One of the more subtle effects of the recent financial crisis has been the steady influx of new financial jargon into our everyday lives. Terms such as ‘national debt’, ‘austerity’ and ‘quantitative easing’ have tiptoed into the common vernacular in recent years, causing considerable controversy en route.
The recent flourishing of the financial lexis has been further aided by the high profile financial woes of popular Scottish football clubs, with terms such as ‘Company Voluntary Arrangement’ and ‘Employee Benefit Trust’ rapidly gaining ground on traditional favourites ‘pie’ and ‘Bovril’ as the preferred topics of half time tête-à-tête.
Perhaps more than anything else however, it is the referendum on Scottish independence that has been most responsible for bringing financial questions to the forefront of public debate. Among the many issues that have arisen from the prospect of a yes vote in September, the fate of the UK national debt has perhaps been subject to the most feverish speculation.
The UK Treasury maintains that an independent Scottish state would be responsible for a “fair and proportionate” share of the UK’s liabilities, but that since the debt will remain the legal responsibility of the UK, Scotland’s share of the debt and the terms of repayment would ultimately be subject to negotiation.
The Scottish Government’s White Paper on independence proposes that the national debt could be apportioned either in line with population share or on the basis of Scotland’s historic contribution to the UK’s public finances.
While the question of what should constitute Scotland’s “fair and proportionate” share is undoubtedly an important consideration, a seemingly obvious but important question has so far been overlooked: Scotland’s fair and proportionate share of what, exactly?
There are many different measures of debt reported in the public accounts, but the figure that is most often reported in the media is ‘public sector net debt’. Under this measure, the UK national debt currently stands at £1.25 trillion, or 75% of annual economic output.
Behind this figure lurks an odd reality, however. Since 2009 the Bank of England has purchased £375 billion of government debt from the private sector using newly created electronic money – a process that has been referred to as quantitative easing (QE). As a consequence, the UK government now owes £375 billion – or 30% of the total outstanding public sector debt – to the Bank of England. Strangely, however, the Bank of England is itself an agency of the public sector. To put it another way, the UK government owes £375 billion to the Bank of England, which in turn is owned by the UK government. In essence, the UK government owes £375 billion to itself.
Confused? Bear with me – things get a little more confusing yet.
When a government borrows money it has to repay the principal amount that it borrowed plus interest. In the UK, around £50 billion of the annual government budget currently goes towards interest payments. As a result of QE, the government is required to pay interest to the Bank of England on the £375 billion of government bonds that it holds. In late 2012, however, George Osborne announced that the interest that the Bank of England receives from the government will be returned to the government to help pay off the national debt. Over the next 18 months the Bank of England transferred £35 billion, which it earned from the UK government as interest on government bonds purchased with newly created money, back to the government so that it could be used to help pay off the debt. Talk about funny money!
Aside from causing headaches, why does any of this matter? To begin with, if the people of Scotland vote yes in September intense negotiations will be required to ensure that assets and liabilities are divided in a fair and sensible manner between Scotland and the rest of the UK. The allocation of the national debt will be a key part of these negotiations, and this has been the reflected in the significant amount of discussion that has taken place on both sides of the campaign so far. What has been noticeably absent from these discussions, however, is the recognition that 30% of the total outstanding UK public debt is effectively owed to the UK government, and that the government is not paying any interest on this element of the debt.
The implications of this are potentially significant: given that £375 billion of the UK’s public sector net debt is owed to a public sector body (an inherently paradoxical position), does this ‘debt’ really exist at all? If Scotland were to become independent would it be compelled to take on a share of this debt? If £375 billion of the UK debt is owed to itself, should the starting figure in any negotiations about debt allocation be £875 billion, rather than £1.25 trillion?
On the basis of population share, Scotland’s share of the debt owned by the Bank of England currently amounts to £32 billion. This is equivalent to what Scotland spends on education, health, defence, housing, transport, environmental protection and policing each year combined. Were Scotland to take on this debt under current circumstances, the interest that would need to be paid on it – initially as much as £1.3 billion per annum – would end up lining the pockets of the UK treasury.
So where do both sides of the independence campaign stand on this issue? Unfortunately it’s impossible to tell – aside from is an excellent paper from Jim and Margaret Cuthbert for the Jimmy Reid Foundation, the effects of QE on the potential debt settlement between Scotland and the continuing UK have been largely ignored.
One possible reason for this is the belief that the effects of QE are only going to be temporary; once the economy is in full recovery the Bank of England will sell its stock of government bonds back to the private sector, therefore returning things back to ‘normal’.
While it is true that QE was initially intended as a temporary measure, there is a growing consensus that QE will never be fully unwound. Indeed, in a recent interview the Governor of the Bank of England, Mark Carney, appeared to hint that this may well be the case.
Many respected commentators, including ex-Chairman of the Financial Services Authority Adair Turner, suspect that the UK Government may arrange to effectively ‘write-off’ the £375 billion debt owed to the Bank of England. If this was to happen after Scotland became independent (and once Scotland had already assumed its share of the debt, including a proportion of the £375 billion owned by the Bank of England), Scotland would be left feeling somewhat short changed.
Although this outcome is far from certain, the fact that it is a possibility highlights a wider issue. The implementation of QE should be the first indication to the general public that, when it comes to our monetary system, not all is quite as it seems. QE has highlighted that money itself is not inherently scarce, and that the rhetoric used to justify aggressive austerity – for example by likening the constraints on the government budget to that of a household budget – is erroneous at best and intentionally misleading at worst. Whether in an independent Scotland or a United Kingdom, understanding our monetary system is essential if we are to have a sensible debate on the economy. This is something I’ll return to in a future article.