Since I previously wrote on why the option of retaining the pound was the correct approach for the Yes campaign, it is safe to say that there has been a lot of chatter on the topic. While it is important to remember that the referendum is not just about currency (as Lesley Riddoch writes here), I do think it is worth reflecting on the situation and considering the context.
Sure Alistair Darling said that he thought that it would be logical and desirable to create a formal currency union after a Yes vote but I think it is more interesting to look at what those outside of politics are saying. The Yes campaign has based its position on the outcome of a comprehensive review by the Fiscal Commission Working Group of all of the currency options that would be available to an independent Scotland.
The Fiscal Commission Working Group consists of four eminent economists, Professor Andrew Hughes-Hallett, Professor Sir Jim Mirrlees, Professor Frances Ruane and Professor Joseph Stiglitz, and is chaired by Crawford Beveridge. The members include two Nobel Laureates for Economic Sciences and they are all world-renowned for their expertise in the areas of monetary policy, fiscal policy, and financial stability.
If you want the full 226 page report from the Fiscal Commission Working Group then you can read that here. Surely no-one can read that and claim that the Scottish Government have not thoroughly thought through their options on currency. The summary report is perhaps more accessible and worth reading if this issue is important to you, but in summary they outline 5 potential options as illustrated in this table (which is on page 11 – the last page of the summary report):
The recommended choice for both Scotland and the rest of the UK is to create a formal currency union. The Bank of England announced on the 13th of August that they are making arrangements for Scottish independence and for ensuring stability as Scotland transitions to independence – in effect the Bank of England were confirming that they are ready to establish a formal currency union if required. It was also made clear that they are preparing for multiple scenarios; should Scotland choose a different path then the Bank of England are poised to respond.
The Scottish Government have gone through a thorough process to assess the optimal currency for an independent Scotland, but Alex Salmond hasn’t always managed to get this point across to the electorate. He was clear during his interview with the BBC – and in particular he demonstrated how the statement from the Bank of England demonstrated that the Scottish Government are in a strong position (the Q&A with Stewart Hosie is also worth watching if you can’t get enough of this chat).
So what is the alternative should the Westminster Government inform the Bank of England that they oppose a formal currency union. Firstly, they would provide the Scottish Government with a very strong position on negotiating the debt that an independent Scotland would take on. On the 13th of January 2014, the UK government announced that they would honour the debt held at the Bank of England, which currently runs at £1.3trillion. Within the UK our taxes are used to pay £1bn of interest on the debt every week! So if the UK Government insists that they don’t want Scotland to have any association with the Bank of England then an independent Scotland could feasibly start with no national debt (as outlined by Alex Salmond here), though in reality I think during the negotiation process it would transpire to something more akin to 3% of the total rather than 9% if Scotland did join a formal currency union.
Plan B – a wealth of options
At this point I’d like to bring in Avinash Persaud, chairman of Intelligence Capital, and a former global head of currency research at J P Morgan. He says that ‘25 years in currency markets tell me that the No campaign’s argument that Scotland cannot keep the pound is false. It would certainly be a limited version of independence, but there is nothing stopping an independent Scotland from declaring sterling sole legal tender and borrowing it on the financial markets to hold in reserve.’
This in effect would be an informal currency union or ‘sterlingisation’. He goes on to write that ‘the list of countries that have adopted a currency issued by another state, outside formal agreement, includes about 30 small countries from Andorra to Panama and the Vatican that have officially chosen to do so. History and the present day teach us that currency substitution is possible. It should also be easier for Scotland than others, because it already uses sterling and its economy is tightly integrated into the rest of the UK economy.’ It is worth noting that the Adam Smith Institute recently reported that Panama has the seventh most stable financial system in the world.
However, I think the most likely scenario will be for Scotland to continue to use the Scottish Pound as has been well articulated by Jim Sillars. On this option Avinash Persaud writes that ‘while many rightly note that an independent Scotland using sterling could not print currency and devalue, the benefits of being able to do so are themselves not free. Beyond those that have adopted another state’s currency, there are a further 20 relatively successful countries – like Hong Kong, Denmark and Saudi Arabia – that have chosen a rigid exchange rate fix with another currency without seeking permission. They are also unable to provide unlimited liquidity to their banks without devaluing – something most have avoided for decades.
They have made the decision, however, that the long-term costs of governments giving in to pressure to inflate (or financial markets second-guessing whether they will) outweigh the short-term benefits of flexibility. Instead, they have chosen an exchange rate fix as a signal of fiscal and regulatory responsibility. They tend to be small countries, where the benefits of exchange rate devaluations are scant anyway, because there are few competitive local alternatives to most imports, and their main exports, like oil and gas, are priced in US dollars.’
In other words, many nations currently use this method of pegging their currency and they use it to their benefit. When the UK government commissioned the McCrone Report in the 1970s, it was assumed that Scotland would go for a Scottish pound and interestingly they concluded that it would be far stronger than the pound sterling, in fact at the time their concern was that it would be too strong relative to sterling (which was collapsing at the time as I detailed here). Here’s what was written:
‘Scotland’s central economic problem is to secure a faster rate of economic growth so that she can raise income levels and absorb the excess labour which presently appears as high unemployment and emigration. As has been explained, this is a situation which would normally point to devaluation as a possible remedy. North Sea oil, however, by giving the country a chronic balance of payments surplus, would rule out any possibility of devaluation. Indeed, it is hard to see how an upward valuation of the currency could be avoided. Obviously this pressure should be resisted as far as possible; but unless there was a remarkable change in the strength of sterling, it must be expected that the Scots pound would rise in relation to it fairly soon after independence, especially if the latter continues its downward slide. A revaluation would give rise to none of the difficulties which were argued earlier to apply to a Scottish devaluation. Since the effect would be to reduce prices and raise incomes there would not be the same resistance to making it effective in Scotland. An exchange rate of £1 Scots to 120p sterling within two years of independence therefore seems quite probable.’
Unfortunately, the demographic challenges highlighted in the report still remain and this is a failing of the current political system of the UK. I’m sure a government directly accountable to the people of Scotland would find a way to use such a significant balance of payments surplus to accelerate our economic growth – there are several ways in which this could be achieved.
It is worth remembering that 23 countries within Europe have changed their currency in the last 15 years and the key point from that is that currency isn’t the key factor in how well an economy and society performs. The economies of Germany, Austria, Luxembourg and several others have actually shown higher levels of economic growth than the UK economy since joining the Euro. It is also worth noting that despite Alistair Darling’s opportunistic attempt to undermine the Irish economy, Ireland is one of the other Euro economy’s which is in a better state than the UK’s. However, it is actually technically impossible for Scotland to join the Euro upon independence so this isn’t an option in the short term.
Ultimately, when it comes to currency though I think Irvine Welsh summarised things effectively on the night of the first Salmond-Darling debate:
It is worth bearing in mind that political priorities of a nation adapt to the landscape around them. If an independent Scotland needs to adapt down the line then that is something that the people can vote for, the adaptability of smaller nations is the reason that so many are leading the way in the modern world. Scotland can only take control and drive the economy forward if it has the powers of independence – that is surely the most efficient ways to increase the overall wealth of the nation.
For some extra reading, I’d recommend:
- Prof Andrew Hughes Hallett and Prof Drew Scott Financial Times article ‘Scotland has thought the options through and counted the cost’
- Sir Donald Mackay was chairman of Scottish Enterprise and an economic adviser to Secretaries of State for Scotland in the 1980s and 1990s but in a recent interview has explained why he thinks a Yes vote will be the right direction for the Scottish economy and also detailed why an independent Scotland will be able to continue using the pound.