Daniel Gay: Sterling best Scots option
The euro's toxicity burnishes the allure of the pound. Picture: Getty
SHOULD Scotland win independence, the question of currency must be addressed, but keeping the pound would be in the country’s best interests, writes Daniel Gay
Ditching the pound would narrow Scotland’s economic options, not enlarge them. Even if Holyrood keeps sterling, the eurozone crisis shows that independence risks throwing away some hard-won freedoms.
A healthy currency is a golden prize, as Europe is discovering. In a classic 1961 article Nobel prize-winner Robert Mundell theorised that a currency zone was only optimal if capital and labour could flow easily from one area to another. A bit like the way that pouring water into one corner of an ice cube tray fills the other sections evenly, workers and capital would move to fill in any economic gaps. Mundell argued that to make up for remaining unevenness and differences in economic cycles, a central authority would need the mandate to tax the prosperous parts and spend more on the laggards.
Half a century later the Eurocrats would do well to reread Mundell’s paper. Optimal the eurozone is not: the result of naïve optimism and bad design.
Capital didn’t flit in a jiffy from Paris to Lisbon. How many Slovakians flew to Austria to find work, or Greeks to Belgium? Internal migration remains low because people are comfortable with their own cultures and languages.
Another design flaw is that no central agency has control over spending. When France and Germany broke the 3 per cent budget deficit target in 2003 Brussels could only watch. Contrary to prejudices about southern fecklessness, Franco-German rectitude is a myth.
A paper by Charles Wyplosz of the Graduate Institute in Geneva found that France flouted the rules in seven of the 12 years after the euro began and Germany five. Every country misbehaved, because nobody could punish them.
Compounding the difficulties, a single interest rate set in Brussels (by an inflation-paranoid European Central Bank) doesn’t fit all 17 members. The economic result: more black spots than an adolescent Dalmatian.
The United States is almost the perfect currency zone. Workers and capital move freely between states, helping equalise differences in wages, employment and financial returns.
Few barriers to investment exist between states; most people speak the same language (English, not Spanish); and cultural differences are minimal. At the drop of a Stetson, a Texan will relocate to New York to get a better job.
US states control their own budgets, so they can fine-tune spending. The 12 Federal Reserve banks each have a role in deciding interest rates. And even if the internal movement of capital and labour doesn’t smooth out economic differences, the Federal government can step in to bail out flagging states or issue a rap on the knuckles when a governor gets his wallet out once too often. These reasons are partly why the American economic recovery is outpacing Europe’s.
The UK currency area has outlasted any other. In 1603 the pound Scots was pegged to sterling at a rate of 12 to one. In 1707 under the new Parliament of Great Britain, sterling replaced the pound Scots as the legal currency.
Just like the dollar, the sterling area has all the right ingredients: Brits speak the same language; capital and workers can move easily from one area to another; the central bank sets an effective monetary policy for the whole country; and the government can spend more in one region when growth falters.
As Alex Salmond seems to be acknowledging, the euro’s toxicity burnishes the allure of the pound.
But a new article in the National Institute Economic Review by Angus Armstrong argues that: “It is noteworthy that at the same time that Scotland may [give up fiscal union], the Euro Area countries are looking… precisely to secure the fiscal union that Scotland may leave behind.”
Under the sterling zone, Westminster and Edinburgh share revenues and debts. Armstrong calculates that in the event of a split Scotland’s public debt would total about three-quarters of Gross Domestic Product depending on how oil revenues are shared.
The deficit – how much more the government spends than earns – would have been about 4 per cent of GDP over the past half-decade assuming Scots got their geographic share of oil.
That’s not too bad in today’s climate, but a hefty sum of investment comes from abroad. Despite Donald Trump’s grumbling, all those renewables projects from down South create a lot of jobs.
Firms based elsewhere in the UK account for a fifth of employment and turnover and almost half of registered medium and large companies, according to the Office for National Statistics. Companies from the rest of the world provide 16 per cent of employment and 36 per cent of turnover.
One of the big lessons from the euro crisis is that small countries relying on foreign investment must pay more to borrow.
Using the pound and issuing government debt in sterling, Scotland would lose the ultimate response of printing money to repay creditors. This risk would further hike interest rates on government debt.
As the Italians, Greeks, Spanish and Irish know only too well, being bullied by the bond markets is a harsh form of discipline; the kind of discipline that means less cash for schools and hospitals.
The Bank of England wouldn’t want to play central banker for Edinburgh without guarantees on Scottish spending, because otherwise it would effectively be writing blank cheques. Any Holyrood backstop would cost yet more money.
Having unravelled the union, Scotland would have even less control over official interest rates than it does now. The British central bank doesn’t currently pay much heed to events north of the Border, but in future it wouldn’t even have to bother pretending. An English boom at the same time as a Scottish slump could prove disastrous.
Scotland could cut out the Bank of England by issuing its own new legal tender. Jim Sillars has argued for a Scots dollar and the SNP is said to be keeping the option as a back-up.
But setting up a currency isn’t like opening a new Paypal account. Edinburgh would need its own central bank equipped with an arsenal of foreign exchange sufficient to fight off speculators – who would be queuing up to test the fortitude of a newly-minted currency in a resource-rich country.
Some small Asian countries learnt from their regional own economic crises in the late 1990s that they would need reserves of up to twice GDP. In Scotland, not all of the necessary scores of billions of pounds could be coaxed from the coffers of Threadneedle Street.
To have any credibility the Scots unit would need to be pegged to the pound, a move which would constrain monetary and fiscal policy.
And the credit ratings agencies have in recent months hinted that Holyrood’s debt would receive a lower rating than the triple-A currently enjoyed by the UK. That could raise interest rates to more than double those currently paid by the British government, according to some estimates, and they would be even higher with a new currency than if Scotland broke with England but kept the quid.
Many of the 126 nations with smaller populations than Scotland will testify that control over education, health and defence can reap bigger rewards than the economic gains from staying glued to a union.
But even if Scotland sticks with sterling, in splitting with its neighbour it might abandon exactly what Europe covets. Freedom often comes in a strange guise.
• Dr Daniel Gay is an independent political economist advising on trade policy in small countries. www.emergenteconomics.com
Email to a friend
Print this page- Scottish independence: I don’t want ‘separatism’ says Sir Tom Farmer
- Call for sleaze inquiry into peer’s expenses
- Craig Levein insists Scotland will recover from US thrashing
- Man arrested after woman found dead in subway pool of blood
- Rangers administration: Duff & Phelps ‘hopeful’ that Taxman will agree to CVA
Looking for...
Featured advertisers
Jobs
Search for a job
Motors
Search for a car
Property
Search for a house
Weather for Edinburgh
Monday 28 May 2012
Today
Sunny
Temperature: 9 C to 21 C
Wind Speed: 15 mph
Wind direction: North east
Tomorrow
Cloudy
Temperature: 10 C to 16 C
Wind Speed: 12 mph
Wind direction: North east
Comments
There are 12 comments to this article
Page 1 of 1
22SEPT2012
Thursday, February 23, 2012 at 01:29 PMScotland will decide - meanwhile we are marching for independence www.independenceforscotland.com
Tartancult
Thursday, February 16, 2012 at 06:39 PMRead my lips - your funny money is not accepted anywhere other than within your narrow borders (and given the narrowness of your minds, this is not a bad thing.)
Vote 'NO'
Wednesday, February 15, 2012 at 11:28 PMTrue independence can only come if the newly 'freed' Scotland aims to stand on its own 2 feet, with no piggy back on Britain's coattails, whether that be the shared embassies, defence force or by having sterling as the currency or pleading for the Bank of England as the lender of last resort to add some desperately required credibility.
fairfax
Wednesday, February 15, 2012 at 10:01 PM7: "I don't see any reason why a similar arrangement could not be in place when Scotland becomes independent. " ---------- The difference is that neither sterling nor the Punt were then freely convertible currencies; much has changed since 1979. There is nothing to stop Scotland creating a new currency, pegged initially to sterling, but this is not being suggested at present. ------------- "Scotland could always decide at a later stage to join the Eurozone," ----- One of the requirements to join the Eurozone is to have a suitable stable currency and monetary policy, and that requirement is likely to become more strict, not less. That cannot be attained by using a foreign nation's currency following independence.
fairfax
Wednesday, February 15, 2012 at 09:55 PM6: "t'd likely go along the lines of Scotland wouldn't have £300bn to float a new central bank" --------- Founding central banks and currencies costs money, but hardly £300bn. In any case, an independent Scotland would have little choice if, as seems likely, England does not wish to prolong currency union following the demise of the Union.
wl
Wednesday, February 15, 2012 at 09:46 PMThe Republic of Ireland had its poundpunt linked with the pound sterling (on a one-for-one basis) for more than 50 years, till end of March 1979. I don't know if there was a formal agreement between the 2 countries, but I don't see any reason why a similar arrangement could not be in place when Scotland becomes independent. Scotland could always decide at a later stage to join the Eurozone, if it still exists then.
rider000
Wednesday, February 15, 2012 at 09:35 PM4 fairfax 3:"the solution is obvious: recreate the Pound Scots and a Scottish central bank on independence. Why is the SNP so unwilling to consider this?. .................Send a letter to Swinney and if you get a response it'd likely go along the lines of Scotland wouldn't have £300bn to float a new central bank unless every Scot from 1 day old and up sent King Alex a cheque (that wouldn't bounce) for £60,000.
Tartancult
Wednesday, February 15, 2012 at 06:44 PM#4 recreate the Pound Scots and a Scottish central bank on independence"------------------------Which money will be accepted nowhere but in Scotland (and possibly where monopoly is played, internationally).
fairfax
Wednesday, February 15, 2012 at 01:40 PM3:" The £ has always been Scottish currency." ------------------------------------------------------------------------------ The Pound Scots and the English Pound Sterling were not the same currency before 1707. Following Scottish independence, there is no obligation on either England or Scotland to continue in a currency union and I find it particularly difficult to believe that England would wish to prolong currency union. Scotland can indeed continue to use sterling (or any other free convertible currency), but would not be able to create sterling, and would then be subject to the vagaries of English monetary policy. This would be a strange development for a newly independent nation, but the solution is obvious: recreate the Pound Scots and a Scottish central bank on independence. Why is the SNP so unwilling to consider this?
and I'm not making this up
Wednesday, February 15, 2012 at 09:40 AMThe £ has always been Scottish currency. The SNP were right, Westminster and Whitehall were wrong. Why is that not surprising?
New Unionism
Wednesday, February 15, 2012 at 09:02 AMThank God for the SNP fighting against the Nazil like rule of Westminster. Shame on Labour for being part of their social engineering experiments.
unimpressedone
Wednesday, February 15, 2012 at 08:55 AMSince England will not abandon sterling then our beligerent fuhrer will go for the euro. The man has a anti-anglo chip on his shoulder bigger than the Scot monument. Greece today, an independent Scotland tomorrow.
Page 1 of 1
Your view
Please sign in to be able to comment on this story.