Things Fall Apart: Scotland Edition

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Sep 8, 2014 1:02:21 PM

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scotlandEven as the U.S. economy continues to improve, and signs of better times keep popping up—the most recent being a break in the oil price below $100 per barrel, which will support consumer spending—other parts of the world continue to show signs of weakness.

Today, I want to highlight something that hasn’t yet become a major worry for Europe, but probably will: the possible secession of Scotland from the United Kingdom.

For those not following the situation (which is pretty much everyone who doesn’t live there), Scotland is scheduled to vote on September 18 on whether to remain part of Great Britain. Things got interesting over the weekend, when, for the first time, a poll showed the pro-independence movement in the lead.

With 10 days left until the vote, an independent Scotland looks like a real possibility.

What would independence mean for Scotland?

Unfortunately, how an independent Scotland would work isn’t all that clear.

Would it have its own currency? The pro-independence activists say the country would continue to use the pound, but the British government and treasury say no way. In which case, surely, Scotland would use the euro—right? Well, again, we don’t know. It’s far from clear whether Scotland would be allowed to join the European Union as an independent country at all, much less immediately and painlessly.

Would Scotland at least have that unmistakable hallmark of a modern country—its own debt? Yes, of course. But how much of the debt from Great Britain would it inherit? Good question. The same applies for the military forces, the North Sea oil fields, and so forth.

Potential repercussions across Europe

Of all the European countries, the UK has rebounded most successfully from the financial crisis. The kind of uncertainty sure to be created by Scotland’s secession would hobble one of the main engines of the eurozone recovery.

More, if Scotland secedes, every questionable region in Europe (Catalonia and the Basque country in Spain, northern Italy, and even parts of Germany, such as Bavaria) would find itself back in play. Were Scotland admitted to the EU, Catalonia would certainly seek the same deal—a significant disincentive to the EU to allow Scotland an easy transition.

Could this fracture the EU?

With the potential for a Scottish split, the likelihood of the rest of the UK exiting from the EU increases substantially. The British government has promised an “in or out” referendum on EU membership in 2017. With Scotland gone, the existing government would be more likely to remain in place, and such a referendum would be more likely to result in an “out” decision.

A large part of what has held the EU together so far has been the perceived irreversibility of membership. Should a major country like the UK pull out, the chances of the EU dissolving completely go way up. With the current economic and political conflicts between Germany and most other states, particularly France, set to rise over the next couple of years, this could be the straw that breaks the whole structure.

The last thing either Europe or the world economy needs right now is a substantial jump in uncertainty, but that might be exactly what we get in a couple of weeks. Keep an eye on this one—it matters a lot more than it might seem to.

Upcoming Appearances

Are you attending the 2019 FPA Annual Conference in Minneapolis, Minnesota? Be sure to join my “Economic and Market Update” during the Educational Breakout Sessions on Friday, October 18, from 7:45 A.M. to 8:45 A.M. CT. To learn more, visit https://fpaannual.org/.

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