A Wee Problem For The UK

September 11, 2014

Last weekend several polls emerged that shockingly forecast Scottish independence from Great Britain is within the realm of political possibilities. Although the September 18th vote had worried a number of people, the evenly split polling results burst upon the world like a thunderbolt, perhaps shattering the image of a steady, genial and conservative Britain. But the ramifications of Scottish independence go far beyond national pride and historical score settling. Watchers of the global economy should be aware of the potentially serious follow-on results.

With some 5.3 million people, Scotland contains about 8.4 percent of the UK's population of 63 million. In U.S. terms, this would be the equivalent of the entire State of Texas leaving the union (an outcome that many in the Lone Star State desire!). So clearly the move would greatly alter the character not only of Scotland, but also the country that it intends to leave behind. 

Suddenly, major questions about currency, government debt, oil reserves and nuclear defense have come to the fore. Even the most basic questions, like whether Queen Elizabeth would remain sovereign in Scotland and, if so, with what major constitutional powers, have been largely unaddressed. Based on the confusion, sterling fell and Gilts (British government bonds) spiked in yield. What are investors to make of it? Could it spark a trend? Why has it erupted so suddenly?

Great Britain's government debt is equivalent to some $2.21 trillion. With secession, would Scotland be responsible for its 8.4% share, or $185 billion, equating to some $34,900 per person? Would the debt be repaid in pounds, euros, or whatever currency Scotland decides to adopt? What would happen to the UK's nuclear deterrent, which is largely based in a hugely expensive submarine facility in Scotland? How much of the North Sea oil revenues would revert to Scotland? No one knows.

In the case of separation and a leftward drift of a new Scottish government, would corporations and wealthy individuals look to move from a socialist Scotland (the Scots government is decidedly more left-leaning than the broader government of the UK) to an increasingly conservative England? Would financial emigration lead to a run on the Scottish banks, like the failed Royal Bank of Scotland, owned now largely by British taxpayers? The resolution of these questions would require months, if not years, of tortuous negotiation and uncertainty.

It is widely understood that the Scots receive more in benefits and government spending from the national government than they send to London in taxes. Without this positive flow of funds, Scotland likely would have to raise taxes and borrow heavily to meet massive shortfalls in social security payments and additional expenditures. Given this reality, it is utterly irresponsible for pro-independence politicians to suggest that a "Yes" vote would result in lower taxes and greater benefits for Scottish citizens.

Until very recently most people had dismissed the idea of Scottish independence as unthinkable. But recent internal politics gave independent-minded Scots an unexpected boost. To prevent further gains by the United Kingdom Independence Party (UKIP), the Conservative Party, led by Prime Minster David Cameron, had offered a "cast iron" promise to give the British people a referendum on withdrawal from the EU. However, as a dyed-in-the-wool Europhile, Cameron has consistently failed to fulfill his promise. This lost him yet more support and boosted UKIP, which now has more seats in the EU parliament than any major UK political party.

Some speculate that Cameron allowed the Scottish referendum as a means to dampen dissatisfaction with his EU referendum failure (perhaps one referendum is just as good as the next?). But there may be even more cynical political calculations. By getting 'rid' of Scotland he would be delivering to the EU another potential member. He would also relieve the British House of Commons of 41 socialist seats from Scotland, offering Cameron the chance of winning the next General Election without the necessity of negotiating an 'EU referendum deal' with UKIP. These are of course speculations, but one must always consider who benefits from any particular action when attempting to arrive at a full understanding.

Anti-English sentiment has always been part of the Scottish character. The ferver was rekindled a few years ago by the film 'Brave Heart.' In that light, the current union crisis is somewhat remarkable. However, I believe it likely that when faced with the threatening economic realities that would accompany a separation, most canny Scots will vote 'No'. If this view prevails, the recent falls in Sterling, Gilts and some equities could presentopportunities.

On the other hand, a "Yes" vote could open a Pandora's box of unresolved issues. Perhaps the most significant of which would be to embolden the myriad other separatist and secession movements that are happening around the world in seemingly stable places like Belgium, Spain, China,  Turkey and  even Texas.   

John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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