Can it be made to work politically? Can it be turned into practical measures that will work operationally? Is it durable, meaning will it last? The problem with designing a currency for an independent Scotland is that you get different answers to each of these questions.
We know from opinion polls that majority opinion does not currently back independence. There are many reasons for that, but a big one is uncertainty. While Nationalists argue that Scotland’s future in the Union is uncertain, unionists have history and the UK’s recovery from bad times on their side.
They can plausibly argue that whatever problems manifest themselves, history says that the Union UK state can deal with them and everybody, or nearly everybody, can benefit. The independence proposition, lacking such a history, is by comparison much more uncertain.
The political task, therefore, is to maximise the opportunity of independence and to minimise uncertainty. Perhaps the biggest uncertainty concerns the currency. People trust and value the pound sterling; the euro, which might have looked attractive a decade ago, certainly doesn’t now.
There is no real reason why a pound Scots might not become similarly treasured and trusted. But right now, it is an unknown quantity and people prefer the familiar. So, when asking what currency option works politically, the answer is keeping the pound sterling since that makes it more likely that people will vote Yes to independence.
Does it work economically? At the micro-level, it does. The pound sterling would still be trusted for daily transactions and keeping it would be convenient for the many people who regularly cross the Border from and to England, Wales, and Northern Ireland.
It would also be convenient for the thousands of Scottish businesses that sell their goods to the rest of the UK and also import from the rest of the UK, a trade which is much bigger than that with the rest of the European Union. Maintaining this currency convenience also helps to reduce the political uncertainty of a Yes vote.
But asking the political and economic questions cannot stop there. Having a currency union necessitates a willing partner and here, unfortunately for the Scottish Government, the partner in the shape of George Osborne, Chancellor, has said he might not be willing.
That creates some uncertainty. Let’s assume, however, that Osborne is saying this more for political than economic reasons. Let’s also assume that Alex Salmond is right and that there are good reasons – facilitating rest of UK exports to Scotland, keeping North Sea oil production and Scottish exports within the currency zone – why the rest of the UK government might agree to a sterling currency union.
This leads on to asking whether a sterling union works at the macro-economic level. It does pass a number of tests. Labour productivity north and south of the Border is broadly similar, there is free movement of people, goods, services and capital across the Border, so there is reason to think that the UK is an optimal currency zone.
By that, economists mean that there are no fundamental problems which suggest that the kind of troubles that have afflicted the eurozone – high labour productivity in northern Europe, low productivity in southern Europe – are unlikely to arise within a Scotland-rest of UK currency zone.
That, however, is only a static assessment. Economies are dynamic and are subject to dynamic effects. A big issue here, raised by Ronald MacDonald, professor of political economy at Glasgow University, in The Scotsman yesterday, is whether the Scottish and rest of UK economies might be hit by shocks that affect them differently.
As he outlined, because Scotland would be a net oil exporter and the rest of the UK a net oil importer, the answer is yes. The price of crude oil is highly variable, so it is quite realistic to imagine that it might, in any one year, be a lot lower than it was the previous year.
This, since it would reduce the cost of transport and travelling, would positively benefit the rest of the UK economy. There would be a similar benefit north of the Border, but Scotland would also have the problem of reduced oil tax revenues. The reduction could be high enough to necessitate other tax increases, or spending cuts, or increased borrowing, or some combination of all three, which would negatively impact on the Scottish economy.
One standard economic tool for reducing such negative impacts is to manage a currency devaluation, making exports more competitive and thereby producing compensating increases in jobs and taxes. But Prof MacDonald’s point is that if Scotland is in a sterling currency union, it won’t be able to do that.
It could do it if there was a Scottish currency. For that reason, he is part of what seems to be a rapidly growing body of economic opinion which thinks that Salmond should abandon his sterling union plan and go for a separate Scottish currency. Such a currency could be managed in ways that have been proven to work elsewhere to reduce exchange rate fluctuations but which do not eliminate transaction costs, the big drawback of this option.
Which brings us, if we were civil servants working for Salmond, back to the political question. Clearly, the sterling union option works best for winning the referendum, but a Scottish currency may work better for making a success of independence. Sticking with the sterling option while privately preparing for a Scottish currency fall-back position looks superficially attractive, but won’t work in practice. People working in financial markets are not stupid. They will know that there is both political opinion (in Nationalist ranks) and economic opinion that favours a Scottish currency.
So, when the Scottish Government goes to the market to borrow money, the market will price in a premium to allow for the probability that this debt might switch from being denoted in sterling to a Scottish currency. Thus Scots may pay a price for independence even before it has happened, so it might be better to go straight to the Scottish currency option, though that may reduce the chances of a Yes vote.
What will Salmond do? It rather looks as though he is damned whichever choice he makes.