In questioning Scotland’s ability to weather an economic storm the Treasury is sailing rather close to the wind, writes George Kerevan
THIS week both sides on the independence debate were firing off economic broadsides at close quarters. There was a lot of shouting and the sound of wood splintering, but when the smoke clears will anyone have scored a decisive hit on the opposition’s main mast?
First shot came from the UK Treasury with a 113-page analysis purporting to prove that “the exceptionally large and highly-concentrated financial sector of an independent Scotland would be likely to increase the risks, to markets, firms and consumers, of financial services firms operating in an independent Scotland.”
As an economic argument, this is frankly tendentious and mendacious. The argument that size should confer greater risk is not found in any economic textbook I’m familiar with. Nor has a large, concentrated banking sector been bad for, say, Switzerland or Luxembourg.
The Treasury paper argues that in an independent Scotland, the assets of domestic banks would equal 1,250 per cent of GDP. That random statistic is there to frighten the unwary, especially if compared to bankrupt Cyprus, where the comparable figure is circa 700 per cent. Of course, safe, dependable Luxembourg has bank assets worth 2,500 per cent of GDP, or double the Scottish figure. In fact, Luxemburg has enjoyed social and economic stability since 1945.
Sensing the Luxembourg case undermines their argument, the Treasury spin doctors clutch at straws. They claim Scotland “would require to run large… current account surpluses” in order to emulate Luxembourg’s economic strength. But an independent Scotland would run a very large current account (trade) surplus. Oil and whisky would generate circa £50 billion in exports annually. The rest of the UK – having lost Scottish export earnings – would see domestic interest rates rise in order to borrow the foreign currency needed to finance its massive trade deficit.
The point is that the size and concentration of a financial system is not a problem per se – the real issue is how well regulated it is. And the effectiveness of the regulatory regime has nothing to do with size and everything to do with the public authorities. Glaring example: it was the UK Treasury that, as part of the triumvirate of British regulators, failed miserably to head-off the 2008 banking crisis. The self-same Treasury that now has the unmitigated gall to lecture on financial prudence.
Had Scotland stuck to its traditional banking model, which eschewed banks borrowing on the wholesale money markets to fund their own investment gambles, we would not have had the credit crunch. Indeed, the Canadian banks – still operating on those traditional Scottish banking principles – came unscathed through the global financial meltdown of 2008. The best reply to the Treasury nonsense is that an independent Scotland will ban such proprietary trading.
The Treasury document does its best to frighten the horses by constantly referring to the financial crisis in Cyprus. It makes scant mention of the reason the Greek Cypriot banking system imploded: because it converted the massive influx of Russian funds into imprudent loans to the neighbouring Greek government, which was in no position to pay back. The loans to Greece – the main ally of Cyprus in its conflict with Turkey – were political.
I can’t see the banks in an independent Scotland taking it into their heads to finance a Cameron, Miliband or Farage administration.
My favourite bit of jiggery-pokery in the report is the bold statement: “There could be questions about an independent Scotland’s ability to stabilise its banking system in the event of a future financial crisis.” As proof, the report cites aid to RBS, noting that bank “received £275 billion of guarantees through the UK Government’s Asset Protection Scheme. This combined support from the UK Government to RBS is equivalent to some 211 per cent of Scottish GDP”.
Folk are meant to draw the conclusion that wee Scotland can’t protect its domestic depositors. The truth is that the Asset Protection Scheme did not involve any cash at all, far less multiples of Scottish GDP. It was an insurance scheme forced on RBS for which the bank paid to the Treasury (i.e. which RBS depositors paid). In fact, RBS never called on a cent of the insurance payout because it was too expensive. If it had, the Treasury would merely have borrowed the cash on the financial markets and lent it on to RBS at a higher interest rate, thus making a whopping profit.
However, I accept one key point repeated throughout the Treasury paper: that there is a “tight relationship between the sovereign and bank’s credit risk”. In lay terms, if a government is imprudent in borrowing, the markets will worry about the implications for the domestic banking sector. The result is higher bond insurance rates and lower credit grades for private financial institutions as well as for the government. And the bigger a country’s banking sector, the bigger the likely negative impact.
The Treasury ghost writers interpret this as meaning Scottish banks will move their HQs to London to enjoy lower risk ratings and lower borrowing costs.
But note the Treasury sleight of hand: the paper implies that an independent Scottish Government would be imprudent and so trigger a negative market reaction.
Here we come to the other economic document published by the SNP Government. This includes an interesting compendium of statistics showing that over the period 1980-2012, an independent Scotland (with oil) would have had an annual average budget surplus of 0.2 per cent of GDP.
As for banks moving their HQs, the real threat comes from the likelihood that an alliance of the Tory rightwing, the London tabloids and a populist Ukip will take the UK out of the European Union. Then just watch City banks flee to Frankfurt taking their £17bn trade surplus with them.