Former heavyweight boxer Mike Tyson once famously said, “Everyone has a plan until they get punched in the face.” The same could be said of potential British prime ministers, especially after the spectacular ouster of Liz Truss after just 49 days in office in 2022. Everyone has a plan until the government bond market hits them.
Andy Burnham, Nigel Farage and my friend Zack Polanski will have to deal with this, if they ever move into 10 Downing Street. I think they know it. But I doubt they appreciate the true magnitude or nature of their plight.
Conventional wisdom holds that the bond market is made up of people looking to invest their savings in government debt. They seek the right balance between a higher interest rate and the greater risk that this implies. For example, higher bond yields may indicate that the market expects future inflation to reduce the value of the fixed interest payments your bonds will generate. Worse still, higher yields may herald a risk of state default, as occurred in Argentina and Greece.
That’s pretty much what first-year economics and finance students are taught. And all that is true. But this explanation ignores the most fascinating and worrying aspect of the UK government bond (gilt) market: the British government’s ability to refinance its nearly £3 trillion ($4 trillion) of public debt does not depend on savers choosing to invest in gilts.
Indeed, the UK Government’s ability to sell gilts depends largely on the willingness of numerous US-based financial institutions to borrow substantial sums of dollars to purchase gilts. These companies then use this money as collateral to obtain loans for their own purposes within the US.
And therein lies the crux of the matter. There is a world of difference between needing to borrow from savers and relying on speculators who borrow to lend to you. The savers who lend you focus on your long-term repayment capacity. They may tolerate your desire to make infrastructure investments that could increase your short-term debt, with the promise that future benefits will help you pay them back in full and on time.
But speculators who borrow to lend are a completely different beast. They are much more nervous and prone to margin calls. If the bonds they bought from you start to lose value, they get rid of them, fearing they won’t be able to pay their own creditors, which turns a crash into a debacle.
So why are British government bonds so much more dependent on American speculators borrowing money to buy them compared to German, Japanese, Italian or Greek bonds? Why are all UK governments so reliant on US leveraged capital inflows?
It all began in the 1950s, when the City of London discovered how to avoid following the British Empire down the road to oblivion. The trick was to carve out a niche within the emerging dollar empire, which was institutionalized within the framework of the Bretton Woods system. American financiers faced rigid capital controls within that system, but three invaluable features allowed the City to ease these restrictions.
First, London’s business experience and legal system offered American financiers efficiency and immunity from all types of intervention, including democratic accountability. Secondly, the British network of offshore jurisdictions offered fabulous tax minimization opportunities. And third, London quickly became the repository for a torrent of petrodollars and eurodollars, not to mention opaque dollars created outside the United States by foreign bankers.
Hence the great British paradox: while the real economy of the United Kingdom was in decline, the City of London was flourishing. When the Bretton Woods system collapsed in the 1970s, American financiers discovered another use for the City: borrowing short-term in the United States to buy long-term British government bonds, which they then quickly sold to repay their loans. They repeated this process over and over again to obtain huge profits.
This is how the British Government became dependent on leveraged American institutions. To continue business as usual, London today needs American balance sheets willing to expand through borrowing and use British government bonds as collateral to maintain liquidity in the United States.
In other words, the flip side of the City’s success is that, although it borrows in a currency it prints itself, the United Kingdom is not financially sovereign. Yes, the City occupies a strategically important position within the global dollar system, but the price it pays for this is that the British Government is constrained by its need to maintain the City’s central position in American finances. As long as this remains the case, the British Prime Minister’s powers are equivalent to rearranging the deckchairs on the Titanic.
There is an alternative to this peculiar form of financial subordination to US-based leveraged financiers, but it requires a willingness to accept a fall in the pound and house prices. It also requires increasing public investment through a new investment bank issuing bonds backed by the Bank of England.
Any British prime minister who attempts to maintain Britain’s financial servitude to American capital while investing in public goods could well put Britain on the path to an International Monetary Fund bailout. The UK would simply go from the frying pan into the fire. Let us not forget that the sole purpose of the IMF is to create the political influence that will cause – as happened in Greece – the loss of sovereignty over fiscal and spending policy. Do the current contenders for Britain’s highest office understand this?
Yanis Varoufakis, former Finance Minister of Greece, is leader of the MeRA25 party and professor of Economics at the University of Athens.
Copyright: Project Syndicate, 2026.
