Black Swans in a Scotch Mist
A Black Swan is a term coined by former Wall Street Trader Nassim Nicholas Taleb to describe an event which is so unlikely or unpredictable that no one has assessed what the consequences might be. It is the unthinkable happening. On the Donald Rumsfield scale of knowability, it would be something “we don’t know we don’t know”. Nothing strikes more fear into the heart of bankers and fund managers.
Some saw Scottish independence as just such an event. Until a fateful opinion poll in September, few had seriously contemplated the consequences of a UK break up. When they did, all they could see were black swans in a Scotch mist. In the panic that ensued, there was only one certainty: it must not be allowed to happen.
A barrage of negative stories was unleashed to change Scottish hearts and minds which had been strangely impervious to effusive declarations of undying love and affection and bleak prognostications about a separate future. The gloves came off, objectivity was thrown to the winds and a grim, forbidding picture of life outside UK painted. Leaving Britannia’s sanctuary would lead to a brain drain, a barren land without shipyards, banks, scientific institutions, pensions, housing market, hospitals, supermarkets and almost everything else that civilised states have come to expect.
At the heart of the media onslaught was a report by Deutsche Bank entitled, “Scotland: Wrong turn”. The foreword was penned by chief economist David Folkerts-Landau, whose qualifications for the task included attendance at a Scottish boarding school as a teenager – he had local knowledge but there was little danger of him having gone native.
The economist scoured history for devastating errors of judgement. He found two examples whose dramatic effect upstaged any lack of relevance to the situation in Scotland. “A Yes vote for Scottish Independence on Thursday would go down in history as a political and economic mistake as large as Winston Churchill’s decision in 1925 to return the pound to the Gold Standard in 1925 or the failure of the Federal Reserve to provide sufficient liquidity to the US banking system, which we now know brought on the Great Depression,” he wrote.
Folkerts-Landau’s continued his analysis by peering into the murk of the eurozone for “stark examples of what can happen to countries seen to be on the brink of breaking away from a strong union.” He found Ireland, Portugal and Spain had all suffered recessions, higher taxes, lower public spending and higher interest rates after risking an exit.
How three countries staying in a union was comparable to Scotland’s leaving one was not explained. The banker studiously overlooked the fact that the crises in these states was mostly caused by the conditions imposed on their continuing membership in the single currency not because they were on the verge of cancelling it.
In any case, analysis by another investment bank, Bank of America, in 2012 provided an alternative interpretation. Ireland was predicted to have better growth, lower borrowing costs and a healthier balance sheet outside the euro, especially if it could orchestrate an orderly exit. Greece and Portugal might also benefit although less markedly. The countries which would suffer most from leaving the euro, according to Bank of America, were Germany, Austria and Finland, the most stable economically.
Folkerts-Landau ended his diatribe with a haughty dismissal of the whole independence idea. “Why anyone would want to exit a successful economic and political union with a G-5 country – a union which another part of Europe so desperately seeks to emulate – to go it alone for the benefit of… what exactly, is incomprehensible to this author,” he said.
Below his introduction, two Deutsche Bank strategists, Bilal Hafeez and Oliver Harvey, cited “overwhelming” economic and financial arguments against independence. They summarised them as five wrong turns. The first two were underwhelming arguments that philosopher David Hume came after the union and Scotland is not a Nordic country. The other three were the shortcomings of currency plans, the prospect of less trade and “twin deficits”, all problems which had been profusely aired and debated in previous weeks and months.
Deutsche Bank itself had already commented on the currency issues earlier in the year. In a May report, whimsically entitled “Should auld acquaintance be forgot”, Oliver Harvey took a more measured view. He did warn of the risks, including a flight of capital, of a Yes vote but suggested agreement and cooperation between Scotland and rUK might mitigate the worst effects of a break up.
Harvey even offered qualified support to Alex Salmond’s sterling plan. “Our bilateral option would be for Scotland and the rUK to form a currency union. While this has its own set of risks, it would not be impossible,” he wrote. The strategist suggested setting up a Scottish currency was not out of the question either. “Interestingly, Scotland is not only one of the more productive regions in the UK, it also has the lowest unit labour costs. Using this approach, Scotland’s currency may appreciate in value relative to sterling.”
In May, rUK was deemed to be a potential loser in a union break up. “It is also difficult to argue that GBP would be ‘better off’ without Scotland. It would likely increase the UK’s debt to GDP ratio and also deprive the country of one of its most productive regions. We therefore see risks to sterling as tilted to the downside,” Harvey.
It was made clear that Scotland’s destiny would be in its own hands just like any other independent nation. “Much would depend on the future economic policy of a Scottish government,” Harvey wrote.
By September though, the Deutsche Bank team could only see toil and trouble in an independent Scotland. In interviews after the publication of their analysis, the strategists ratcheted up the hyperbole. When asked by BBC News to explain what independence might mean, Hafeez replied: “It would be quite catastrophic economically for Scotland bordering on the possibility of a depression in Scotland that would last for a number of years.” Scottish financial institutions would lose access to borrowing from the Bank of England which would be “very debilitating.”
More worryingly, everyone would stop shopping.
Deutsche Bank’s lack of objectivity was mirrored by the media which trumpeted the cataclysmic conclusions across the globe without questioning the premise for them. Fraser Nelson was especially triumphant in his blog for The Spectator. He hailed the messenger as a messiah in the factual wilderness of the referendum campaign.
“Many voters in Scotland moan about the media: half of the country wants separation, according to the polls, but almost all newspapers are against it. So where to turn, for dispassionate analysis? As James Forsyth says in his brilliant political column this week, there’s no one left to tell the truth,” he wrote.
And in case there were any doubts about a banker and veritas, Nelson quickly dismissed them. He continued: “Private advice, issued by financial analysts to their clients, is interesting: these guys have no interest in spin, only accuracy. If they issue duff advice, their career is over.”
The Spectator blogger was not the only one enchanted by money talking. In Nick Robinson’s infamous on-air spat with Alex Salmond, the BBC correspondent asked: “John Lewis’ boss says prices could go up, Standard Life’s boss says money would move out of Scotland, BP’s boss says oil will run out. Why should a Scottish voter believe you, a politician, against men who are responsible for billions of pounds of profits?”
Who should the people trust, Big Business or Wee Eck? It was this question which Robinson believed Salmond hadn’t answered. Maybe the first minister thought it was rhetorical.
So what now? George Osborne’s autumn statement has sent shivers down the spine of the union. The Institute of Fiscal Studies predicts there will need to be “colossal” UK spending cuts to fill a £55 billon hole. That would shrink public spending by 35% of GDP in 2019-2020, according to the Office of Budget Responsibility. The BBC’s political correspondent Norman Smith described it as an extraordinary prospect, a return to the land of George Orwell’s Road to Wigan Pier, which documented the poverty, strife and inequality of pre-war working class life.
So, it looks like Scotland will be heading back to the 1930s anyway, just not in the way imagined by Folkerts-Landau and others.