Thursday, September 4, 2014

Financial Implications Of A Scottish Yes Vote

  • A Yes vote would create great uncertainty about the future of the Scottish financial system.
  • Both a new currency and sterlingisation are very risky.
  • The shock could be immediate.

Should we be spending our time worrying about Scottish independence? I’ve got to say yes, because it is a major contingent risk that should be understood before it happens, if it happens. The polls are quite close, and the referendum is only weeks away.

I don’t want to discuss the long-term issues such as viability or governance. I’d prefer to focus now on the short-term risks. Goldman Sachs has just published a paper on the short-term risks of a Yes vote. Among other risks, it discusses the adverse implications for Scottish assets and Scottish banks:

“Even if the Sterling monetary union does not break up in the event of a ‘Yes’ vote, the threat of a break-up would provide investors with a strong incentive to sell Scottish-based assets, and households with a strong incentive to withdraw deposits from Scottish-based banks. The Bank of England would retain responsibility for the whole of the UK financial system until 2016 (at least), so it would be able to prevent the worst of the short-term consequences. However, the decision as to whether Scotland remains part of the Sterling monetary union will ultimately be a political one, so the BoE would be unable to credibly commit to the currency union remaining unbroken (implying some negative consequences for Scottish-based assets, even in the short term).”

Douglas Flint, chairman of HSBC, recently wrote in the Telegraph that “At the extreme, uncertainty over the Scotland’s currency arrangements could prompt capital flight from the country, leaving its financial system in a parlous state.”

So if you’re looking for something to worry about,, you should worry about the immediate future of the Scottish financial system. Yes, maybe the UK will relent and agree to monetary union. But right now, the risk is not that the monetary union will break up, but that it might. The UK has said that monetary union is off the table, and the EU has said that Scotland must have its own central bank. Remember that the EU wants to discourage regional secession from its member states. Almost every country in Europe has a region that seeks greater autonomy-- or worse. Scotland will have no friends in Brussels or Frankfurt.

Whether Scotland decides to print its own money, or whether it decides to unilaterally adopt sterling, there are substantial risks to holders and issuers of Scottish financial assets. If Scotland decides to print its own money, the currency will be entirely novel, and Scottish monetary and fiscal policy are complete unknowns. If Scotland instead decides to unilaterally “sterlingise”, its banks will lack a lender of last resort. In either case, there are substantial risks. A Yes vote would create great uncertainty for a very long time.

In addition, the rump UK’s credit would suffer if Scotland chose to repudiate its debt, which has been discussed. This would leave the UK with a higher debt-to-GDP ratio, since the UK can’t repudiate its own debt. Every pound of UK debt is a liability of HM Treasury.

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