Bill Jamieson: Is a central bank worth the money?

Alan Greenspan oversaw a period of ruinous expansion of US asset prices and debt. Picture: AP
Alan Greenspan oversaw a period of ruinous expansion of US asset prices and debt. Picture: AP
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An independent Scotland might need its own institution, but they don’t always punch their weight, writes Bill Jamieson

If SCOTLAND cannot enter a formal currency arrangement with the pound, one of the many searching questions to emerge in any “Plan B” would be whether we would then need to create our own independent central bank.

Intriguing issues soon crowd in. Who would be the governor? What would be its remit? What reserves would it have? And to whom would it be accountable?

Opportunist juices would soon start to flow: impressive job titles and matching salaries for a new financial power elite in Edinburgh; a cadre of officials, advisers, analysts and bag carriers; an impressive head office building, if not in the grand imperial style of Sir Edwin Lutyens certainly something imposing and prestigious. And let’s not forget the underground cavernous vaults to hold our reserves.

For its dedicated directors and executives there will be a constant round of international travel to attend those important conventions of global central bankers; obligatory attendance at IMF events and, of course, the annual trip to Davos to mingle with the powerful in business and finance. Do we have the institutional capacity? What model should we follow?

Any country aspiring to be taken seriously in financial markets would surely require such heavy apparatus. But the biggest question of all remains: would an independent Scotland really need a central bank at all?

Scotland did once boast such an impressive sounding institution. There was a Central Bank of Scotland in existence between 1834 and 1868. It is not the happiest or most appropriate of precedents. It was formed in Perth as a joint-stock company. It was a commercial banking venture, without any of the financial obligations and duties that we would today associate with a central bank. Its initial working capital was just £79,125. It was not a success. By 1864 it was financially crippled, with debts of £51,525. It was taken over by the Bank of Scotland, a dissident minority of shareholders clinging on till 1880 when the BoS bought them out for just £5,375 – generous in the circumstances.

Today, central banks have assumed enormous prestige and importance and especially in recent years when their interventions in monetary policy and interest rate setting have been particularly pronounced. But the scale and reach of their activities is one thing. Whether their interventions have been up to the mark of these inflated reputations quite another.

The United States managed without a central bank until the formation of the Federal Reserve System in 1913. This was seen as a response to a series of financial panics. Since then its powers and responsibilities have grown massively. Whether it has succeeded in delivering price and financial stability is moot. It failed to predict, still less cauterise, the Great Depression, or the crises that befell the monetary system in the 1970s. (Canada did not set up a central bank until 1935, and avoided the worst of the Depression).

Under Alan Greenspan, the US Fed presided over a ruinous expansion of asset prices and debt. Since its formation interest rates have fluctuated between zero and 21 per cent. Prices have continued to rise, and financial crises have been frequent.

As the Federal Reserve has tried to prevent recessions, economic growth on average has slowed. While there may be many reasons for this, free market critics have questioned the assumption that central banks bring both stability and growth. “Indeed”, they say, “it could be argued that the attempted suppression of the business cycle has been a source of weakness to the US economy.” Now, as it struggles to wean the US economy and its financial system off the massive monetary expansion (“quantitative easing”) of the past four years, doubt has entered many minds as to whether QE will really end at all. It has entrapped itself in the addiction to monetary methadone.

In Europe the European Central Bank formed to oversee currency union, has from the first lacked the authority of the Bundesbank and has conspicuously failed to resolve the eurozone financial crisis – a cautionary tale for those minded to argue that new, bigger, ostensibly more powerful central bank institutions are by their existence a guarantor of financial stability.

Here in the UK the Bank of England is enjoying plaudits for bringing inflation down to below its 2 per cent target rate – but this is after more than 40 successive months when inflation has persistently exceeded this target, driving down real wages. As with the US Fed, it failed to read the runes of surging debt, borrowing and house price inflation in the decade before the financial crisis. Now its most recent policy innovation – “forward guidance” to help address uncertainty over interest rate policy – has signally collapsed. No-one today is at all sure when interest rates will rise.

As Allister Heath, editor of City AM, points out this week, Scotland’s banking system thrived when it did not have a central bank. “The free banking era, which ended in 1845, was characterised by prudently managed banks with high levels of capital, a convertible currency and an alternative system of liquidity management with an industry association in charge of payment processing, standards setting and acting as lender of last resort.”

Even with a shiny new central bank, free to follow the bad example of today’s central banks to simply change the rules when things get tough, this hardly lets Scotland off the hook today. Countries that don’t control their own currencies such as Ecuador, El Salvador, and Panama, he points out, need to be better managed than those, like the US or the UK that print their own fiat money. That requires, he adds, “making sure the government has a large enough stock of cash to meet interest payments on its debt, sufficient reserves to defend a currency peg in case of speculative attacks and a credible fiscal policy to borrow cheaply on the global markets.”

This would be a formidable challenge for an independent Scotland. We have a political culture heavily skewered towards public spending, deeply entrenched spending lobbies and interests, no independent track record for credit rating purposes and an administration unafraid to threaten a walk-away from its debt obligations.

Given these stark realities, the financing and staffing of a prestigious independent Central Bank of Scotland, the recruitment of prestigious economists and academics and deep vaults encased in bomb-proof concrete would prove the least of our problems.