Whether Scotland gains its independence will not only be a question of logic and rationality but of nationalism and emotion as well. Why do the Scots want independence? Why not? Some 300 years ago Scotland was an independent country. Lately, every 18 years, the Scots have brought up the issue of independence.

Scotland wants to decide what’s best for Scotland. It clearly believes that the decisions in Westminster have not been optimal for Scotland. This is the single most compelling argument for independence. It believes that the revenues from North Sea Oil have been squandered or misdirected and that an independent Scotland could follow in the footsteps of Norway with the creation of an oil financed Sovereign Wealth Fund. It feels that Westminster has neglected Scotland generally, but particularly in investment and infrastructure. Be that as it may, the calculus around North Sea Oil is equivocal. At current production, reserves are expected to last 30 years. Independence is expected to last longer than that.

Lately, indications are that the pro independents will win the referendum. There are issues to be addressed in the event of a separation.

The currency is an important consideration. An independent Scotland will need a currency. It currently uses the sterling pound. Scottish bank notes are not in fact legal tender anywhere, not even in Scotland, and are therefore legally a form of promissory note. Scotland will have to establish a currency and decide on the basis o that currency, whether it will continue to use sterling as part of a currency union, use sterling without a currency union, join the Euro or have an independent currency and central bank. Options 1 and 3 require the concurrence of the BoE and ECB respectively. Either will impose conditions which will likely severely limit monetary policy independence.

In any divorce, the balance sheet needs to be divided. This includes assets and liabilities. Each side wants the assets but not the liabilities. The Scots will understandably claim the North Sea oil reserves as their assets. How exactly the national debt will be distributed will be interesting to see. The question goes beyond the proportion of the national debt that gets allocated to an independent Scotland but to defining the new conditions of default for English and Scottish debt.

What does Putin want? It’s not clear. It’s likely he wants more than Ukraine. Those who believed that he would stop with South Ossetia and Abkhazia were wrong.

What drives Putin? Avenging the humiliation of the USSR is a clear motivation. Having held arbitrary power within the KGB, he longs to exercise it again. He does so within Russian territory but he longs to exercise it at least to the extent of the old Soviet boundaries.

How does Putin operate? He sows discord among his enemies. He knows when to hold and when to fold but he’s always at the table. He doesn’t need allies, only that his enemies are not completely aligned. He relies on his enemies not being committed to action, a glimmer of fear, a seam of pacifism.

He lives by obfuscation, behaves erratically, arbitrarily and disingenuously. In a word, he is capricious.

Those who engage him are bewildered by his irrationality, a gambit he employs well. They misread him. The illogic is designed to confuse and to conceal a deeper logic which is only revealed when it is too late. Putin needs to be dealt with firmly. Europe’s prevarication plays into his hands. Their measured and considered approach is based more in hope than experience and they will pay for it. This man does not mean to stop at Ukraine. Nor are his ambitions circumscribed by geography. He is a danger to Europe and to world order. Deal with him meekly and the world will pay.

There is no such thing as an omnipotent central planner, even if the central planner has complete and perfect information and has unlimited resources and ultimate technology. Even an almost omnipotent central planner would not be able to satisfy everybody’s wants and needs. Sci Fi has explored such Utopian scenarios before but while they have examined the technological and social aspects of such societies, the economic aspects can confound. For one, if you give everyone all that they need, they will go crazy comparing their endowments with one another. Envy will animate avarice and before long contention and conflict will ensue. This is the human way. One mitigating strategy might be to endow each agent equally. However, different agents have different utility functions and the equal endowments will be valued differently. Envy will animate avarice and before long contention and conflict will ensue. Assuming that the central planner had access to all private information as well, it might allocate so as to equalize utility. However, utility is variable over time. Before long the equality of utility is broken and everything again descends into hostility.

Perhaps a central planner might sell the concept that each agent has the opportunity to exceed the utility of their competitors if they were good and worked hard. This is selling hope and hope is the most powerful thing ever. What precisely is that hope? It is the hope that an agent who considers themselves as inadequately endowed can achieve an equal or higher utility than their peers. That is, that they have a chance of being above average. Clearly not more than 50% of the population can be above average. It is therefore the hope that one can be above average, or equivalently, that one is not one of the 50% who will be below average.

Coincidentally, the efforts to achieve above average utility drive the population towards progress and growth. Efforts to remain above average are as strong as efforts to become above average. If all are equally successful and achieve the same incremental success, then the status quo ordinality is maintained and the efforts are ultimately futile. If the below average are more driven, under conditions of equal opportunity, they may gain an advantage over the better endowed and thus equalize the distribution of wealth. The newly below average will then strive to excel and the perpetual cycle continues.

If for whatever reason the above average excel relative to the below average then the distribution of wealth becomes more unequal. The probability of being able to move from below average to above average shrinks. In other words, hope is eroded. How might the better endowed excel relative to the less well endowed? There are all kinds of possibilities. The wherewithal to lobby government, ownership of capital, investment in knowledge and intellectual capital, networks, nepotism, the ability to cope with volatility and the unexpected are some examples. Inequality cannot increase without a point at which hope is lost, that is the probability of the below average catching up to the average or above average becomes improbably low. At this point the status quo is likely to be challenged.

What if the central planner has real time perfect information and can redistribute wealth in real time? Such a redistribution while it may bring agents into a position of equal utility on a pre-redistribution basis, will likely lead to agents valuing each redistribution payment or debit differentially. The perceived arbitrary nature of the redistribution will impair the perception of hope and is thus self defeating. Is it possible to take into account the differential valuation of the incremental transfers? Yes, but this creates a feedback loop which renders the solution hard to obtain and highly unstable. This difficulty and instability of the solution necessitates frequent adjustments to the basis of the redistribution which will render it indistinguishable from arbitrary redistribution, which again impairs the perception of fairness and hope, and is self defeating.

Absolute acceleration in aggregate wealth increases hope and stability. Absolute deceleration or negative growth in wealth decreases hope and stability. Extreme equality slows growth. Moderate to high inequality promotes growth. Acute inequality violates the social contract and leads to disruption.

The near term direction of rates and bonds are not dependent on whether or not the Fed actually hikes rates in Q3 2015 or Q1 2016. They are dependent on when the market thinks the Fed will hikes rates in Q3 2015 or Q1 2016. It is clear from the ruminations of central bankers that they themselves don’t know when they will hike rates; so much is dependent on data. Each piece of data exerts a pull on the Fed, some towards raising rates and some towards delaying the day.

1. The US economy is stronger than the Fed or the market thinks. Especially relative to the new lower long term potential mean.
2. The labour market is healthier than consensus.
3. Economic nationalism will favor economies with a deep consumer base, intellectual property generation and manufacturing capability. NAIRU will, however, be lower.
4. Inflation may surprise on the upside. Inflation could arrive sooner than expected as slack in the economy is underestimated.
5. The US treasury’s funding requirements may be lower than expected on the back of stronger tax revenues.
6. The substitution of funding type from fixed coupon to floating creates a relative shortage of fixed coupon.
7. War may change the funding requirements for Treasury. Currently, however, military spending is expected to continue to decline.

Point 1 above allows one to trade around cyclical assets as the market misjudges the cycle by misjudging growth relative to long term mean. Cyclical slowdowns are pauses which can be misinterpreted as fails creating buy opportunities. Cyclical lows are misjudged as fails when in fact they are inflexion points. Trading should be buying and selling earlier than the consensus cycle.

Point 2, 3 and 4 may introduce volatility to the treasury market and duration assets. Point 5 and 6 could imply a relative oversupply of corporate duration relative to sovereigns translating into spread widening.

Points 5 and 6 in isolation of 2, 3 and 4 suggest buying the dips of longer dated treasuries. Unless 7 takes hold.

Central banks have been printing money aggressively since 2008. The US Fed is now slowing its money printing with a view to a static stance in the near future. What are the consequences for markets and the economy?

When money is printed it has to go somewhere. So far it has gone into asset markets to a far greater extent than it has to the real economy. The transmission mechanism from large scale asset purchases and suppressed interest rates has directed liquidity to stabilizing the mortgage market, and keeping interest rates low across the USD term structure. This has stabilized the housing market and restored household balance sheets to stronger equity positions, strengthened bank balance sheets through their mortgage loan portfolios, and driven yield seeking investors to supporting the corporate bond market which in turn finances share buybacks buoying the equity markets. The impact of QE on financial markets and capital values has been significant yet the impact on the real economy, on employment and wages and on cash flows has been less ebullient.

After 3 rounds and 5 years of QE we are only beginning to see some impact on employment, investment and output. Yet the Fed began, in 2013, to slow its Large Scale Asset Purchases and is expected to end it altogether by October 2014. It is unclear when the Fed will actually either raise rates or shrink its balance sheet; it is currently expected to continue to reinvest coupon and maturing bond principal. The implications of an expanding Fed balance sheet are now known but what about the effects of a static or shrinking balance sheet?

The transmission of QE has thus far directed liquidity to asset markets, notably the agency mortgage backed securities market and the US treasury market. Liquidity, however, has struggled to spur bank lending to financing growth as banks lend out of capital and not just liquidity, and the SMEs which rely on bank lending have faced tight credit underwriting standards. The treatment of riskier, smaller loans under bank regulatory capital rules also hampers such lending. Larger businesses, usually with listed equities, have access to the corporate bond market and have taken advantage of lower rates to raise debt capital. Companies with listed equities have aggressively raised debt to buy back shares thus increasing earnings per share growth without the challenge of having to actually grow their businesses organically. Smaller companies without listed equities do not have this luxury.

That business investment has been slow is concerning. Corporates have raised significant levels of debt in the bond markets, yet hold substantial cash on balance sheet, or engage in share buybacks and M&A. Surveys of business sentiment notwithstanding, the actions of business leaders is not encouraging.

Equity valuations in the developed markets are no longer cheap. Even in Europe, the market has been selective and quality is expensive. Asia is the only region showing any significant value. Yet for equities to push higher, assuming fundamentals are in place, liquidity needs to flow into the asset class. The US Fed is close to neutral, the BoJ, ECB and BoE are all expansionary and the PBoC is probably at an inflection point ready to run loose again. As long as the world’s central banks are in aggregate accommodative, markets will find some support. Under neutral liquidity, such as in the US, for equity and other risky assets to rise, liquidity must be diverted from the real economy. The equity market is therefore highly vulnerable to inflation since such would signal a substation to current consumption. Low inflation has been a sign that liquidity was being directed to investment. The other example is Europe, where inflation has been significantly below expectations and targets. Absent direct asset purchases, a pick up in inflation is in fact a bear signal.

The current structure of the economy is possibly a consequence of income and wealth inequality and that policy has favored the rich. Whereas expansionary monetary policy is normally inflationary, where the benefits of such policy accrue to the rich, the tendency to save or invest the new wealth is high and the marginal propensity to consume is low. Perhaps this is one price of inequality: that monetary policy is blunted and diverted towards more investment and less consumption. Policy makers may wish to consider how the distribution of wealth impacts policy efficacy. Policy that is blind to the distribution of wealth and income can create positive feedback loops which lead to unstable paths or accumulating imbalances.

6 years after the crisis, monetary and fiscal policies have not improved the economy significantly, especially when taken in the context of the financial resources and measures deployed. Global growth has slowed, unemployment remains high and where it has recovered has done so at the expense of the participation rate, income inequality has worsened at the individual and commercial level and geopolitical turbulence has risen, in part from America’s energy boom but in no small part due to growth withdrawal symptoms. What is concerning is that central banks and governments appear to have exhausted their crisis management resources and tools. Interest rates are acutely low, negative in the Eurozone, central bank balance sheets are grossly inflated, and sovereign balance sheets while improving, remain fragile. That inflation is low is a relief for high inflation would inflict serious losses for holders of duration heavy assets such as government bonds which fill the balance sheets of many commercial banks, but low inflation is also failing to erode the value of the stock of debt.

How long can central banks and governments go on supporting asset markets in the hope that sentiment can drag along the real economy? How long can wealth and income inequality continue or worsen, aided and abetted by current economic policy? How long are central banks happy to carry on with their policy tools fully deployed while their efficacy has become blunted? What are the consequences of resetting policy tools such as asset purchases and suppressed interest rates? What if inflation picks up?