The Tory / DUP Arrangement

I hold no brief for the Conservative Party. However if I were a Labour supporter right now I'd hesitate to accuse anyone too loudly of friendship with terrorists. Pots and kettles spring to mind.

As an economist I'm naturally concerned about the public finances. On the other hand in respect of the agreement between the government and the DUP we are talking about finding an extra £1b over an extended period as opposed to the Labour policy of finding £50b. Unsurprisingly I'm less exercised by the former.

The inescapable fact is still that the crash of 2008 ruined the public finances and since then we've only partially recovered. The National Debt is unmanageably high and we're adding to it every year rather than reducing it. The so-called austerity policy aims for nothing more dramatic than ceasing to increase National Debt by 2025, in other words we're already allowing ourselves another 8 years of living beyond our means for which we expect our children and our children's children to pick up the bill.

I accept of course that some debt-financed public investment will lead to growth, though usually public investment is less productive than private investment. A certain amount of public investment in NI would have been needed anyway in order to maintain a frictionless border after Brexit. At the moment I don't know whether that's included in the £1b or not.

I don't accept that large scale running up of debt to finance public consumption is a wise course. Like any public body the NHS for one has extended its remit well beyond treating and preventing sickness. When we can't pay nurses properly we have no business providing free fertility care for example. A reassessment of NHS priorities is overdue.

The same would seem to apply to local authorities which neglect basic housing yet seem able to finance all sorts of special interest groups.

We don't need more government, we need better.

Sum You Lose

The recent electoral success of the SNP throws the spotlight back on the question of Scottish independence. It seems few people remember that the economic forecasts of the nationalists were discredited within months of last year's referendum. Perhaps therefore a summary of the crucial points might be appropriate.

In December 2013 The SNP published Scotland's Future, a document long on words and short on numbers. Yet amongst the numbers it did contain, one received surprisingly little attention. It was projected that in the first year of independence the Scottish fiscal deficit would be £4.4 billion, or approximately £1,000 for every adult member of the population.

Remember that figure, it is important. At a time when people were blithely talking about being one of the richest countries in the world, creating a more caring society and setting up an oil fund for the benefit of future generations, the numbers actually showed that Scotland was already living beyond its means and proposed to go even further into debt.

In order to arrive at this deficit figure, they made assumptions about likely sources of government revenue. Large receipts were expected from taxes on Scotland's oil and finance industries, which together form a disproportionately large component of our national income. Assumptions were also made that Scotland would continue to use the pound sterling as its currency and that Scotland would run a Balance of Payments surplus. All four of these assumptions were flawed.

Official statistics were pessimistic about future oil prices, given the threatened slowdown of the Chinese economy and the rapidly expanding supply of cheap shale gas from the USA. Alleging deliberate manipulation of the figures to disparage the potential riches of an independent Scotland, the nationalists substituted their own oil price estimate (of over $110 per barrel). In fact the official statistics turned out to have been over-optimistic. In 2015 oil prices are in the range $50 to $60, around half the nationalist projection. So far from supporting an independent Scotland, the oil industry was soon in need of UK government help.

The UK Chancellor of the Exchequer challenged the assumption that Scotland would continue to use the pound sterling. He expressed himself poorly. What he meant to rule out was a currency union by which the rest of the UK would continue to underwrite Scottish finances. Fresh from the 2008 banking crisis in which UK taxpayers had been required to find £46 billion to bail out Royal Bank of Scotland, that was hardly surprising.

His lack of clarity was misrepresented as a threat. "No-one can stop us using the pound," Alex Salmond declared. This was of course true. Surprisingly he did not go on to explain that no-one could stop us using the dollar or the yen or the Zambian Kwacha either.

An independent country may use any foreign currency it likes, provided it can get hold of enough by means of a trade surplus. Panama, for example, uses the US dollar. All that you have to do is give up any desire to control your own monetary policy. If Scotland were to use the pound without a currency union it would have no choice but to accept UK monetary policy as its own.

It also means the Scottish government could only run a fiscal deficit to the extent that it could cover the revenue shortfall with reserves of sterling.

An odd sort of independence, you might think, that resulted in less economic powers than Scotland already has?

When the currency problem became clear, the large Scottish financial institutions announced plans to move their services to UK customers south of the border. This was not simply a brass plate technicality to comply with EU regulations as nationalists claimed.

Banking profits derive from the difference between the interest rates at which banks can borrow and those at which they can lend. Essentially a bank's lending operations create new money and most of the money supply in a modern economy consists of bank deposits, not cash. In order to perform these money-creating operations, banks must be within the jurisdiction of, and accept regulation by, the central bank responsible for that currency. A bank attempting to create new foreign currency would be acting illegally; it can only operate in a foreign currency to the extent that it possesses reserves of that currency.

The net result of this alleged technicality would therefore be twofold.

      1. Scotland's financial institutions would be responsible to the Bank of England and pay their taxes to the UK Treasury.

      2. Without financial exports it is unlikely that Scotland could run a Balance of Payments surplus. This would eliminate the Scottish government's ability to acquire reserves of sterling and thereby to run a fiscal deficit.

Now please remember the important figure that I quoted at the beginning of this article. By the SNP's own projections, the fiscal deficit in the first year of independence was to be £4.4 billion.

This was before accounting for the fall in the oil price and the loss of the financial services industry. It was before losing control of monetary and overall fiscal powers as a result of sterling becoming a foreign currency. This £4.4 billion deficit was actually a serious underestimate, perhaps not within several orders of magnitude of the reality.

Not only would a future Scottish government be unable to afford the promised fairer society, it would have to borrow improbable sums just to keep public spending at present levels.

Why improbable? Because in order to borrow you must first establish that you are creditworthy. Why might the international financial community suspect that Scotland was not creditworthy? Because the SNP threatened that if they did not get their own way on the currency they would walk away from responsibility for Scotland's share of the UK National Debt.

Let us leave aside whether one could throw over this debt without sacrificing Scotland's claim to a share of the national assets and infrastructure which that debt has financed, much of which is not located in Scotland and nearly all of which would need to be replaced by an independent country starting from scratch.

Let us also leave aside the fact that a country involved in a major financial dispute with an existing EU member would struggle to find an easy path to re-joining the EU.

Just consider this single point. What international lenders would offer reasonably priced funds to a new government whose first independent monetary act had been to deny any responsibility for debts accumulated jointly under the previous political union?

I am an economist. But of course I am also human. I might be wrong. To persuade me that I am, would enthusiasts for independence please not shout at me. Just show me your numbers.

And before you do, please check that they add up.

The more things change ...

I hope that amongst those whose enthusiasm for Scottish independence has more than a passing resemblance to support for a football team, some will take time to consider the issues before they vote.  I won't be holding my breath.

Those who make out a reasoned case are capable of entering into reasoned argument.  Those who behave like football fans are not.  I speak as a football fan.  There is no one who will ever convince me of the superior merit of an alternative team to my own.  I was born to support my team and it never occurs to me to waver. Whether we are bottom of the league and regularly thrashed or masters of all we survey, we are who we are.  That's why I refer to my team as 'we' and, as everyone knows, 'we' are permanently in opposition to 'them'.

I can afford to be so illogical because, fortunately, my livelihood is not at stake in matters of football. In matters of politics mixed with economics the issues are, hard though it may be to accept this, more weighty.

These are some of the issues that I wish to see resolved:

1) It is claimed that Scotland needs independence in order to lay hold of the important levers by which our economy is to be directed.  It is simultaneously claimed that we shall immediately hand back all of the monetary levers and a large proportion of the fiscal levers to The Bank of England and the rest of the UK. The Governor of the Bank of England seems to have confirmed this. Question: remind me again what is the point?

2) It is claimed that a currency union is in the interests of the rest of the UK because of the way it will simplify trade. Problem: it also makes the RUK responsible for the debts of the Scottish government, banks and public institutions and gives the Scottish government a say in UK monetary and fiscal policy.  There are quite good reasons for their refusing to accept this. Please explain to me why they will do it.

3) It is claimed that we shall automatically continue as members of the European Union, despite the claims to the contrary of, amongst others, the President of the European Commission and the government of Spain.  Bad news; this has to be unanimously agreed by EU members and the Spanish have a vote.

4) It is claimed that we could be added to the existing membership of the EU without having to accept the rules normally applied to new members, such as signing up to the Euro and the Schengen free travel area and that for some reason we would be entitled to a share of the UK's current budget rebate. Problem: in return for all their concessions, we are giving the other members what, exactly?

5) It is claimed that we shall continue to enjoy a common travel area with the rest of the UK, whilst adopting a radically different immigration policy from them.  Question: exactly how do we stop them setting up border checkpoints to enforce their immigration policy?  How much would consequent delays cost us?

6) It is claimed that we shall be able to go on financing our universities by charging fees to students from the RUK, despite the fact that EU law forbids discrimination against other member states.  Right.  So we think that they will let us get away with charging the English provided we don't charge the Bulgarians?  Seriously?

That's to be going on with.  When I hear the answers to these I'll start on the rest of the questions.

Scottish Debt

The only surprising thing about the UK Treasury statement that it will honour all UK debt, including Scotland's notional share, in the event of Scottish independence is that the statement needed to be made at all.

A gilt-edged security certifies a contract between a lender and the UK as a sovereign borrower. A contract cannot be unilaterally amended by one of the parties.

It is fair criticism to say that I should not have used the word default in my articles on this subject back in November, since that word might be understood as suggesting that the lenders risked not being repaid at all, rather than not being repaid by the beneficiary. Legally the UK government is responsible for its borrowing, irrespective of whether the whole of the UK or only a part is in receipt of the resultant spending.

The point that I made in November is still valid. The divorcing partner who refuses a fair share of the joint debt behaves immorally. Suspect behaviour raises the spectre of default in the collective mind of the market and that raises interest rates for the irresponsible partner's future borrowing.

Scotland's Future

Imagine that you are a banker. (If you are not already a banker this may be hard, but please try.) On a certain day you have appointments with each of a newly divorced couple, both of whom require loans to help them on their separate ways. The divorce has been acrimonious and reported in the press. Partner A has repeatedly threatened to accept no responsibility for the debts incurred on their joint account, not even those incurred in making purchases on his own behalf. He has now changed his mind. Partner B has gone on settling all debts as usual. Bearing in mind that, as a banker, your first responsibility is the security of your own funds, to which of the couple will you be more inclined to lend?

Amongst all the sound and fury surrounding the launch of the White Paper 'Scotland's Future', one figure has received surprisingly little attention. It is projected that in the first year of independence the Scottish Government will require to borrow £4.4 billion.

This is the same Scottish Government that:

1. has repeatedly threatened not to accept a share of the UK national debt,
2. denies Scotland's responsibility for the actions of a Scottish Chancellor in raising the UK national debt in order to bail out failing Scottish banks,
3. is already spending beyond its means,
4. has promised yet more spending in pursuit of a fairer society,
5. is about to destroy Trident-related jobs by the thousand,
6. is committed to a currency union and thus will not be able to set its own monetary policy.

Are you still imagining that you are a banker? You are not of course a Scottish banker, since the major Scottish banks are no longer Scottish owned. You are a foreigner and this Scottish Government is asking you for £4.4 billion. This year.  Alternatively you could lend to the RUK government which also needs a loan.

Bearing in mind that, as a banker, your first responsibility is the security of your own funds, what will you do?

Scotland and The National Debt

Alex Salmond has once again (19 November) threatened that non-compliance by the rest of the UK with his demands to 'share' sterling and The Bank of England after Scottish independence could lead to Scotland refusing to accept its share of the UK national debt. I realise that this is campaign rhetoric. It is nevertheless misguided.

The markets are listening.  They want to know what to do if they have to deal with an independent Scotland in the future.  The more likely a ‘Yes’ vote becomes the more they will trawl through the backlog of such remarks for guidance on future Scottish financial policies.  They will not like what they find.

Let us be clear. There are three important reasons why this demand is misguided.

1. Firstly, sterling is not an asset it is a national currency.  A currency is a claim on goods and services within an economy; it is not itself a good or a service. I have already explained in an earlier article the problems that are likely to face an independent Scotland that seeks to share a currency with its much larger neighbour.
2. Secondly, The Bank of England is the official banker to the UK government and an instrument of UK monetary policy.   Although its terms of reference are laid down by UK law, its independence from direct UK government control has been guaranteed since 1997.   Scotland is seeking to leave the UK. SNP ministers claim to want control of the economic levers for themselves. In what way would this purpose be served by 'sharing' an institution that does not take orders from government?
3. Thirdly, and most importantly, governments must never suggest defaulting on debt.  They must not imply it, or hint at it, or say anything that may be misinterpreted as an implication or a hint.  Everything that a First Minister or Finance Minister says is market sensitive.

The reason is that governments always need to borrow money.  Even governments running a surplus on the budget need to borrow money, because, just like you and me, the timing of their income does not coincide with the timing of their payments.  People who lend money to governments are sensitive to anything that makes them the tiniest bit afraid they might not get it back.  Every such unguarded remark could add half a per cent or so the Scottish Government's borrowing costs after independence.

We may end up with a Scottish currency whether we like it or not, for reasons outlined in my earlier article.  In any case, foreigners will have to hold Scottish paper with confidence.  The more suggestions there are that Scottish ministers don’t understand the markets and are careless or glib with financial pronouncements, the more reluctant foreigners will be to hold Scottish currency or bonds.  Scottish interest rates will have to rise to compensate for this perceived increase of risk.  In consequence, Scottish investment will become more expensive and therefore Scottish economic growth will fall. 

Is a point or two in the opinion polls today worth a point or two on the Scottish government's borrowing rate for years to come?