Index-Linked Gilts: Bad Policy that bear the mark of their time
Index-Linked Gilts are in part a standard U.K. Government bond. An investor loans money to the government on the promise that the funds will be paid back, with interest. Introduced in 1981, the indexing part differentiates this product from other bonds, in that interest and principal are coupled – ‘indexed’ – to the going rate of inflation. We must ask who benefits (cui bono) from this de-risking. Quite obviously it is the bondholder and the interests of private finance. It follows that we ought to probe why investors have become a privileged constituency.
This is a historical question that captures the neoliberal turn. Under the neoliberal regime of sovereign debt management, financial markets are empowered as a political choice. Whereas democracy once constrained markets, the demands of the market were made beyond reproach.
The postwar era witnessed a rather different relationship between the state and financial markets. Indeed, amongst the developed economies, the average real interest rate was negative 1.94% due to a concerted policy of ‘financial repression.’ The postwar period sought to reinvent the financial system as one that only served the public good – vested with a ‘social purpose’ - defined as the full employment of a given economy’s resources. The state as guardian of this public good would command more legitimacy than the defenestrated financial rentiers. No longer would the financier be able to claim fat rents, in the form of interest charged, or deny lending unduly. Real interest rates were thus held down to make public investment feasible. This was the postwar ideology.
Index-Linked Gilts are alien to this zeitgeist. They reward the financier. They are thus indicative of a relationship between state and financial market recast. If not impelled by dependency, why else would the government cede such concessions to the investor class? The rationale of the postwar political economy was that the prosperity of a peoples should never be held to ransom by striking private capital. Fiscal vulnerability had to be created by policy:
capital controls were eased, hot money flows resumed once again, and ‘liability management’ banking took off. The once slayed financial monster had been wilfully resurrected, set against the public goods demanded by national polities; unruly, untrammelled capital sloshed around the globe. Out went financial repression, in came the voguish crusade of financial liberalisation. A funny kind of liberty. The Bretton Woods order was demolished, as countries became financially needy, reliant on markets for financing their sovereign debt.
Whilst the financial sector amassed ideological and material clout, the U.K. government’s deficit started to swell. But one more factor served to inflame the government’s financial headache: the spectre of inflation. 24.9% in 1975, and 17.2% in the year Mrs. Thatcher took office. For the financier, inflation is enemy number one. Why would one invest in government bonds if one knew that their nominal return would de drowned by runaway inflation. Policymakers, embedded in this new ideology of market dominance, were terrified of a ‘gilt strike;’ they feared a repeat of Summer 1976. They fretted that ‘the capital market... [was] dead.’ No longer was it understood that the aspirations of a polity should trump the shrieks of financial markets. This ideologically informed fear materialised. The gilt market went on strike in September 1979.
The markets could now cash in the structural dominance they exercised over the state. Despite Governor Gordon Richardson’s point that gilt sales, for the most part, had been robust, newly orthodox notions of ‘market management’ demanded index-linked gilts. Richardson lost the argument. The government in 1981 thereby forced itself to make a wager: inflation would come down faster than the markets suspected; the government would make sure this happened, and investors would kill to have their investment protected against inflation. As inflation would fall, the bill on these bonds, since they were so aggregable to the markets, for the government, would fall to. This was the plan. By its own logic, it mostly succeeded.
Above I have articulated the rubric under which inflation-linked Gilts were inaugurated. We have probed how the privileging of the investor class came to be. Now we turn to the normative question: Is this good policy?
The question of how to mobilise affordable finance is of paramount concern. The postwar period accordingly enacted financial repression; the neoliberal period chose to make nice with private finance. In fiscal year 2023, public debt servicing costs are forecast to reach £104bn. Index-Linked Gilts account for 25.4% of the total stock of public debt. Amidst the immiseration of those exposed to brutal inflation and recession, we must ask if it is right that bondholders’ rents are protected. It is plainly unfair. Instead, the financial markets should be brought to heel, with the apparatus of financial repression reinstated.
For decades, states have wilfully shaken out the economic toolbox: ceding sovereignty – the historic dividend won in two world wars – to actors who are often inimical to a democratically defined public interest. The ideological justification for this self-neutering has been the veneration of the financial markets as the wellspring of all prosperity. How lame is it, that under this common sense, a democratic polity must resign itself to the whims of these markets, their risk premia, their policy proclivities? Yes, interest rates have declined since 1980. But at what cost? Politics may be insidiously disavowed in such discussions amongst ‘practical men,’ but make no mistake its presence is inescapable: politics is about ‘who gets what’. As such, the political decision to issue index-linked gilts is the granting of a real rate of return to a privileged investor class. It is the pecuniary reward that ideology and structural dominance has netted for investors. And in return what has the polity received from this concerted appeasement effort? The U.K. economy still craves good investment, our infrastructure is crumbling and dirty, and our growth is anaemic. The optimal policy option would ensure good investment is diffuse and yields only a fair rate of interest. Private finance has been bestowed a great public function - the creation of credit and money; this license ought to be held contingent upon acting in the public interest. The licentious empowerment of the financial markets has only created a socially corrosive market ‘utopia.’