Peter Jones: Crossing the great currency divide

John Swinney said the Bank would have to take into account Scotlands requirements. Picture: Ian RutherfordJohn Swinney said the Bank would have to take into account Scotlands requirements. Picture: Ian Rutherford
John Swinney said the Bank would have to take into account Scotlands requirements. Picture: Ian Rutherford
The need for fiscal union could be met by agreeing terms, but a banking union is more complex, writes Peter Jones

IT BEING the season of goodwill, I thought I would helpfully explain to the Yes campaign how they can get out of the hole they are in over how an independent Scotland and a sterling zone can work. This has taken a bit of a battering recently, but I think credibility can be restored. It just needs a bit of honesty on the part of the Scottish Government.

It argues that having a single currency covering two sovereign countries is desirable because it will benefit trade and thus the economies of both countries. If trade was the only criterion for judging this issue, Alex Salmond’s case would be iron-clad.

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But, reading the recent report issued by Fitch, a ratings agency, it might not even be a criterion at all. Fitch was much more worried about the need for fiscal and banking unions to ensure a monetary union was stable, and didn’t mention trade.

This, I am sure, will be pointed out to the First Minister by Mark Carney, Governor of the Bank of England, when the two meet early in the New Year. On many questions around this issue, Mr Salmond is either vague or silent. But the eurozone has taught us that vagueness and silence creates uncertainty, causing a crisis to worsen. Firmness and decisiveness are essential to kill uncertainty and prevent dramas turning into disasters.

When Mr Salmond gets cornered on any topic, he either turns up the volume to drown out the opposition, or finds clever ways to turn the tables on the opponent, or both. This won’t do in the meeting with Mr Carney, who will be utterly unmoved by bluster that Scotland has as much right to use sterling as does England.

Mr Carney, I am also sure, would respond that this alleged right counts for nothing if a sterling union cannot be made to work. Mr Salmond will have to be honest and straightforward.

The big problem with honesty is that it leads to positions which many supporters of independence may find unacceptable. Some have said as much, but Mr Salmond has made up the independence bed with sterling zone blankets. Now he must lie on them and use his well-honed political skills to persuade the sterling sceptics to bed down with him.

Some of the honesty he will need has been seeping out. At a conference organised by The Scotsman earlier this month on the independence white paper, I asked finance secretary John Swinney about how monetary policy might work inside a sterling zone.

In the UK union, this is now handled independently from the UK government by the Bank of England’s monetary policy committee (MPC). It decides what interest rates should be and how much quantitative easing (increasing the quantity of money in circulation to stimulate economic activity) should be applied. It does so inside broad targets set by the government on inflation and (at Mr Carney’s initiative) employment.

The difficulty here is that the UK economy is a big one and conditions within it are variable, both between different economic sectors and between different geographical parts. Monetary policy which might suit one sector or one part of the country, may be disagreeable to other sectors and other regions.

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The MPC tries to cope with this through the Bank of England’s network of agents in each part of the country. So the agent now based in Glasgow feeds in a monthly report telling the committee about Scotland’s economy, what’s affecting it, and what might be needed to improve things.

One very big difference which would become more sharply highlighted with independence is that Scotland would be an oil-exporting country while the rest of the UK would be an even bigger oil importer than at present. In the event of a big oil price shift, either up or down, resulting economic conditions might require very different policies – tightening via raised interest rates in one country, and loosening by reduced interest rates or quantitative easing in another part.

I put this to Mr Swinney. He said: “The model for monetary policy that we are putting forward is essentially the model of monetary policy that exists today, which is that the Bank of England has an obligation, which its agent in Scotland would certainly maintain, that their agent in Scotland diligently researches the basis to inform the Bank to ensure that it sets monetary policy for the economic circumstances throughout the UK.

“That is the obligation of the Bank of England. The structure we are talking about is that the Bank of England would have to continue to set monetary policy to take into account the requirements and circumstances of all parts of these islands, which would be comprised of the rest of the UK and an independent Scotland.”

In other words, an independent Scotland would have no more control over interest rates than it does now. It also implies, as Scotland has about 8.5 per cent of the UK population and about 10 per cent (including North Sea oil) of UK GDP, Scotland would be very much the junior partner.

And that, in fact, would be the rule that would have to be applied to pretty much everything in the sterling union.

The need for a fiscal union could be met by a Scottish government agreeing terms limiting its deficit and borrowing and to submit its budget plans to the Bank of England and the Office of Budget Responsibility for an assessment on how well the plans comply with the limits.

A banking union is more complex. It could only work if present pan-UK financial firms were to re-structure themselves into Scottish and rest of UK divisions. Then, if a bail-out rescue became necessary, each government could swiftly take similar stakes (say 
50 per cent) in the divisions of the banks in their territories in return for injecting their own taxpayers’ money into the ailing institution.

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There would have to be Scottish headquarters of these financial firms, but they would be junior to the HQs (all located in England) of the much bigger rest of UK divisions.

This isn’t pro- or anti-independence talk, it is simply a realpolitik assessment of the real world an independent Scotland would have to live in.

And if Mr Salmond is serious about getting there, he needs to indulge in some realpolitik too. Merry Christmas, Alex, maybe see you on the golf course soon.