The debt Scotland stands to inherit as an independent nation is often used as a stick to beat the Yes camp, and various “estimates” of the size of said debt – ranging from the merely extreme to the comically deranged – are a core element of the scare stories that suggest Scotland would have a fragile economy prone to collapsing the first time there was a bad year for oil prices/production.
But to understand the reality you need to dig a little into the nature of the debt, as the relatively widely-known figures of outstanding UK debt only tell half the story. Delving into the (deliberately) labyrinthine world of finance is a daunting task, but we’ll keep this as understandable as we can.
To predict the fairest and most likely outcome for an independent Scotland, you need to first know a little about the nature of government debt, where it originates, and the role of the Bank of England in its Quantitative Easing programme.
Government debt is issued in the form of bonds (called “gilts” in the UK for purely historical reasons, but for simplicity’s sake we’ll stick with “bonds” throughout this article). A branch of the Treasury, the Debt Management Office (DMO), issues the debt in auctions. You can see the results of the auctions here.
The buyer of a bond (banks, insurance companies, hedge funds, companies, foreign governments and private individuals) fork over cash in an auction in exchange for a bond. The bond is a contract that defines regular interest payments for the lifetime of the bond (up to 30 years), after which the nominal value of the bond (the principal) is given in cash to the holder.
After the term, the bond ceases to exist, and the holder of the bond has received cash interest payments and a cash nominal payment greater than the initial sum paid in the auction to the DMO. (The risk lies in the fact that depending on inflation, they may have lost out in real terms.)
So the DMO issues the debt and gives the Treasury the cash from the auctions to be used in regular government spending. Over time the Treasury gives money back to the DMO to be distributed to the bond holders as interest payments and for paying off the principal sums when the bonds mature.
The current outstanding nominal value of UK bonds is £1,269 bn (or £1.27 trn) according to the DMO here. This is the major component of the Big Scary Number of which Scotland has a proportional share, which would theoretically make up the Scottish Government’s inherited debt in the event of independence. (Minus, of course, consideration for Scotland’s share of UK assets.)
So far, so normal, but the system was changed in March 2009 when the Bank of England (BoE) began its Quantitative Easing (QE) programme. The programme is very simple: the Bank of England creates pounds Sterling electronically, essentially out of thin air. They use these pounds to buy UK government debt in the “secondary” market (ie from private investors, such as insurance companies).
Up until today, approximately £375bn worth of UK government bonds have been bought in the QE programme – roughly 30% of the outstanding bonds – and this number is now set to increase as the QE programme expands. So private investors are buying bonds from the UK government, then passing them along hot-potato-style to the Bank of England in exchange for newly-created money (and doubtless earning themselves a nice little commission on the way).
(If you’re wondering why the Treasury doesn’t just get the Bank to create more fake cash and pay the debt off in one go, the market believes that the amount of money printed in QE so far is a proportional measure to stave off the kind of deflation you’d normally expect in a debt bust like we’ve been experiencing, and not enough to result in excessive inflation. Another trillion and nobody would be fooled – it’d start the biggest run on a national currency since the Weimar Republic, and you’d quickly end up with a packet of Corn Flakes costing half a million quid.)
The defense that QE is not money-printing rests on two arguments. The most commonly asserted, but most threadbare, is the literally-true fact that the Bank of England is not printing up banknotes to specifically use in QE. In reality though, the people who receive the newly-created money have every right to convert it to cash, but just choose not to, so the point is rhetorical.
The other reason is more complicated, but more sellable: eventually the programme will be unrolled. For this to occur, the Bank of England would have to destroy the money electronically that they receive from selling bonds back to the private market (which they aren’t doing or planning to do), or in the form of interest payments and principal payments on the bonds they hold – payments they receive from the Treasury.
So far, so not money-printing, until we get to the end of 2012, when it was announced that the interest payments that the Treasury pays the Bank of England, instead of being magicked out of existence, had been collected up and were now to be given as a gift to the Treasury.
So the circle is now complete, and the government debt is being financed by money-printing, since the bond assets held by the BoE are depreciating in value as they approach maturity and all the cash received by the BoE in this regard is being passed on to the Treasury. The BoE therefore can never destroy the QE money electronically, since it all gets given to the Treasury and the bonds are eventually worthless.
It’s never mentioned, but Scotland would have just as much right to the bond assets held by the BoE as they would have obligation to the DMO’s debt, and it’s important to explain why these central bank holdings reduce the government debt, since the BoE really are directly funding the Treasury through money-printing and the Treasury will never pay off the bonds held by the BoE in any meaningful sense.
Still with us? In short, the consequences for an independent Scotland are that by 2016, because of QE, the net debt Scotland inherits a share of will to all practical purposes be at least 30% lower than the headline UK debt figure would suggest. (Because the £375bn of outstanding bonds don’t ever really have to be paid down, since every payment the government makes to the BoE gets sent back to them. Call it a permanent payment holiday.)
Given the current QE expansion plans brewing under new BoE chief Mark Carney, it’s not unreasonable to expect that 50% of Scotland’s share of the national debt will be cancelled out by the practicalities of Quantitative Easing, and that’s before any other reductions which might be obtained during negotiations.
But whatever happens, almost any frightening debt figures for an independent Scotland you hear from the No campaign and the Unionist media over the next year are almost certain to be greatly exaggerated.
*Yes, “Robert Bruce” is my real name. Want to see my birth certificate?