of new government debt increases when yields rise
3. Andy Burnham wants to borrow more money to nationalise stuff, which will mechanistically increase the cost of all the new borrowing the government does

Last year the deficit was £132 billion. Back of an envelope calculations suggest that old debt that will need refinancing is about £207 billion a year. That’s £340bn. If Burnham adds 0.25% to borrowing costs that an extra half a billion a year to our collective tax bill (4). For context, rates have risen about 0.20% since the local elections.

No seriously, Burnham is Really Bad

The above is of course an extreme simplification, but all things being equal, if Burnham would make good on his promises the only thing that can happen is yields go up. All things are not equal though, and now we come to “confidence”.

Gilts have historically been seen as a rates instrument. This means that everyone buying and selling them takes it as read they will get their money back at the end. So what really matters is the relative value of the coupon you’re receiving. If the wider interest rate environment is low, then high coupon gilts are valuable, and the government can issue new debt at lower interest rates, with the inverse being true when the wider interest environment is higher. 

If the Gilt Market thinks that inflation is going to be higher, for example because of higher government spending then they will demand a higher return right now to compensate them. If the government is going to borrow more and increase supply of debt, then they will want a higher return. 

Notice none of this involves the greedy capitalist bond market trying to manipulate the virtuous labour government into spending less on the needy. It’s just a bunch of people, only a fraction of whom are well paid bankers, trying to work out if the £50m of gilts they are about to buy will be worth £45m when they come to sell them. 

Take Truss for example, what actually happened at her mini budget(6)? First she did a load of front loaded tax cuts with “jam tomorrow” promises of future spending cuts and / or growth boosting supply side reforms. This meant the Gilt market expected more supply to fund the cuts. She then confirmed one of the biggest non-covid related giveaways in history in the form of the Energy Price Cap immediately adding tens of billions of pounds to the UK deficit and therefore gilt supply. The reaction to this was the market wanted compensating for this new supply, and yields rose. Unfortunately loads of Pension Funds had entered into deals which meant they had to sell gilts if rates rose unexpectedly which suddenly increased supply even further. More supply higher yields. Higher yields higher borrowing costs. Higher borrowing costs, higher taxes/even more borrowing. Everyone shit themselves, Truss got the boot. 

None of this was the new establishment taking revenge for the sacking of Tom Scholar. It was simply a logical reaction to a sudden increase of supply into a market. One of the reasons that rates are higher now than they were when Truss was defenestrated is because all that new supply did come to pass. It just paid for public sector pay rises and the abolition of the two child cap instead of tax cuts.

Andy Burnham doesn’t want us to be “in hock” to the bond markets and his outriders have claimed he will bring the markets “to heel”. This means one of three things:

1. Burnham is planning £340bn+ of tax rises
2. Burnham is planning £340bn+ of government spending cuts
3. Andy Burnham doesn’t know how government pays for spending

Thinking you can just ignore bond markets, when you are relying on them to lend you the money to pay for public services is simply insane. Burnham has promised huge amounts of public spending such as nationalising water companies, and the way he is going about it implies he has no idea how the government gets the money to pay for it.

There’s a world where he does get it and rather than whatever the hell it is he is doing now, he gives sensible Social Democratic statements like “We will look to nationalise some infrastructure such as water companies, but we’re aware that this is a significant undertaking and we’d need to make tough choices elsewhere”. He wouldn’t even need to mean it! But just accepting that there isn’t infinite demand for people to lend money to the government would at least be a start. This isn’t about kissing the arse of the Masters of the Universe at Goldman Sachs, it is about making Colin who runs the treasury function of an insurance company in Norwich less inclined to investigate fully hedged German Bunds.

Burnham doesn’t get any of this because he has spent the last decade as Mayor of Greater Manchester. Whilst there he has increased its need to borrow by a billion pounds, and sits on £1.4bn of external debt, 825 per cent of his authority’s annual revenue. But he has borrowed all of this from central government via the Debt Management Office. He’s never had to consider markets, or convince anyone he’s good for the cash. The treasury has just cut him a cheque at preferential rates anytime he wanted the money.

If Burnham tries this approach as PM, we could be headed for disaster.

There’s a world where this ends in a death spiral. Where higher borrowing costs lead to higher borrowing, and higher borrowing leads to higher borrowing costs. There’s a world where higher government spending leads to higher inflation. Which leads to higher debt costs. Which leads to higher debt.

If you are a left-winger reading this, let me meet you on your own territory. If Burnham leads to significant interest cost increases, even with huge tax rises you will still need to cut services to keep the fiscal position stable. Burnham may promise the policies you want, but his approach is a recipe for reduced investment in public services.

His claim that he will respect Reeves’s fiscal rules rings hollow when you consider his record, what he is promising and the potential for jiggery pokers around categorisation of spend and shuffling tough decisions to the end of the window.

This can just get worse and worse and worse, as it did in Argentina for most of the 20th Century. Argentina was once as rich as Germany and richer than France. It isn’t anymore.

If Burnham, or someone like him gets in, that could be us. Bond markets matter, they’re not a conspiracy and you cannot just ignore them.