We may be heading for a new financial crisis

The world is about to witness an epic clash between governments and investors

In Britain, Chancellor Rachel Reeves is facing a bond market revolt after her half-baked, misjudged Budget. On the other side of the Channel, Michel Barnier, the French prime minister, is scrabbling around desperately for any extra tax revenues he can get his hands on to keep the credit ratings agencies on board.
Meanwhile, the EU has no takers for its common bonds for a “green industrial strategy”, and whoever wins the American presidential election next week will quickly find they have to calm Wall Street’s growing nervousness over the country’s massive borrowing.
In the UK, it would be easy to focus just on the chaos in the gilt market this week. And yet, in reality, something far more serious is underway, and it is happening across the world. The financial markets are rebelling against overspending governments – and that means we are in for a long spell of financial turbulence and potentially a full-blown crisis.
Reeves has been so puffed up by the likes of Mark Carney, the former Bank of England governor, and the rest of the Davos crowd, that she probably expected global investors would cheer her Budget for its plans for public investment to restore stability and growth. Instead, it has proved about as popular as a second-hand Erik Ten Hag flag in a pub in Salford.
Investors crunched through the numbers, rumbled that she would not get nearly as much from her tax rises as she hoped for, worked out that her “fiscal rules” were completely bogus, and promptly started demanding more for holding the vast quantities of debt she plans to issue over the next few years.
If Reeves was even a quarter as clever as she keeps claiming she is, she would not have been taken by surprise. She would have figured out this was the worst possible moment to tax, borrow and spend more.
It is a mistake to be too parochial. The backlash against this Budget is simply part of a global trend. Driven by Left-leaning bodies such as the IMF, many political leaders fell for the line that the markets automatically supported bigger government. 
Borrowing to invest would pay for itself with higher growth, while hugely expensive “green industrial strategies” would be self-financing, generating lots of well-paid jobs and plenty of extra tax revenues. In France, President Macon believed that, so did President Biden in the US, and so did leaders across Europe, including those of the Labour Party.
That has now clearly changed. France is the most dramatic example. Under President Macron, the country effortlessly borrowed its way through the last seven years, adding 20pc to its debt-to-GDP ratio. Following chaotic elections earlier this year, the ratings agencies have downgraded its debt twice, bond yields have soared and it can’t borrow any more.
It is not hard to work out why. A government addicted to big spending is running a deficit of close to 6pc of GDP, with no crisis to deal with, while growth has stalled. 
France can’t keep adding to its debts, and Barnier has been reduced to desperately searching for extra taxes, charging the likes of LVMH hundreds of million of euros a year in “temporary surcharges” to try and keep the country’s finances afloat.
Likewise, after getting bailed out by the EU’s massive Coronavirus Recovery Fund, Italy is back in deep financial trouble, imposing windfall taxes to try and balance the books. The EU has abandoned plans for joint debt to reboot its stagnant economy with green investments because no one wants its paper.
Perhaps most importantly of all, Wall Street is starting to worry about the stability of the American government’s debt, with bond yields hitting a three-month high over the last week even as the Federal Reserve cuts interest rates (which means yields should be going down). It has become clear that neither candidate in next week’s presidential election has any plans to reduce a deficit already running at 6pc of GDP and might even increase spending further.
Add it all up, and one point is clear. The bond markets are now turning ruthlessly on big-spending governments. They are no longer willing to finance every programme a president or finance minister wants to launch, and will charge a huge premium unless deficits are kept under strict control. They are starting to worry that governments have reached the limit of potential tax revenues.
In France, for example, the state already collects 48pc of GDP in tax, and it is very hard to believe Barnier can get that over the 50pc line no matter how hard he tries. In Britain, even Attlee in the 1940s didn’t manage to squeeze the 44pc of GDP in tax that Reeves has planned.
Even worse, the markets are no longer buying the fiction that higher debt always leads to faster growth. Too often, it is just squandered on welfare benefits and vanity projects. The result? Rates on government debt are soaring everywhere.
Back in the 1990s, when the bond vigilantes reigned supreme, James Carville, Bill Clinton’s political adviser, used to joke that he hoped to be reincarnated as the bond market because “you can intimidate everybody”. That is about to be true all over again, and even more ferociously than in the Clinton era.
So far we have only seen the first skirmishes, but we are about to witness an epic clash between governments and investors. The result will be huge volatility and potentially a full-scale crash. Eventually, the markets will thankfully prevail, and governments will have to stop borrowing and spending money as if it had no consequences.
Fiscal sanity will finally be restored. But it will be a tough fight. And Reeves, who this week spectacularly misread the way the global financial markets were changing, will be just one of the victims along the way.