Lack of detail on what currency sharing means may bedevil a newly independent Scotland, writes Bill Jamieson
What is full fiscal freedom, exactly? And when we get our hands on those coveted “economic levers”, how far could an independent Scotland really push and pull them?
These were among the questions Bank of England Governor Mark Carney chose not to address with any detail in his carefully crafted speech in Edinburgh yesterday.
He cannot have been comfortable handling that fizzing grenade of the referendum campaign – the mooted shared currency proposal for an independent Scotland. He deftly set out the arguments for a shared currency without taking sides. But he also clearly set out the many caveats and conditions that would be required to make it work.
And the message was clear: together, these would impede to a considerable extent on the notion of “full fiscal freedom”. And that may prove as difficult to swallow in the rest of the UK as in an independent Scotland.
From the inception of the SNP’s long march for independence, the currency issue has been central to the credibility of the referendum campaign. That is why the meeting yesterday between First Minister Alex Salmond and Mr Carney attracted intense attention. Would this at last turn the key in the lock and resolve the myriad of uncertainties and unresolved questions that crowd the Yes campaign’s proposal to share the pound?
What limits and constraints would be placed on an independent Scottish treasury? How would banks be supervised? Would there be a separate and unique Scottish input to the Bank’s interest-rate-setting monetary policy committee?
For committed nationalists, all these must seem second-order issues to the question of whether we wish to see Scotland as an independent country. Even more so, surely, are all those “technical issues” that Mr Salmond was keen to emphasise were at the centre of discussions with Mr Carney at their breakfast meeting yesterday. Can it really be that detailed matters such as the arrangements for banking regulation and the mediation of fiscal and financial risk asymmetries in a sterling union will be decisive issues for voters in the approach to 18 September?
Yet it is imperative that currency sharing arrangements are agreed in detail and expectations adjusted in advance. Currency arrangements have long bedevilled countries that sought independence, as well as those who sought currency union. It took decades for Ireland to arrive at its separate currency. The Czechoslovakian monetary union in 1993 lasted just 33 days. Speculative activity put enormous pressure on the arrangement and indeed, such activity in 1992 drove the UK out of the Exchange Rate Mechanism – a debacle from which the Conservative government never fully recovered, even after 18 years.
More recently, arrangements for currency union have proved no less vulnerable to setback. The impact of the global financial crisis on the European single currency exposed severe weaknesses in a scarcely tested and vulnerable monetary union arrangement. Mr Carney spelt out how dramatic the consequences proved. Between 2010 and mid-2012, peripheral European countries experienced outflows of between 10 and 85 per cent of total deposits from elsewhere in the euro area. Interbank lending rates rocketed. Bank lending to the real economy collapsed and credit conditions tightened massively.
At the height of the crisis, markets were not at all certain that the euro was economically or politically durable. As it is, critical issues on fiscal integration, the drive for oversight and limits on tax, spending and borrowing to a central authority, together with banking supervision and monetary policy remain unresolved.
The complex system of Maastricht Treaty rules, sanctions and penalties to keep member country deficits and debt within prescribed limits broke down entirely. Now the heads of the European Council and European Commission are wrestling to build mechanisms to share fiscal sovereignty. “The degree of fiscal risk sharing”, Mr Carney pointed out, “is likely to be significant.”
But that is easier said than done. This week, concern has returned to the fore that Germany’s constitutional court may stymie proposals for European Central Bank bond rescues for Italy and Spain. It is seeking to stop the Bundesbank from taking part in the ECB plan. The German court may rule that it is illegal as designed. Expert witnesses say the ECB’s bond plan violates the Lisbon Treaty and Germany’s Basic Law. In its submission to the Constitutional Court, the Bundesbank has argued that the ECB has no mandate to uphold the “current composition of monetary union” or to “rescue states in crisis”.
This tussle is being closely watched here, as many in the rest of the UK will be apprehensive about the Bank of England’s role as lender of last resort post a vote for independence. Extensive and robust supervision and controls on both rUK and an independent Scottish Government will be required.
This is the background to Mr Carney’s conclusion yesterday that “a durable successful monetary union requires some ceding of national sovereignty”. He added: “It is likely that similar institutional arrangements [to those in the eurozone] would be necessary to support a monetary union between an independent Scotland and the rest of the UK.”
Today we are witnessing a further outbreak of currency turmoil across developing country markets amid nervousness over expected changes to central bank policy. Mark Carney’s experiment with “forward guidance” has not gone well as the fall in unemployment has been sharper and more swift than the Bank expected.
Investors have been fleeing smaller and emerging country markets to repatriate money to perceived safer havens. Markets can be unforgiving of currencies where they perceive may be at risk of structural faults and uncertainties over fiscal and monetary policy.
Mr Carney was anxious to stick to technicalities and to economics. But what his speech made abundantly clear was that it is by no means an economic or technical matter alone: political commitment to a shared currency arrangement is also vital.
If financial markets perceive that a currency union is not economically or politically durable, or only a transitional arrangement, then speculative activity can put immediate pressure on the arrangement.
As Professor Brian Quinn, former head of supervision at the Bank of England, made clear last autumn, a shared system of banking supervision would encounter difficulties at the level of both individual financial institutions and the financial system with, in particular, serious weaknesses in governance and accountability.
And, once an independent Scottish Government adopted economic policies that differed from those of Westminster – the very point of the SNP’s case for independence – then these flaws, he believes, would increase in severity.
As a result, it seems “very likely” that the Bank of England would judge Scottish financial institutions – notably its banks – to have become riskier and apply higher regulatory requirements to protect depositors and investors.
Whatever else can be said about currency sharing, this much is clear. Scotland (and the rest of the UK) has set out on a steep learning curve about the meaning of sovereignty and its limits. In a world of massive international trade links and volatile global flows, is the pursuit of full fiscal freedom a chimera? Mr Carney has warned us that it is set to prove so.