Andy Burnham, Nigel Farage, and my friend Zack Polanski will have to face this, if they ever move into 10 Downing Street. I think they know it. But I doubt whether they appreciate the true magnitude or nature of their predicament.

Conventional wisdom has it that the bond market comprises people looking to invest their savings in a government’s debt. They seek the right balance between a higher interest rate and the increased risk this implies. 

For example, higher bond yields may signal that the market expects future inflation to reduce the value of the fixed interest payments that their bonds will yield. Worse still, higher yields may foreshadow a risk of government default, as occurred in Argentina and Greece.

That’s more or less what first-year economics and finance students are taught. And it’s all true. 

The UK's worrying economic position

But this story misses the most fascinating and worrying aspect of the United Kingdom’s government bond (gilt) market: the British government’s ability to refinance its public debt of almost £3 trillion ($4 trillion) does not depend on savers choosing to invest in gilts.

In fact, the British government’s ability to sell gilts depends heavily on the willingness of numerous US-based financial institutions to borrow substantial sums of dollars to purchase gilts. 

These firms then use this as collateral to borrow for their own purposes within the US.

And there’s the rub. There is a world of difference between needing to borrow from savers and relying on speculators who borrow to lend to you. 

Savers who lend to you focus on your long-term ability to repay. 

They may tolerate your desire to make infrastructure investments that could increase your debt in the short term, on the promise that future profits will help you repay them on time and in full.

But speculators who borrow in order to lend are a different beast entirely. They are much jumpier and prone to margin calls. 

If the bonds they purchased from you begin to lose value, they dump your bonds, fearing that they will be unable to repay their own creditors, thus turning a decline into a crash.

Britain and its reliance on US bonds

So, why are British gilts so much more reliant on American speculators borrowing money to buy them relative to German bunds, Japanese bonds, Italian bonds, or Greek bonds? 

Why does every UK government rely so heavily on American leveraged capital inflows?

It all started in the 1950s, when the City of London figured out 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 institutionalised within the Bretton Woods system. American financiers faced rigid capital controls within that system, but three invaluable features enabled the City to alleviate these constraints.

First, London’s trading expertise and legal system offered American financiers efficiency with immunity from all sorts of interventions, including democratic accountability. 

Second, Britain’s network of offshore jurisdictions offered fabulous tax-minimisation opportunities. 

Third, London quickly became the depository of a torrent of petrodollars and eurodollars, not to mention the shadowy dollars created outside the United States by foreign bankers.

Thus, the great British paradox: while the UK’s real economy 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: short-term borrowing in the US to buy long-term UK government gilts, which they then sold quickly to repay their loans. They would repeat this process again and again to profit handsomely.

This is how the British government became reliant on leveraged US institutions. In order to continue operating as usual, London today requires American balance sheets that are willing to expand through borrowing and use British gilts as collateral in order to maintain liquidity in the US.

Put differently, the flip side of the City’s success is that, even though it borrows in a currency that it prints, the UK is not financially sovereign. 

Yes, the City occupies a strategically important position within the global dollar system, but the price for this is that the UK government is constrained by its need to maintain the City’s central position in American finance. As long as this remains true, the UK prime minister’s powers are akin to re-arranging the deck chairs on the Titanic.

The alternative

There is an alternative to this peculiar form of financial subservience to US-based leveraged financiers, but it requires a willingness to accept a falling pound and falling house prices. 

It also requires increasing public investment through a new investment bank that issues bonds supported by the Bank of England.

Any UK prime minister who tries to maintain Britain’s financial servitude to US capital while also investing in public goods may well put Britain on a path toward an International Monetary Fund bailout. 

The UK would merely leave the frying pan for the fire. 

Lest we forget, the IMF’s sole purpose is to create the political leverage that will bring about — like it did in Greece — the loss of sovereignty over tax and spending policy. 

Do the current contenders for Britain’s top job understand this?

• Yanis Varoufakis, a former finance minister of Greece, is leader of the MeRA25 party and Professor of Economics at the University of Athens