Hi Investors!

Welcome back to another week of Market Movers, where I summarise the top headlines that attracted my attention this week to keep you up to speed with the markets and give you some light reading for the weekend.

As usual, lets start with a look at the general markets, followed by the digital asset space.

Don't forget to check out the Risk On Investor resources page for access to the growing selection of calculators, tools and video guides to help you become a better investor. There is also more content posted frequently on the YouTube channel to keep you informed and entertained - you can also read back on previous newsletters if you're a new joiner to the investor club

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Have a great weekend

Chaz (RiskOnInvestor.com)

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Disclaimer - The opinions of the author in this newsletter should not be taken as financial advice. Any mention of investment products is not a recommendation to buy.

If you are looking for financial advice, please seek the services of an industry professional and do your own research.

Capital is at risk when investing

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Major Market Indices

They'll never take our freeeeeddddoooooommmmm!

Most countries seem to have an independence movement from one or more ethnic groups and the UK is no different.

Perhaps the most high profile of these movements is the Scottish movement which has been spearheaded by the Scottish National Party (SNP) in recent decades and seeks to break the ~400 year old union between England and Scotland and it's slightly shorter union with the United Kingdom of ~300 years.

10 years ago, in 2014, this movement was given its big chance when the Westminster parliament gave permission for a Yes/No referendum to take place. The result was an almost 10% vote in favour of remaining part of the UK.

Since then, Scotland as a region voted overwhelmingly in favour of staying in the EU but was outweighed by votes, particularly in England, which resulted in Brexit which appeared to trigger fresh calls only a few years after the prior vote for another referendum.

With a new government being elected to westminster the calls are starting to come again to revisit the option of independence.

One of the big issues discussed in the last referendum was the economy, so I thought it was time to revisit some of the potential economic issues and see what the current standing is.

So let's play a little thought experiment out. Scotland has voted to leave the UK, what happens next?

Who gets the debt?

Just like a relationship breakdown there would need to be a division of assets. A working paper from the UK government prior to the referendum simply stated that "An independent Scottish state would become responsible for a fair and proportionate share of the UK’s current liabilities" [Source]

What does that mean?

I think this is intentionally left ambiguous to allow negotiation. There are a couple of ways I think this could be split:

• Proportional to population - Scotland would take 8.1% of the UK's liabilities [population source]
• Proportional to GDP at ~8% [source]

This was a bigger disparity back when the referendum was held when Scotland accounted for a larger share of the population and a similar share of GDP.

In other words, it looks like less of an argument point now with a number between 8-8.1% seeming likely.

The major issue Scotland would have is that Scotland would begin life as a country with a very high national debt as a percentage of GDP, if split proportional to GDP, it would largely match the UK's at ~100%

However, like the current UK government, Scotland would need to raise it's own debt to cover ongoing costs. This is likely to be significantly higher in cost than current UK debt as the risk lenders are taking would be higher.

Who gets the oil?

This was perhaps one of the most contentious points during the referendum.

Oil and Gas generates a reasonable size tax receipt for the UK government every year, and as the map below shows, you can make a strong argument that most of the UK's offshore oil reserves would be in Scottish waters, especially if Orkney and Shetland went with Scotland (this is still debated)

Based on information available at the time of the referendum, if the split was broadly geographic, which appears to make sense, about 90% of the tax receipt the UK government received from oil and gas currently would accrue to Scotland [Source]. This would likely account for ~19% of tax revenue in Scotland and therefore leaves Scotland vulnerable to the international price of these commodities. Since the referendum the price of oil has fallen by about 15% which would have hit the Scottish government bottom line.

Scotland would also face another substantial issue, many of these oil and gas fields are old.

Some estimates put the reserves of oil and gas at another 20 years of high levels of production so Scotland would face the same issue many of the middle eastern oil rich countries face - a countdown to diversify the economy.

The cost to decommission and oil and gas field is substantial with estimates in the region of £30b. As these wells come to the end of their life the drilling companies will begin writing off the cost of decommissioning which will begin hitting Scottish tax receipt long before the wells run dry, and if Scotland controls 90% of the reserves, then they will have benefitted from startup costs being spread across the UK as a whole, but the decommissioning costs born by Scotland only.

It is expected that if this 90% scenario was to play out, at current levels, this would likely replace the funding Scotland currently received from Westminster so in the short term no real net change for Scottish finances, but this receipts would be volatile compared to the grant funding from the UK government which is based on a number of variables such as population..

How are Scottish public finances looking?

In short, not great.

Scotland would face some very difficult decisions.

Currently Scotland runs a large spending deficit of ~9% per annum. Significantly higher than the UK as a whole (remember the UK's number would be lower if Scotland was removed as Scotland currently acts as a drag)

and this is despite total revenue as a percentage of GDP being similar to the UK as a whole.

As such Scotland would either need to make pretty harsh spending cuts, raise taxes or a combination of the two.

As a comparison, the UK as a whole had a deficit of -10.3% in 2009/10 when the Conservative government enacted austerity at the end of the financial crisis. The deficit was cut every year until 2018/19 when it reached -2.1%, so still not a balanced book but broadly in line with growth, and as such, debt stopped growing as a percentage of GDP.

Assuming the Scottish government follows a similar path, there would likely be a decade of cuts and tax rises coming Scotland's way which I imagine will be very unpopular, especially given that Scotland has already had a lot of service cuts as part of the wider UK austerity scheme.

Who controls the money?

Another sticky issue that isn't resolved is who controls the money?

Scotland's biggest trading partner is the rest of the UK and would likely remain so. As such it would make sense for Scotland to use the pound as it's currency to make trade seamless.

That's fine for the short term, but gives up control to the rest of the UK.

The Bank of England controls monetary policy and those decisions are based on economic data from the UK. Presumably Scotland would be excluded from that data going forward.

As such, if Scotland's economy started to detach from the wider UK there would be no assistance from the Bank of England with an easing of interest rates in bad times and tightening in good times. Scotland would instead just have to weather the storm.

The alternatives would be to join the Euro or issue it's own currency.

Joining the Euro has exactly the same issues as keeping the pound.

Creating its own currency would be an interesting option. In theory it would give the benefit of control, however I am concerned that with Scotland running a big deficit and no debt issuance/repayment history to re-assure investors, Scotland would have to issue debt at a high interest rate and the Scottish currency would likely be very weak on the international stage against its peers which would be a natural upward force on inflation in Scotland.

Would Scotland rejoin the EU?

Many proponents of independence claim that Scotland would rejoin the EU.

That's easier said than done.

I imagine the political rules would be fairly easy to meet as Scotland has only recently left, as such there would be limited disruption there.

However there are economic criteria that would need to be followed.

Namely; a deficit of no more than 3% per annum and debt to GDP of no more than 60%.

As we've seen earlier Scotland is a long way from both of these measures and ~9% and ~100%. As such the rules would either need to be relaxed or it would likely take decades before Scotland was in a place to join the EU.

Conclusions

This of course is a broad brush overview of the main arguments.

There are significant other economic challenges, such as setting up new regulators for financial markets, breaking off the NHS, and loss of other central government funding which I haven't explored.

From an economic point of view I therefore only see negatives for Scotland if it was to leave the UK based on current data.

Looking at it from a purely utilitarian point of view however as someone who doesn't live in Scotland, it would actually ease pressures on the public finances for the rest of the UK should Scotland leave as Scotland is a net drag on UK public finances.

However, as a traditionalist, I would personally like to see Scotland stay and the UK remain as a whole!

I don't see Scotland being given permission for another referendum any time soon, however this does highlight, that in most instances, a breakaway region is often small and as such is usually a net beneficiary from the larger area it is currently part of.

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Digital Assets

Solana ETFs in the US

I have argued in previous newsletters that a US Solana ETF isn't coming anytime soon.

We just had further confirmation of that when this week the Chicago Board Options Exchange withdrew it's 19-b4 form for spot Solana ETFs.

This doesn't mean that the applications are completely dead in the water, but it does show that there won't be any spot Solana ETFs anytime soon, especially with Solana named in some lawsuits the SEC has filed.

I would expect those lawsuits to be completed prior to any movement on the ETF as it would undermine the SEC if they allowed a commodity based ETF (as was the application) and at the same time list Solana as a security in some lawsuits.

My concern about interest rate cuts

I have noted that a lot of chatter I have seen recently in the crypto and digital asset space as a whole has been very positive around potential interest rate cuts in the US.

There are two main events to watch for in the near term.

First is the central banker shin-dig happening 22-24th August (almost over by the time you read this) when a bunch of central bankers get together to chat finance and do whatever central bankers do in their spare time to unwind.

The second is the federal reserve meeting in September.

At the time of writing, the markets are pricing the likelihood of no cuts until November with the November chance balanced finely between 1 and 2 cuts.

lets compare that to the newsletter I wrote back in January

8 months ago the markets thought we were ready for cuts and were pricing in 5. Those expectations have been tempered by the Fed over the year so far to the point where we haven't seen a single cut.

But why would you cut interest rates as the federal reserve?

Because something is going wrong. And that's usually bad news.

Now, it's not quite that simple in the current situation.

The rates were raised quickly to combat high inflation that got away from the federal reserve so you would imagine it is currently running high to bring down inflation and the neutral rate is lower. The neutral rate being where it doesn't cause any overly restrictive or loose impacts on the wider economy.

The question is where does that neutral rate sit?

There are different models to try and predict this but the two most prominent seem to suggest that interest rates (r star) should be in the 1.0-1.5% range.

Interestingly this is significantly below the Federal Reserve long term estimation which is in the 2.25-3.75% range

Interestingly the market is suggesting that rates will go lower than the Federal Reserve suggests.

This is where the recession fears are being priced in.

The Federal Reserve rates are based on a 'soft landing' and whilst so far everything seems to be going OK on the path to a soft landing. Anything lower than the Fed's long term projections is therefore predicting a recession.

Recessions aren't great for assets generally.

People have less disposable income and so there is less buying pressure on assets.

I personally don't think that a recession in the world's largest economy would be good for crypto. I of course, have very little evidence to back this up due to the short history we have of digital assets.

Therefore I am starting to get a little twitchy.

Currently I have no intention of getting out of the market but I am watching economic news releases closely.

Unemployment is ticking up but many economic indicators suggest that we may have had the worst of the downturn (blue line below - Leading economic indicators - LEI's) and as such we might be on the rebound now.

Time will tell if we have just been through the soft economic period or if it's still to come. The UK experienced something very similar 12 months ago where it went through a very soft technical recession but bounced back afterwards.

[DISCLOSURE - Chaz holds $MSTR and $RIOT in an ISA and $wStETH and $GALA in unsheltered positions]

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Latest from the YouTube Channel

The UK pension landscape has undergone a transformation over the last few decades with Defined benefit pensions being phased out of the private sector. In this video I explore the potential for phasing them out in the public sector as well using a recent teaching example - watch here​

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Have a great weekend!

Chaz

P.S - Want to work with me? Reach out by replying to this email and lets chat