The Default Line: THE INSIDE STORY OF PEOPLE, BANKS AND ENTIRE NATIONS ON THE EDGE (7 page)

The day after the June election I went to Athens fish market and met Vasili, a 21-year-old worker there. ‘Young Greeks have no dreams any more,’ he told me. He does not want to sell fish. He is an economics graduate from a top university in Greece, and wants to be a journalist like me. Another fish seller, an Albanian who had lived in Athens for twenty years, told me he was planning to return to Tirana, where the economy was booming and he could earn more. A third man, in his twenties like Vasili, does not flinch as he calmly explains why he voted for neo-Nazis. Although they ‘occasionally do bad things’, he says, at least they are ‘proud Greeks’.

The cash machines
did
work on the Sunday after the election, partly thanks to the second secret Athens Airlift. There were contingency plans afoot to deal with the consequences should an enforced euro exit come about. At the Bank of Greece, there were discussions about whether or not some sort of controls should be implemented if the outcome of the elections was ‘worrying’ and could cause a bank run. The Greek newspaper
To Vima
was told that at one point someone ‘stupidly’ tossed the idea of imposing a €20 withdrawal limit from banks, but that others at the Bank of Greece rejected the idea. However there was a contingency for the imposition of a specific withdrawal limit, in the event that an Alexis Tsipras election win had sent Greeks to mount a run on their banks. The night before the election, an international energy company, fearful of an immediate return to the drachma, asked for and got payment of a massive bill in euros. No one could have predicted how a society as concussed and volatile as Greece might have responded. A clue was to be provided nine months later, not so far away – in Cyprus (see
here
).

Dramatis personae

Nick Clegg, UK Liberal Democrat leader

Sir Mervyn King, governor of the Bank of England (2003
–13)

David Cameron, then leader of the UK Opposition

James Carville, adviser to President Clinton

Brian Edmonds, bond trader, Cantor Fitzgerald

Anonymous hedge fund credit default swap trader

George Soros, financier and philanthropist

Jim Rickards, ex-Long-Term Capital Management (LTCM), lawyer, economist, trader

Gordon Brown, British prime minister (2007
–10)

Jesse Norman, Conservative MP, member of the Treasury Select Committee

Rachel Lomax, deputy governor of the Bank of England (2003
–08)

Dick Moore, mayor of Elkhart, Indiana, USA

Robert Lucas, Nobel Prize in Economics. University of Chicago

George Osborne, UK chancellor of the exchequer (2010
– )

Robert Stheeman, chief executive, Debt Management Office

Lord James Sassoon, commercial secretary to the UK Treasury

John Moody, founder of Moody’s rating agency

Corey Lovell, unemployed auto worker, selling his blood plasma

Perhaps Antonio Clegg had picked up more of what was going on in Greece than his father. Even for a bilingual primary-school pupil, he had an awful lot resting on his judgement.

‘My 8-year-old son ought to be able to work this out,’ his father Nick had told journalists on 1 May 2010, just five days before the general election that would make him Britain’s deputy prime minister. ‘You shouldn’t start slamming on the brakes when the economy is barely growing… You create more joblessness, and the deficit goes up even further. So it is completely irrational.’

So what turned the ‘completely irrational’ into a central policy plank of the coalition government in which Clegg played such a key role? A few weeks previously, Clegg had said something even stronger to
Channel 4
News
about the Conservative plan for immediate ‘in-year’ (i.e. within-the-year) spending cuts as a down payment to the markets on government austerity. ‘We think that merrily slashing now is an act of economic masochism,’ Clegg said. ‘So if anyone had to rely on our support, [if] we were involved in government, of course we would say, “No, do it sensibly.”’

Within days of these statements, Mr Clegg had performed an about-face. He now said ‘Yes.’ The circumstances were somewhat mysterious. Among the points included in the 11 May draft agreement between the Conservatives and the Liberal Democrats was a ‘significantly accelerated reduction in the structural deficit’, together with ‘modest cuts of £6 billion to non-front line services within the financial year 2010–11’. Not only had there been the sort of U-turn that happens in coalitions, but a U-turn on an issue of policy that he had specifically said he would not support. To be clear, the amount was modest in comparison to a record deficit, but what triggered the change of view, if not Antonio’s abacus?

The 2010 general election and coalition negotiations occurred against the backdrop of the tumult in Athens. Greece’s bust would be Britain’s fate, said proponents of the new government’s deficit reduction strategy, if there was no credible deficit plan. Greece’s fiscal woes also provided an alibi for Clegg and the LibDems. The election had delivered a mandate for some sort of deficit reduction plan. All parties had rhetorically referred to, if not outlined, large-scale cuts to public services during their campaigns. But there were marked differences in the speed and timing of the fiscal consolidation on offer to a crisis-weary electorate. After the hung Parliament, there was in fact a clear majority of popular votes – and not far off a majority of parliamentary seats – for parties that opposed the immediate ‘in-year’ cuts promised by the Conservatives. So Mr Clegg’s change of opinion was the biggest reversal in the coalition negotiations. The LibDem volte-face delivered George Osborne to Number 11 Downing Street and his deficit plan to the nation.

The ‘belly-up implosion in Greece’ was a factor subsequently mentioned by the LibDem leader. In the weekend between the election and the signing of the draft coalition agreement, Greece’s first Troika bailout was signed in Brussels, alongside the setting up of the European Financial Stability Facility (EFSF) and the European Central Bank’s agreement to buy Eurozone government bonds. The LibDems made various claims that their change of opinion arose out of a briefing from Mervyn King, the governor of the Bank of England. However, the key phone call between the governor and Deputy Prime Minister Nick Clegg occurred days after the draft agreement was signed. No direct contact was made with the governor by the politicians negotiating the deal. Vince Cable was reassured indirectly by senior civil servants that King favoured the faster-paced and immediate cuts. The strongest direct advice on the feasibility and advisability of following Conservative plans came from the top civil servants advising the coalition negotiators. As Chancellor Osborne puts it: ‘That weekend there was the crisis in Greece, and market comment around an inability to form a UK government. The government machine was very concerned. I said to the LibDems that if you have any doubts about this, speak to [Cabinet Secretary] Gus O’Donnell, speak to the permanent secretary at the Treasury, and speak to Mervyn King.’

The morning after the draft plan had been agreed, Mervyn King held a prearranged press conference that endorsed the new government’s fiscal plans. He had avoided getting involved in the election campaign or the coalition negotiations. There is, for the historical record, an exchange of letters between Threadneedle Street and Whitehall that confirms this. But the moment the deal was done, King was in crisis-aversion mode, selling the common sense and stability of the infant and novel new British government. ‘The Bank has been requested as to the feasibility and advisability of these measures,’ King announced. ‘The Treasury can advise on the feasibility; our advice on the advisability is that it is sensible to take measures in this fiscal year to demonstrate the genuine commitment and determination of the new government.’ The coalition agreement had made the £6 billion in-year cuts contingent on advice to this end from the Bank of England. The Bank of England was being used as an alibi for the LibDem change of policy.

Earlier in 2010 I had interviewed the then Opposition leader David Cameron at the World Economic Forum in Davos. He was selling the early cuts plan. I asked Cameron repeatedly if he would proceed with the cuts even if Britain’s economy fell back into ‘a severe renewed contraction’: ‘You must make a start in 2010,’ Cameron told me, ‘but clearly the scale of what you can do needs to be worked out in conjunction with the Bank of England, because we want to keep those interest rates low.’ The next day he softened his line, stressing that the cuts need not be ‘particularly extensive’ or ‘swingeing’. But he set in stone the notion that the public should not worry, the Bank of England would advise. (Mervyn King’s response a fortnight later was a blunt ‘I don’t know what this means.’) It was clear that Cameron felt that, in the run-up to an election, the public would be more inclined to respect the judgement of a technocratic central banker than that of a politician when it came to calls for public-sector austerity. Seared into the consciousness of most British politicians was the fact that the only government that had imposed austerity on the British people and then managed to get itself re-elected was the government of Margaret Thatcher.

Back in the coalition negotiations of May 2010, the Labour team were stunned to find in the course of their failed talks with the LibDems that the latter were making in-year cuts part of their negotiating strategy. Both parties had very publicly agreed the opposite during the campaign and in their manifestos. This should have been an area of agreement, but Andrew Adonis, one of the Labour negotiators, revealed that the LibDems were evangelising for the approach they had vociferously opposed just days before. LibDem negotiators Chris Huhne and David Laws both apparently believed that a fall in sterling in the preceding weeks would offer a stimulus to the economy, so in turn creating room for the immediate cuts.

At the Bank of England, Mervyn King had sounded a little cautious on the timing of fiscal consolidation before the election. The day after the formation of the new coalition government, when I asked him why he was now suddenly in favour of immediate cuts, he answered, ‘I think we’ve seen several things. We see the recovery beginning to take place, and we expect that the pace of that recovery will pick up. But we’ve also seen the market response in the past two weeks, where major investors around the world are asking themselves questions about the interest rate at which they are prepared to finance trillions of pounds of money that will need to be raised on financial markets in the next two to three years, to finance government requirements around the world. Markets were not expecting any action before the election. After the election they need and they want a very clear, strong signal, and evidence of the determination to make it work. And I think that it’s quite difficult to make credible a commitment to fiscal consolidation if all the measures are somehow in the future. You need to start and get on with it.’

Invisible bond vigilantes had not just influenced the creation of a government in Britain, but were troubling most of the debtor nations of Europe. A tidal wave of economic reform and austerity changes, even the default of Europe’s cherished social model, was justified on the basis of the anticipated reaction of these caped crusaders of credit. But who were they? And what did they want?

At Spink & Son Ltd, the London dealer in old coins and medals, you begin to get the feel for the bond market of the old days, when bonds were actual pieces of printed paper: florid bond certificates from the United States of Brazil, the Lower Saxony Government and the 1911 Hukuang Railways Sinking Fund Gold Loan for the Imperial Chinese Government depicting a glorious steam train. The last certificate had some special historical resonance. It was possibly the last debt issued by the Qing dynasty before its overthrow by revolutionaries in 1911. Historians argue that the granting of this concession to foreign bankers (including J. P. Morgan), secured not just by rail revenues but also by taxes on salt and rice and the tax on the internal transit of goods known as the ‘lekin’, helped foment revolution and the establishment of the Republic. The Chinese Republic promised to honour the railway debts, and debt interest continued to be paid until the 1938 invasion by Japan. Mao’s People’s Republic of China then repudiated the debt in 1949, prompting court cases into the 1980s.

The old bond certificates that collectors are able to get their hands on tend to represent defaulted debts, as such certificates no longer have any value as debt instruments – only as collector’s items. Bond certificates where the debt had been repaid were usually returned to the borrower, and then destroyed. So the collectors’ market is awash with pre-Soviet Russian bonds, while bonds from Britain, which has never formally defaulted, are a rarity.

These days, bond trading is done electronically. And by 2010 Britain was running the second worst deficit in the G20, after the USA. By then, the Chinese were buying the bonds, rather than issuing them. The bond markets determine the solvency of nations and the fate of governments. For Britain, in the months that followed the crisis, a series of auctions was to determine the appetite for British sovereign bonds, known as gilts, like never before outside of a world war.

It was President Clinton’s adviser James Carville who mused that in a future life he’d want to return as a trader in government bonds. ‘You can intimidate everybody,’ he chuckled. The term ‘bond vigilante’ was coined by the US economist Ed Yardeni in 1983 to describe traders who would sell off the debt and demand higher yields (averaging 11 per cent) to compensate for the perceived risk of higher inflation and higher deficits in President Reagan’s America. The bond vigilantes were unleashed again on President Clinton, when in 1993 he introduced his wife’s plan for extra health-care spending (‘HillaryCare’), and ten-year US Treasury bond yields shot up to 8 per cent. HillaryCare was parked as US politicians baulked at rising mortgage and business lending rates (which tended to go up if government rates went up).