When The Economist Lacks Faith in Markets

I was reading an online article of The Economist discussing market responses to the prospect of a divorce between Scotland and England resulting from this month's referendum. Long story short: markets place a premium on uncertainty. Who knew? They're basically pointing out that this political question will have economic consequences, as there is no free lunch. Right-o!

Still, I detect the implication that a political division is inherently more costly. While it may appear that way in the run-up to making the decision, when it comes to risk and efficiency, that depends on how the distinct government of the U.K. and the new government of Scotland would perform on average in the long run relative to the alternative of staying, well, United. Yes, there would be a hiccup, but on a grave question, that's immaterial. Like with marriage, you estimate your future gains of staying versus leaving - psychic and/or moral, not just financial - and act accordingly. To suggest otherwise is to advise a middle class couple contemplating divorce to hesitate on the absurd basis of court fees.

Now, such a couple should consider that rancor, heavy bargaining, and/or delayed proceedings will needlessly make the transaction costs much more dire, and the article rightly points out there could be some of that over such matters as debt allocation, currency, and bank regulation. I wish a magazine with an appreciation for free market functioning would put more stock in them. They suggest that even if England & Scotland could agree how to split the national debt, that the transition could really roil markets. They say:

Rating agencies have indicated that Scotland would have a lower credit rating than the UK, requiring a higher yield. BNP reckons the spread would be 150 basis points (1.5%) putting 10 year yields at around 4%. Say the debt was split 16 to 1, with Scotland taking £100 billion of the UK's £1.7 trillion total (this seems to be the Yes camp's case). So would an investor with £17m in UK bonds, get £1m of Scottish debt or would they have a choice? You can see that some investors might not want the lower-rated paper so there could be a bit of turmoil. 

Wouldn't this basically just be a big refi? With two key premises granted, (a) the parties have agreed a split, and (b) the agreement was struck with an expectation/preparedness to pay a higher yield, shouldn't allocation be easy? Offer a coupon to increase the yield until enough investors voluntarily exchange U.K. bonds for Scottish national ones that the ratio struck at the bargaining table is achieved. The Economist asks the right question - choice or assignment - but they portray too much ambivalence. Also, surely "turmoil" is too strong of a word. It's not as if a reasonable top-up couldn't achieve the necessary ratio. If France tried to get investors to voluntarily swap into new Free Republic of Guyana bonds after a separation of this colony, that might be a real question, but if Greece can find buyers, Scotland can.

This might seem an overreach, but this is the same magazine that agonizes over Brexit and Grexit to the point of (elsewhere - I'm not going to find a source but they've done it multiple times) advocating some level of debt mutualization at the European Union level. Too big to fail hasn't wrought enough carnage to warn off any market proponents from enshrining this policy even more? True, palpable uncertainty can smother markets, but remember Hayek's argument that not only is its polar opposite of certainty unattainable, but it'd make markets superfluous. Stop chasing it, and let markets allocate risk!