‘I used to think that, if there was re-incarnation, I wanted to come back as the President or the Pope … but now I would want to come back as the bond market.You can intimidate everybody.'
James Carville (political adviser to Bill Clinton)
The risk of government bond market meltdown is not restricted to the United Kingdom: the challenge for the U.S. economy is clear for all to see, and now France is the latest EU nation to face the prospect of an humiliating appeal to the International Monetary Fund. The markets are starting to show that they’ve had enough of western democracies piling obligations for repayment onto future generations.
The news that Liz Truss supports Trump in his assault on the Fed is graphic evidence of the incoherence of presidential ‘economic policy’, if it can indeed be described as such. It's not easy setting interest rates in order to find the right balance between rising inflation and falling growth at any time, but to have the President continually seeking to replace Federal Reserve board members with his ‘yes men’ must make it even more difficult. Meanwhile the legal challenge to his global tariff imposition makes the tax-cutting provisions of his ‘Big, Beautiful Bill’ look distinctly premature. No wonder 30-year treasury bond yields are nudging 5% yet again.
Meanwhile UK long bond yields have now increased to 5.6% — a rate which must be sending shivers down the spines of Rachel Reeves and Sir Keir Starmer. Professor Tim Evans drew attention to the dire state of UK public finances in The Bigger Picture on 8th August, and the media are full of warnings of big tax rises to come. This week’s This is Money brings alive the very real attraction for working people to head off to tax-free domiciles such as Dubai, and the exodus of millionaires from the United Kingdom is already well-documented.
Meanwhile, the HM Treasury theory of ‘taxing anything which is fixed to the ground’ is causing serious distortion in the UK housing market, demonstrating that the only real option is to cut government expenditure significantly by ending Attleean universality. As we have said for years at Share Radio, the short-termism of western governments is a real Achilles’ Heel for democracy, and it is desperately unfair on future generations who will have to live with the consequences.
My first main job in the City was to run the Gilt (Government Bond) Settlement and Money department for the then-leading market maker Wedd Durlacher Mordaunt, back In the early 1980s. Margaret Thatcher and Nigel Lawson were hard at work dealing with the financial and industrial chaos that resulted from the 1970s.
By the end of WWII, Britain had amassed a debt of £21 billion, much of which was held in foreign hands. The Bank of England inflation calculator presents this as worth £788 billion in today's money; but this is still only 44% of actual net national debt as at the beginning of this year. Nevertheless, the 1970s Labour Government had to go ‘cap in hand’ to the International Monetary Fund (IMF) for a bailout of £2.3 billion in 1976.
Long-dated bond yields rose to 15% during those early Thatcher years, accompanied by a Bank of England base rate which remained in double figures for most of these years. Tight public spending, bearing down on industrial unrest and continued high taxes gradually brought things under control and, by the early 90s public sector net debt was just 30% of UK GDP (Gross Domestic Product). It now stands at 96% of current GDP.
This is why a collapse in confidence such as we experienced in the 1970s would be far, far more serious today. The annual interest cost of public debt is already £111 billion, and the yield on those 30-year government bonds has already risen by over 10% so far this year.
There is only one way for Rachel Reeves to tackle this challenge, and that is to call an end to Attleean universality. This would limit government support to those most in need, bringing government finances back into surplus. The Chancellor should also scale back much of that government-financed growth expenditure which she announced in her Spending Review.
But we are not alone in shouldering such massive public debt. The European Union has been struggling with it for years, and its failure to integrate political control across the Eurozone has resulted in a series of public finance crises, the latest of which is in France.
Now the United States is also joining this select band of ‘first world’ countries with 'third world' public finance strategies. The cause of their chaos is not rooted in socialism as in the UK and the EU, but in pushing ahead with excess tax reductions before Trump's tariff strategy has been established. Meanwhile, his drive to cut public expenditure has been exposed as insubstantial by the Musk-Trump breakdown. Dictatorial control simply doesn't work in the United States.
It's therefore all in the hands of international bond markets as we enter autumn 2025, and experience shows that these markets can be very testing for inadequate control over public finances. The problem is that any meltdown will not this time be limited to just one nation or just one currency; if long-dated bond yields start soaring, it will quickly turn global. This will make any recovery based on currency re-evaluation, such as we experienced in the Thatcher years, very unlikely.
The reason why government bonds are described as ‘gilt-edged’ in the United Kingdom is that any thought of their default has to be inconceivable. That's why, when the chips are down, a resort to the International Monetary Fund is a critical recovery move; but how can this be done with today's colossal public debt mountains? That's a question which the economists will have to resolve, but let's just hope that any meltdown doesn't impoverish a raft of future generations.
Gavin Oldham OBE
Share Radio