Last week, financial markets began to take seriously the possibility that Scotland might vote Yes to independence. A constitutional change would raise the possibility of three types of market risk: currency risk, government credit risk and the credit risk associated with financial institutions.
The position on currency is today a stand-off. The Scottish government has said it will negotiate a currency union and the Westminster government has said it will not enter such negotiation. But Edinburgh cannot unilaterally establish a currency union and the Westminster government cannot unilaterally determine Scotland’s currency. Plainly there must be agreement. However, might this agreement leave people who had made deposits or loans in sterling at risk of being repaid in Scots bawbees of doubtful value?
As the eurozone discovered, establishing a currency union is easy, operating one is hard and unwinding one is hard. You can pass legislation saying all contracts made in drachmas are now payable in euros; but legislation saying contracts made in euros are now payable in drachmas is another matter. To which contracts does the latter apply? However the question is resolved, the answer will hurt many businesses and individuals, and occupy the courts.
But there is a simple answer in the Scottish case, which is that whatever happens after a new currency is adopted, existing contracts in sterling remain in sterling. This means there is no currency risk ahead of a change. The same answer is not possible for Greece because the point of a Grexit would be to enable the country to default on its debts and effect a large devaluation, a course unnecessary and unwise for Scotland.
British government stocks tumbled last week when opinion polls showed the campaigns neck and neck – perhaps because markets did not know what to make of the news, perhaps because of the Scottish government’s threat to renege on its share of UK debt. But, even if the Scots did so, this would add less than 10 per cent to the debt servicing cost of the rest of the UK – which, at about 2.5 per cent of gross domestic product, is hardly unaffordable.
There is little justification for believing a Scottish exit, on whatever terms, should affect the credit rating of the remaining UK: what repudiation would do to Scotland’s credit rating is a different matter. It is one thing to start life as a new country debt free, another to do so because you have just reneged on a pro rata share of UK debt of £100bn.
The third risk associated with independence is a change in the credit risk attached to financial institutions. Banks and other companies can operate in the EU through branches of their home business, or by establishing local subsidiaries in other member states. Sweden’s Handelsbanken uses branches; the Spanish Santander takes deposits in Scotland into its English subsidiary. If a bank fails, the saver has a claim on the appropriate deposit protection scheme – that of the country in which the regulated entity is located. As in Santander’s case, that might be neither the country where you made the deposit nor the one where the bank’s head office is located.
The “lender of last resort” facility provides liquidity support if there is a run on a bank. Last week’s interrogation of Mark Carney, governor of the Bank of England, at Westminster’s Treasury select committee confused that issue with a quite separate one: the reserves needed to sustain a currency peg; and the resources needed to provide liquidity support to the banking system. The scale of modern speculative capital flows is such that there is probably no currency reserve large enough to sustain the price of a clearly overvalued currency. Meanwhile, the availability of liquidity support to solvent institutions depends not on the reserves available but on the credit rating of the provider of such support – whether another bank, a government or a central bank.
But since the global financial crisis the term “lender of last resort” has routinely been used in wider and ill defined sense: to identify who (if anyone) will make whole the creditors of any failed financial institution or recapitalise any bank, wherever based, no longer able to raise equity from its shareholders. The only sensible answer – for Scotland and perhaps for other countries – is “not us”.
The present debate is demeaned by posturing and scaremongering on both sides. Scotland has prospered as part of a United Kingdom and could prosper as an independent country. Which course is more appropriate is a question of identity and values, not economics. And whatever outcome is declared on Friday morning, sensible people will work together to ensure that outcome produces the best possible economic result.