Scotland’s growth and UK fantasy money

Scots of all political persuasions are prey to the guerilla war fought between unionists and nationalists on the field of the economy.

One side suggests that, freed of the shackles of partial devolution and the leeching of Scotland’s resources by the UK Government, this country will soar in prosperity.

The other is keen to portray Scotland as an economic basket case, politically sectioned for an unknown period for it own good by Doctor UK. The legend here is that Scotland is a high dependency culture incapable of independent operation and that a nationalist administration would ruin the country in short order.

The truth of course is different from any vested interest promotion. Security is found in hard facts – but those too need to be carefully interrogated. ‘Facts’ can be as willow-the-wisp as any fantasy.

Scotland’s 2008 growth outperformed the UK

However, there are some useful bedrock facts available to give us a sense of Scotland’s capacity and to allow us to test how the current Scottish Government has been making out.

According to figures released by the Office of National Statistics in 2009 and related to the measurement of 2008′s Gross Value Added (GVA) performance, the highest growth in the UK was in Scotland at 4.7% for 2008 compared to the overall UK GVA growth of 3.5%.

Gross Value Added (GVA) is the UK’s preferred method of measuring wealth instead of Gross Domestic Product (GDP).

The nationalists continue to focus on the potential impact on Scotland’s economy of its share of oil and gas revenues.

When the GVA per head is calculated to include Scotland’s share of what is called the ‘Extra-Regio’ – mainly off-shore oil and gas revenues – the wealth per head in Scotland is £26,794 compared to £21,147.00 for the UK.

2008 was the current SNP administration’s first full year in office and the year whose last half saw the start of the slide into recession precipitated in the last quarter by the banking collapse and the massive and continuing bail outs by taxpayers.

Riding out the recession

Scotland’s overall ability to recover from the depth of the current recession is centrally affected  by its inability to advance its capital expenditure – a matter controlled by Westmoinster.

This is the solution applied to an irresponsible degree  – until the last few days – by the Labour administration at Westminster. It has also been a major cause in the recent conflict in that administration between the hapless Prime Minister, Gordon Brown, egged on by the personally ambitious Ed Balls and opposed by Chancellor Alistair Darling and First Secretary Lord Mandelson.

Balls had persuaded Brown to base the coming election campaign by the Labour party on a distinction to be drawn between ‘Conservative cuts and Labour investment’, a high spending policy in the face of an extreme national debt burden and a strategy that was already knocking international confidence in the competence of the handling of the UK economy.

The Chancellor had wanted to see the country take the harder course of accepting spending cuts now, in order to pay down the level of debt and to limit the additional borrowing that will drive it higher.

Balls had persuaded Brown to go for potential electoral gain by making spending promises – at the cost of international regard for Britain’s financial position and competence in fiscal management.

Following the failed schoolyard rebellion ‘led’ by Geoff Hoon and Patricia Hewitt, various Cabinet Ministers screwed concessions out of a weakened Prime Minister in return for not lending their names to the move.

Alistair Darling was one of the major winners in this, forcing Brown to agree to rein back on the spending promises that were intended to buy votes at the cost of damage to international confidence in the pound. Brown now ‘accepts’ the Chancellor’s judgment that cuts in public spending must be introduced sooner rather than later.

This does not mean that there will not be a judicious advance of some capital spending to shore up key players in the economy, such as the construction industry.

However, such a key economic instrument continues to be withheld from Scotland for political reasons. Whatever anyone thinks of Scottish Finance Secretary John Swinney, no one has suggested that his economic strategy is driven by populist vote catching.

It would be reasonable, on performance, to expect Swinney to handle the use of capital advance responsibly and effectively – but he’s not about to get the chance and, with the General Election on the near horizon, Scotland will be artificially confined in its economic performance in this difficult time.

About Gilts

The official definition is: ‘A gilt is a UK Government liability in sterling, issued by HM Treasury and listed on the London Stock Exchange. The term “gilt” or “gilt-edged security” is a reference to the primary characteristic of gilts as an investment: their security. This is a reflection of the fact that the British Government has never failed to make interest or principal payments on gilts as they fall due’.

Basically, for the UK Government, the issuing of Gilts is a method of borrowing. A Gilt is a bond which is a promise to repay the value of the bond by a due date and, in the meantime, on set dates, to pay a given rate of interest to the bond holder on the value of the bond.

Gilts and printing money

In the current recession, driven by the failure of largely unregulated and high risk bank business strategies, the British Government has sought to ease the impact on the economy by printing money. To sooth public alarm by a form of disguise, this action is now known as ‘quantitative easing’.

To date, in the recession, the Bank of England has ‘printed money’ to the tune of somewhere between £200 billion and £250 billion. The Prime Minister is alleged to have put pressure on the Bank to increase this by almost double, issuing a further £200 billion. As far as we know – an important qualification  – the Governor of the Bank of England and its Monetary Committee has, so far, resisted such a call.

Gilts have been issued to raise funds to cover this exercise in printing money.

How buying and selling Gilts is an indication of investor confidence in the UK Government

Where the market in Gilts is strong and they are energetically bought by investors, it is a sign that the money markets have confidence in the UK Government’s abiilty to pay the interest on these bonds and to repay their value by the due date.

Where investors holding Gilts are keen to offload them, it is, conversely, a sign that the market doubts the UK Government’s ability to pay the interest and repay the debt at the appropriate time.

The consequence of the UK Government’s recent stance on increasing rather than cutting spending in the immediate future, has been a sharp fall in that necessary international confidence by the money market. This is seen by the recent decision by one of its  major players to reduce its stake sharply in British Government bonds – or Gilts.

Pimco, the U.S.-based bond fund giant, said a few days ago that it will be a net seller of UK government Gilts in 2010. This decision by the company had an immediate negative impact on the status of British currency. The value of the pound fell sharply on the news.

It is interesting – and ironic – to note that the head of Pimco’s European Investment Team is one Andrew Balls – brother of Ed Balls.

The UK Government’s dangerous strategy in the use of newly printed money

The Gilts issued to cover the volume of ‘quantitative easing’ (QE) already undertaken have not been used as advertised by the Government.

The defence put forward by the Government on the decision to print more money was that it would be used to buy corporate bonds.

This was designed to help companies which, in the current banking market, are unable to finance debt by selling their own bonds to banks – so state purchase of corporate bonds was intended to support key businesses through these hard times.

What has actually happened is that virtually none of the new money printed has gone to buy corporate bonds.

What it has been used to do is to buy the Government’s own Gilts, issued as security against the volume of money printed. This has been done to massage the public perception of confidence in the British Government’s ability to pay back its debt.

This is a highly dangerous strategy, taking the use of money into ever more complex realms of fantasy value.

Take a deep breath and consider the reality

The Government has printed new money. It has sold IOU’s (Gilts) to raise funds to cover the value of the money printed. It has then used the money it has printed to buy its own IOUs (Gilts) to create the pubic perception that there is confidence in its abilty to pay.

This means, among other things, that it has not actually raised funds from investors to cover the value of the new money it has printed. That funny money has been used to pay for itself. We’re into Monopoly money territory here and the risks are very high.

Pimco has good reason to plan to sell its holdings in UK Gilts.