REGARDLESS of how you voted, we can all agree on one thing: Britain had a near death experience last Thursday. The fascinating question is why the world’s financial markets felt so threatened by the prospect of Scottish independence. The peaceful secession of a mere 8 per cent of Britain’s citizens is hardly the stuff to trigger a run on sterling or a collapse in inward investment to the entire UK – predictions made during the referendum campaign.
My initial reaction to such histrionics was to dismiss them as the product of: 1) deliberate propaganda by vested interests, such as bankers trying to cuddle up to David Cameron; or 2) cunning City spivs talking up a crisis in order to short-sell equities and sterling, to make a fast buck, as they did in the crash of 2008.
I still believe both motives were involved. Sadly, they had an impact on the referendum outcome, weighing heavily on the No voters from the over-65 age group. However – this is my mea culpa – it is apparent in retrospect that even sober and informed elements in the global financial community genuinely feared a Yes victory would detonate an economic time bomb.
But this time bomb lies not in Edinburgh, or in any long-term weakness perceived in Scottish public finances. Rather, it lies under the City of London itself. And it is a bomb that is going to go off anyway. Market jitters over the referendum vote signal one thing: the world fears that the UK economy itself is desperately weak and therefore vulnerable to any kind of shock. So weak that even a minor democratic reform such as Scottish self-government could bring the whole edifice crashing down.
If this is how the world’s investors see the UK, then last week’s near death experience is hardly likely to be the last. Because the illness has nothing intrinsically to do with Scotland but with the underlying weakness of the UK manufacturing economy coupled to the high-risk, casino operations of the City of London financial sector. In which case, uncertainties provoked by the coming general election – hung parliament, Ukip successes, a dust-up over English votes – could prove the next flashpoint.
Why does the world worry so much about the UK economy? Basically because we don’t export enough goods, which means we live off our banks and banks are mega risky, don’t you know. In 2012, the UK had sunk to only 11th in the global rankings as an exporter. Even Hong Kong bested us. This means we don’t earn enough foreign currency to pay for our imports of Korean smartphones and year-round African vegetables.
We filled the gap through the big City of London banks gambling on foreign derivatives, generating vast paper profits denominated by dollars and euros. Of course, that is exactly the equivalent of you trying to pay off your mortgage by flying to Las Vegas and betting your shirt. You might win for a time, but eventually disaster strikes. It struck the UK economy in 2008. As a result, governments introduced rules to limit banks from gambling. Sensible as that move is, it removes a key source of foreign currency to pay for our imports.
The obvious alternative is to “rebalance” the economy to exporting. Some hopes. UK productivity has stagnated as firms refused to invest. In Ireland – the butt of many jokes by Scottish Labour politicians – productivity has skyrocketed, creating an export boom. Irish economic growth in the year to June was a phenomenal 7.7 per cent, twice the UK number. Foreign investment is flooding into Ireland and government borrowing costs have dropped below those of the UK. The Celtic tiger is roaring again. Britain, on the other hand, faces a crisis – how to fund imports.
Britain is living on “tick”. To find the foreign currency we need, we are borrowing from abroad in ever larger amounts. Some of this is in the form of investment in property, which is why Gordon Brown invented the wheeze of enticing Russian oligarchs to live in the UK by charging them next-to-no income tax. Gordon’s adviser, Ed Balls, seems to have forgotten the script. If Chancellor Balls introduces a mansion tax, the oligarchs will sell up and relocate to Geneva. Ed may win a few cheap headlines about “saving the NHS” but the net result will leave the UK even more desperate for foreign investment to fund imports – including expensive American medicines.
This is where the City’s referendum panic comes in. To pay for its imports, the UK has to raise foreign investment to the tune of 4 per cent of our GDP every year – the current account deficit. The loss of Scotland’s oil and whisky export earnings would have doubled that bill overnight. But the panic lights are still flashing even after the No vote. According to the Daily Telegraph’s Ambrose Evans-Prichard: “What has become ever clearer over past two weeks is that the UK itself is in the crosshairs, at high risk of capital flight and a loss of faith in British debt.”
Why have the markets been so placid until now? The Bank of England responded to the credit crunch by printing £375 billion and used it to prop up share prices artificially. This gave investors a false sense of security. The referendum woke them up to Britain’s systemic vulnerabilities. Unfortunately, it might also have given the world’s hedge funds a taste for interfering in the democratic process. Imagine how they will react to a Labour government (with a tiny majority) that imposes price freezes on business and introduces levies on bank profits? To stop the ensuing run on the pound, Ed Balls will have to raise interest rates. Just watch your mortgage go up.
A Yes vote could have allowed Scotland the flexibility to grow an export-led economy like Ireland’s. Sharing a common currency with England would have allowed both nations to pool their foreign earnings. Now our re-United Kingdom must await orders from the world’s currency dealing rooms.