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Pat Leahy: Governments must retain confidence of financial markets

Bond investors are powerful entities, institutions and individuals as interested in politics as economics

A budget in Dublin, budget meltdown in London: talk about a roller-coaster week. The contrasts between the centrist incrementalism of the Republic’s finance Ministers Paschal Donohoe and Michael McGrath and the feck-it-what’s-the-worst-that-could-happen recklessness of the Liz Truss-Kwasi Kwarteng operation in Downing Street are all too obvious to spell out. But in a way, events in the two countries contain the same message: any government must keep the confidence of the markets. Even if only one of them seems to understand this.

Former US president Bill Clinton’s political adviser James Carville said famously that if there was reincarnation, he wanted to come back in his next life as the bond market, because then, “you can intimidate everybody”.

As long as governments have debts, the bond markets will have that power. We saw this week what that looks like in the United Kingdom. We don’t need to be reminded here of what happens when the markets lose confidence in you.

In 2012 Kwarteng and Truss were among a small group of young Conservative MPs who wrote Britannia Unchained, a manifesto for a low-tax, low-regulation, high-growth UK that inter alia argues: “Too many people prefer a lie-in to hard work.” Truss might have been better off on Thursday morning having a lie-in than doing a string of excruciating interviews with BBC local stations in which — having not made any public comment since the markets began to roil last Friday — she was flayed alive by a succession of questioners. The British prime minister frequently found herself unable to answer their questions: you can find the highlights on social media or on the BBC. Labour deputy leader Angela Rayner observed: “Liz Truss has finally broken her long painful silence with a series of short painful silences.”


Anyone in Fianna Fáil who came through the furnace of 2011 … knows that the lesson of the financial crisis must be: never again

Those silences are the sound of her premiership falling apart. The political implications of losing the confidence of the markets were spelt out by the YouGov poll on Thursday: a 33-point lead for Labour.

We know how this works here. Round about the time Truss and Kwarteng were putting the finishing touches to Britannia Unchained, Donohoe and McGrath were trudging the worried streets of Phibsboro and Carrigaline, listening to the anger and incomprehension of people whose lives had been upended by the financial crisis.

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Donohoe has previously said that this was his formative political experience, a foundation for the fiscal caution that has sometimes made him unpopular within his own party.

While anyone in Fianna Fáil who came through the furnace of 2011 — where candidates were, literally, chased off doorsteps — knows that the lesson of the financial crisis must be: never again.

Markets take a brutally unsentimental view of any country. They’ll compound the misery for ordinary people without a thought in search of yields and profits. Is that a desirable state of affairs? No, for sure. Is that the world we live in? Afraid so. Can Ireland change that? Nope. Not while it has borrowed €240 billion from those markets.

Bond markets are also as interested in politics as economics. I recall meeting one bond investor in the months after the Fine Gael-Labour government took office in 2011 amid the ruins of the EU-IMF bailout. I spoke about the demands of the bailout programme and how a series of savage corrections to the public finances, cutting expenditure and raising taxes, was planned to restore the country to fiscal health. But he knew all that. He could do the sums himself. What he wanted to find out was whether the new government had the political will and capacity to implement the programme.

In the past week, the markets have made some pretty unflattering judgments about the new British government and its plan for unfunded tax cuts and open-ended borrowing. The bleeding was staunched by an unprecedented intervention from the Bank of England, spending £65 billion (€72 billion) of taxpayer-guaranteed money to defend the currency — from the actions of its own government. A potential collapse of pension funds was averted by the emergency action. Commentators and analysts noted that the UK was now being treated by the markets as a developing economy. In other words, the premium charged by markets to lend to countries considered unreliable debtors because bushy-moustachioed dictators or combat-fatigued generals might steal the funds to build palaces for themselves was now being extended to the UK.

You could say that the mark of prudence is not so much setting aside cash for a rainy day when you have lots of it, it’s doing that when you don’t have a lot of cash

The need to keep the confidence of the markets led Donohoe and McGrath to accompany their €11 billion giveaway budget with a wheeze to squirrel away €6 billion over the next 12 months into a reserve fund that will serve as a buffer for any future shocks. Of course, you could say that the mark of prudence is not so much setting aside cash for a rainy day when you have lots of it, it’s doing that when you don’t have a lot of cash. But for now, the two budget Ministers deserve credit for the move.

The unmanageable forces and irresistible imperatives that the Irish Government is navigating with more success than its British counterpart will be a reality for any administration in Dublin, including one led by Sinn Féin. If that party’s finance spokesman, Pearse Doherty, is minister for finance one day (likely only if it’s a left-led coalition without FF or FG) he will have to watch the markets every bit as closely as Donohoe does. Maybe more closely, because the markets will be watching him.

That’s not to say the Republic can’t have a more redistributive government with a left-wing economic policy. A government that would invest more in public housing (though it would run into the same capacity constraints), publicly funded childcare, more investment in healthcare and education, and all of that, financed by higher taxes; of course, it could.

But that government’s sums would have to add up. It would need to keep the confidence of its lenders and of the markets more generally. In the world, as it is, there is simply no alternative.