By Matthew Lynn
The rest of the U.K. would be better off without it
The pound is in free fall. The banks are preparing a midnight flight across the border. Brokers in the City of London are preparing for a flood of money to come their way, while Edinburgh is preparing for the barricades to go up. On Thursday, Scotland will vote on independence, and the polls suggest the result is on a knife-edge.
By the weekend, to listen to much of the commentary, the U.K. could be plunged into political and economic chaos.
In fact, it is mostly nonsense.
The pound GBPUSD, +0.11% has hardly fallen at all. It is the dollar DXY, -0.05% that has been rising. Very few big companies will relocate, because most of the British economy is already centralized in London. After some very minor disruption, trade will carry on much as before. The reality is that Scotland is a very small country that does not count for very much, while the rest of the U.K. would be in a better position without Scotland.
A “Scoxit” will be a big political event, bringing to an end a 300-year old union that has been among the most successful ever forged. It will change the destiny of not just Scotland, but also Wales, and Northern Ireland.
But economically, and for the markets, it will be a nonevent.
Which way the vote will go is anyone’s guess right now. The polls give the “no,” the pro-union camp, a slight edge. But there has never been a vote like this before, and the pollsters have not had any chance to tweak their methodologies. It might well be the case that some people say they will vote for independence in public, but will decide against in the privacy of the ballot box. Or the other way around.
The polls could easily be 10 percentage points out either way. What is clear, however, is that there will be a very substantial vote for independence, and perhaps even a decisive one.
The markets suddenly woke up to that last week, and the pound started to sell off. From close on $1.70 to the dollar at the beginning of the month, it dropped all the way back to $1.61.
Banks such as Lloyds LLOY, +0.93% and Royal Bank of Scotland RBS, +0.28% said they would move their headquarters south of the border in the event of a vote for independence. Brokers started making dire assessments of the consequences of a breakaway. Read David Weidner on “Scottish banks, before the big vote, show their true colors.”
A Deutsche Bank report compared it to the decision to return to the gold standard in the 1920s, and said it might spark a rerun of the Great Depression, at least north of the border.
In reality, it is not necessarily so. In fact, independence would not make much of a difference. Here’s why.
There is not much sign of sterling coming under any real pressure. Sure, it dropped as the polls showed there was a real possibility of independence. But the euro EURUSD, -0.02% dropped against the dollar at the same time, and it is hard to argue that was anything to do with the Scottish vote. In reality it was more a story about the American currency strengthening rather than the British one weakening. Traders were looking for an excuse to sell sterling, and the referendum provided it.
The markets never like uncertainty and there would be plenty of that immediately after a vote for independence. But it would quickly become clear that the rest of the U.K. — England, Wales and Northern Ireland — would be better rather than worse off without their northern neighbor.
Scotland has higher public spending per capita than the rest of the U.K., and it has a population that is aging faster than the rest of the country. Right now it pays for that with tax revenues from the North Sea oil industry, but oil is a declining industry as reserves dwindle, and with the oil price CLX4, +0.01% coming down it is less valuable than it used to be.
Scotland is about to become a net drain on the rest of the U.K. — financially, there could hardly be a better time for it to be leaving.
London’s financial services industry would get a big boost from the Edinburgh-based banks and fund management companies that would inevitably move their headquarters and most of their staff to the City following independence.
Wales and Northern Ireland would get a boost as well. Wales, for example, does relatively poorly for public spending despite its relative poverty because spending there is linked to Scotland. Without that rivalry, it would get more of the money that is redistributed from the wealthier parts of the U.K. to the poorer. So would Northern Ireland.
Against that, there will be no U.K. companies that relocate to Scotland. Once those facts sink in, any nervousness over sterling will soon evaporate.
Scotland would almost certainly be poorer, at least in the short term. But that would mainly be because it was run by a nationalist government addicted to big spending and state regulation. Over the medium term, and with different policies, it could well prosper.
Europe has plenty of small nations richer than the U.K. — Switzerland, Norway, or Ireland, for example. Scotland could be among them. If it doesn’t, and it gets poorer, it does not matter very much to the rest of the world.
In fact, after the initial disagreements, and some haggling over the terms of the settlement, trade would get back to normal.
Ireland broke away in 1922, and yet today the U.K. is one of Ireland’s main trading partners, and vice versa. Ireland sells 15 billion euros of goods to the U.K. every year, and imports 16 billion euros. It is much as you would expect for two economies very close to each other. Very quickly Scotland would be in the same position.
Whatever result the U.K. wakes up to on Friday morning, the markets will react. If it is yes, expect the pound and the FTSE-100 UKX, +0.18% to plunge on the uncertainty. If it is no, they will move upward as that is removed.
In reality, however, it won’t make much difference one way or the other — except that rest of the UK might be slightly better off for being smaller.