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Scotland – Where Will the Money Go?

Alex Salmond’s confident calculations don’t convince Michael Wilson

The battered Saltire drifting above Edinburgh castle fluttered forlornly in the shifting breeze. Nobody seemed to come down George Street and into Charlotte Square any more – not now that the Scexit had done its work back in 2016 when Independence had finally happened. It was too late to reconsider the options.

It was 2020, and it had been three years since all the money had taken flight. The crisis at Lloyds and RBS, following an unpleasant little skirmish about capital ratios, had sent Scotland’s two major international banks into technical insolvency and had driven them straight into the waiting arms of London.

Well, some people said, it had only been to be expected. Between them, the total assets held by the major banks had amounted to twelve times the GDP of the entire country. (Iceland’s banks, by comparison, had had eleven times GDP at the time of their own meltdown). So when a bit of a blip in the global markets had knocked down their capital ratios temporarily and started a run of withdrawals, the Edinburgh administration had been unable, unsurprisingly, to afford the necessary bail-out, without which they would probably have been disqualified under Basel III anyway. Let alone to guarantee the deposits they held.

And so down they went, at bargain prices, to a new home in London, where the ratio was a more affordable five.

Oil’s Not Well

Somewhere up in the highlands, the skirl of a lonely piper lamented the proud days when a man could raise his family without even needing to meet a southerner, except perhaps in battle. And up in prosperous Aberdeen, confidence in the black gold that had once replaced the silver darling had started to falter.

Not just because the flow of oil into the North Sea pipeline terminal at Grangemouth had been falling away drastically since the late 1990s. But also because voices in perfidious Albion had been talking about reclaiming its historic right to Scotland’s precious oil, and questioning the validity of the court agreements that had made it Scottish in the first place.

Ah, it had all seemed so simple back in 1968 when the Continental Shelf (Jurisdiction) Order had defined all the North Sea oil above latitude 55 to belong to Scotland. Too late, the London courts had decreed in 2017 that that ruling had only applied for as long as Scotland remained part of the United Kingdom. Now that it had detached itself, they reasoned, the oil might just as well have been declared Norwegian or Danish or – perish the thought – English. And it was London, remember, not Edinburgh, that had been pouring $14 billion a year into upgrading the North Sea facilities since 2012.

That was never going to be a very comfortable thought for “Braveheart” Alex Salmond, who had assured the BBC back in February 2014 that, for an example of a small nation with one of the most successful oil and gas industries in the world “we only have to glance across the North Sea to Norway”. Alas, when the naval fleet arrived and the construction of the giant English platforms began, his only effective response was to threaten the suspension of the English nuclear submarine maintenance activity at Faslane – not a threat he could realistically pursue, since Scotland still relied totally on its southern neighbour for its defence.

 

Black Hole

But there would have been little enough comfort for Mr Salmond even if the threat of an English oil-grab had never happened. The trouble was, even if we had assumed that Scotland retained all the oil and gas, it still wouldn’t have looked like a very attractive counterbalance to the 8.4% of the UK’s national debt that his government would have been obliged to take on. (Scotland’s 5.3 million people represent 8.37% of the UK’s total 63.2 million inhabitants.)

Unfortunately it wasn’t just the Scottish people who would have had to make that calculation – more importantly, it was the foreign creditors. What they’d have seen was a small country, with a hefty dependence on diminishing hydrocarbon reserves, that owed almost 90% of its GDP. And they’d have concluded that, whereas that sort of ratio was workable for a diversified economy like England, it didn’t look so great in the shape of a country which was largely deserted, had lost its prudent banking reputation, and had a hefty reliance on a rather antiquated industrial structure.

The awkward thing there was that Scotland was still going to have to retire £125 billion of debt, in one shape or another, and then borrow the same sum back as part of the transactional consequence of splitting off from London. Those debts had originally been guaranteed by the United Kingdom, remember, and not by little Scotland, and it would now be necessary to retire the existing bond debts and replace them with new ones. Unless anyone else had any better ideas, of course?

Credit Rating, Anyone?

Let’s not fool ourselves that redeeming £125 billion of UK bonds would be the same as issuing £125 billion of Scottish paper. Unfortunately, a suspicious American or Chinaman would want a rather bigger coupon on those new and riskier Scottish bonds. And that’s what would have set the rest of the debt spiral in motion.

Let’s acknowledge that the average European is none too sure about exactly what Scotland does, apart from amusing tourists of course. Scotland sends 60% of its exports to the rest of the UK (and quite a lot of the rest to the US and Asia), and it also gets 70% of its imports from the UK. Whisky accounts for a sixth of Scotland’s non-oil exports – to a value of £880 per inhabitant in 2012 – and far more than all its services combined. No single European country accounts for more than 2.5% of Scotland’s exports, and booming Germany comes in at under 1.5%.

For all these reasons, Scotland will look to the Europeans like a bit of an unknown quantity, with no track record in managing its sovereign bonds because it’s never had to do it before. (Well, not in three centuries anyway.) Throw in, possibly, the uncertainty of a new currency that isn’t backed by London, and you can imagine what sort of a yield premium those foreigners are likely to want. It won’t be an Argentina situation, but then again it won’t be Canada. This is going to cost serious money.

How much? Make up your own figures, because we have no proper clue. But the numbers being thrown around by economists are in the low thousands of pounds for every household. The money will have to be reclaimed through higher taxes, drastic spending cuts and, of course, through much higher bank charges. Everywhere, the pressure will be on to maintain confidence in the new currency, and that will mean interest rates that will cause serious problems for home-owners.

Financial Regulation

But here’s another strange thing. Alex Salmond is insisting that he wants to stay within the currency union after independence – something that George Osborne did his level best to kaibosh the other week, when he said that it wouldn’t be possible.

I’d say George was throwing his toys out of the pram by threatening to exclude an independent Scotland from the sterling zone. It just sounded so petulant, the way it came out. And Salmond lost no time in threatening to disown his 8.4% share of the national debt if he didn’t get his way. (A battle he’s certain to lose, by the way. Can you imagine how much negotiating clout he’s going to have with the nation where he sends 60% of his exports?)

But in some ways the Chancellor is right. How exactly can the Bank of England hope to oversee and run a currency that’s used in Scotland if it can’t control Scottish fiscal policy? Some sort of a federation, maybe? Okay, that’s an idea, but it’s not an arrangement that has worked very well in the European Union, has it? Just ask the Germans  about Greece or Cyprus.

Of course, a currency is one thing and a financial regulatory system is another. Scotland will absolutely, definitely need one of those if it goes independent. But the cost of setting up a proper financial regulator in Edinburgh will come to maybe £500 million a year. That doesn’t sound so much to us Brits, but to a small nation of Scots it’s £100 a head. And that’s a lot.

The Biggest Tax Haven in Europe

And so we come to the most intriguing question. Could a Scotland divorced from the UK set itself up as a tax haven for foreign investors?

Absolutely it could, in theory at least. Ireland has already pulled off that trick from within the safe confines of the European Union. Dublin’s 12.5% corporation tax draws a presence from more than half the world’s largest corporations, and its International Financial Services Centre, featuring such attractions as zero withholding taxes on interest paid to non-residents, tax exemptions for collective investment/life assurance funds, zero municipal taxes and zero net asset value tax on funds have been massively successful.

But – and it’s a big but – Ireland has done all this under the (occasionally disapproving) eye of the European Central Bank. Ireland’s currency is the euro – a privilege that Scotland will struggle to attain for itself, if we are to believe the comments from Jose Manuel Barroso about the “near impossibility” of its accession, given that its 90% debt-to-GDP ratio massively exceeds the 60% threshold for the euro club.

And then there’s the question of banking credibility. Yes, in theory Scotland could slash its rates for foreigners, open obscure types of bank accounts and generally go out on a limb to bring in fugitive money from all over Europe. But then, that’s what got Cyprus into trouble – as soon as the Russian oligarchs pulled out their cash, the banking system crashed.

It could even pull back from the existing European treaties on the exchange of bank account information. But there isn’t the slightest chance that Scotland’s banks will do any of those things – for the simple reason that it would sacrifice their good name. (It would also annoy the United States’ tax inspectors, who are cracking down on bank secrecy everywhere, and who would be swarming all over the place.)

No, Scotland would have no option but to follow the example of non-EU hidey-holes like Liechtenstein and much of the Caribbean, and simply comply with the pressure to conform. There is, as Mrs Thatcher would have said, no alternative.

Meanwhile, Back in 2020…

Glasgow had been the first region to feel the pressure. The social and religious divisions within a large population had been exacerbated by the forced withdrawal of state subsidies for many social welfare projects, as well as education and health services. For a while it teetered, and then social unrest started to rear its ugly head. This wasn’t going to be easy.

Further south, the fearsome reivers who had once terrorised the Northumberland border territories with their pillaging and cattle rustling were now back – pacing the border landscape this time not with horses but with GPS and cloned numberplates, ferrying contraband whisky, strange brief cases with unknown contents, and the occasional tankerload of diesel across the border in exchange for the untraceable bitcoins that they logged into their iPhones.

If you think that’s unlikely, you’ll find it’s not so different from what’s going on along the Northern/Southern Ireland border today. But hey, business is business.

 

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