Peter Jones: Sterling report sends mixed message

If reasons to oppose currency union are demolished, then so is any economic case for independence, writes Peter Jones

A new report accuses the Treasury, and the Chancellor, of inconsistent arguments on currency. Picture: Getty

ALEX Salmond says that a paper written by Leslie Young, professor of economics at a business school in Beijing, “totally demolishes” the Treasury’s arguments against an independent Scotland sharing a sterling currency union with the rest of the UK (rUK). It may go some way in that direction, but only if the entirety of Prof Young’s argument is accepted – that Scotland in such a currency union could have a vestigial banking system and no fiscal levers of power, which surely is not what Mr Salmond intends.

Indeed, Prof Young warns of some of the risks of independence and a currency union in terms which are so apocalyptic that I suspect even the Better Together campaign would hesitate to use them.

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And while he complains that the Treasury argument is inconsistent, his own paper has some glaring inconsistencies. Right at the start of his paper he makes the case that the Treasury has been making all along: “It is obvious that the current ‘sterling union’ is better for the rUK than the ‘Scottish Government’s putative currency union’. For the latter will add no benefits to rUK, yet will certainly add transaction costs and microeconomic, macroeconomic and financial risks.”

Though Prof Young does not point out that Scotland would also face these costs (which it would), it does put Chancellor George Osborne’s argument as to why Scots should reject independence in a nutshell.

To be fair, Prof Young clearly says that other currency options “would almost certainly be worse for rUK”, which implies they would also be worse for Scotland.

I think he is wrong about that, but debate on that question will have to await Part B of his report which, for some reason, is not yet published. But then, having implied other options are worse, he notes that Mr Salmond is now under pressure to declare his Plan B, and adds: “He has a duty to Scotland’s citizens to answer that question in detail.”

This is astoundingly inconsistent. If the Treasury case against a currency union is so flawed, as Prof Young contends, and therefore bound to fall apart, why is there a need for a Plan B? Even more inconsistently, Prof Young seems to accept that “successful currency unions are based on the near-universal belief that they are irreversible”. If Mr Salmond was to publish a Plan B, and Mr Osborne was to do likewise, as Prof Young urges, wouldn’t that be a huge signal that the sterling currency union is anything but irreversible?

I have argued in previous columns that a currency union can be made to work, but only if the risk to rUK taxpayers of having to bail out a large and failing Scottish bank, or a Scottish Government which is faced with impossible liabilities, can be extinguished.

In considering this issue, Prof Young totally demolishes finance secretary John Swinney’s claim that there is no risk to rUK from Scottish banks. The Treasury argument is that Scottish banks’ assets are 12.5 times Scottish GDP but that ratio is five times GDP for the UK as a whole. He notes Mr Swinney as contending that this is “entirely misleading” because financial services in terms of share of GDP “are actually smaller for Scotland at 8.3 per cent than the UK at 9.6 per cent”.

This, Prof Young says, compares the financial sectors in terms of the value that financial services add to GDP, a comparison which he then dismisses: “But the primary risk to a jurisdiction’s taxpayers is their exposure to the fiscal burden of bailing out banks that are registered, regulated, and insured/guaranteed in that jurisdiction.” So, he says, the Treasury measure is a better indicator of the exposure to risk than is Mr Swinney’s.

He does not say that this is not a risk. But he does say that the risk posed by the two large international banks – RBS and Lloyds – which are registered as Scottish banks, is covered by the deposit insurance and guarantees of the Bank of England, which are credible because they are “backstopped by the UK economy which is large enough to withstand any likely liquidity and solvency risk”.

He goes on to argue that if a currency union is agreed without “the tight banking union and tight fiscal rules” recommended by Bank of England governor Mark Carney and the Treasury, then the big banks as we know them will shift to England.

International counterparts of RBS and Lloyds, he says, knowing these banks required a £65 billion bail-out in 2008 “which the government of an independent Scotland could not have afforded”, would take their business to banks with credible guarantees “unless RBS and Lloyds re-register in rUK to secure the insurance/guarantees of the Bank of England”.

Moreover, and this is where Prof Young gets really apocalyptic, he says: “The transition to independence and a new currency regime would create a great deal of uncertainty, which all Scottish citizens and businesses could hedge by opening an account with a rUK-registered bank.”

He posits that there would be a “slow-motion bank run” on Scottish banks as people shifted their deposits to English banks and that “inertia and the inherently greater long-term risk of banks registered in Scotland would ensure that, after the uncertainties died down, many Scots would keep their banking business with rUK banks”.

He adds: “Few, if any, banks registered in Scotland could retain enough depositors to continue in business.” This is why he rejects the Treasury objection to a currency union – Scottish banks would no longer be too big for the Scottish Government to back-stop because independence would cause the banks to migrate or, if they didn’t, Scots would make them a lot smaller by moving their money.

Is this what Mr Salmond is happy to rely on to support his case for a currency union? On these terms, it could work, but only if, as Prof Young tirelessly points out, there is a “tight banking union and a tight fiscal union”. He doesn’t say what he means by “tight” but I am pretty sure that such a fiscal union would be a lot tighter than just specifying limits on public deficits and debts which Mr Swinney says is all that is needed.

It means controls on tax bases and rates, ruling out the kind of competitive corporation taxes Mr Salmond wants to implement. In short, it seems clear that if Prof Young’s paper “demolishes” Treasury opposition to a currency union, then it also demolishes the economic case for independence.