British politics seems to have learned a lesson: never fight the bond markets. Because you lose that. At the end of September, the first headlines about the financial turmoil in the United Kingdom were about another part of the financial markets, the foreign exchange market. The British pound took a nosedive on Friday 23 September after the British cabinet presented 45 billion pounds (52 billion euros) in unsecured tax cuts. That dive continued the following Monday. But meanwhile, something more worrisome was happening elsewhere in the financial markets. As investors lost faith in British government finances, interest rates paid by the British government skyrocketed. The interest rate on ten-year British government bonds was just over 3.5 percent just before the measures were announced. By September 28, it had risen to a peak of 4.6 percent. Such a rise in a matter of days is seen in the bond markets – which move much less manically than the currency or stock markets – as a sign of great stress. The stress has not abated since – and this has forced Prime Minister Liz Truss’s government into a series of concessions in recent weeks. First, then Finance Minister Kwasi Kwarteng limited the tax cuts a bit, then Kwarteng put forward a medium-term budget plan and last Friday, Truss traded Kwarteng for Jeremy Hunt. Monday saw the most painful political turnaround : almost all tax cuts were withdrawn. Also read: To save the UK economy, Liz Truss plans have been shelved Bond traders were finally a little reassured: yields fell below 4 percent. How did ‘the markets’ get the British government down? Disciplinary effect Treasury bond traders are always aware of risk. If the risks on a country’s debt rise, a higher risk fee is charged: the interest rate. That means higher financing costs for the state, and further pressure on state finances. This market forces usually has a disciplining effect on budgetary policy. Truss’ tax cuts were judged to be high risk. That was not surprising: the prime minister seemed purely ideologically driven and showed little interest in the gap in the budget, which increased further to 70 billion pounds, partly due to rising interest charges. Tax cuts, Truss said at the Conservative party congress early this month , were not only “morally” right — work should pay more — but also “economically” smart: they would generate economic growth. Kwarteng suggested that the UK government debt as a percentage of the economy (GDP) would fall on its own in the medium term – without explaining exactly how. Trussonomics failed to appeal to investors. Tax cuts would not solve the UK economy’s structural problems, including low productivity. In the meantime, the sustainability of the government debt would come under pressure in the coming years. On Monday, virtually all of the Truss administration’s tax cuts were repealed Truss remained true for a long time, even when the International Monetary Fund was extremely critical of the budget plans at the end of September. Such a sullen stance on bond markets may allow a government to allow itself for a while, if it doesn’t have to borrow too much in the short term at the new, higher interest rates. But in the British case, an acute problem arose: the financing costs for British pension funds had become so high in recent weeks that they were in danger of collapse. The pension funds use British government bonds as collateral for other, more risky investments. Due to the plummeting prices of British government bonds (they were sold en masse, because of the increasing risk of them), pension funds were no longer able to meet their collateral requirements. A financial crisis emerged – with all its consequences. Hence Hunt’s emphasis, Monday, on “economic stability.” Trussonomics was dishonorably buried by Hunt—along with all the political vistas that came with it. The death sentence of Truss’ plans had already been signed before that, by the bond markets: the high interest rates were simply not sustainable. The central bank There is one institution that can save a government from turmoil in the bond markets. That is the central bank, which in the UK, as elsewhere in the western world, is formally independent from the government. By buying government bonds, central banks can lower interest rates – something they have done en masse in recent years, to boost the until recently ultra-low inflation and to stimulate the economy. Between September 28 and last Friday, the Bank of England gave the Truss government some breathing space by temporarily buying government bonds to ensure “financial stability”. The bank did this to prevent the UK’s pension sector from collapsing – not to help the government – but for a moment there seemed to be hope within the Truss government that a significant portion of the tax cuts could be rescued by central bank intervention. Until last week. After initially confusing messages, the Bank of England confirmed on Wednesday that the buyout would end on Friday. As a result, the British government was completely on its own from Monday. Doing much other than listening to the impatient bond markets was out of the question. Market discipline has been felt hard in Downing Street. A version of this article also appeared in the newspaper of October 18, 2022