‘Sterlingisation’ better than UK currency union

Independence plus Plan B will trump UK, says think tank. Picture: PA

A report, published today by the Adam Smith Institute, claims that a particular form of “sterlingisation” could also be more effective than Alex Salmond’s Plan A for a formal currency union.

The institute recommends a currency arrangement described as “adaptive sterlingisation”, which would see an independent Scotland adopt a policy of unilateral use of the pound outside a currency union, combined with reform of Scottish banking.

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The paper argues that such an approach would cut risk-taking and increase competition in banking, significantly reducing the prospect of large-scale bank panics and financial crises.

The study quotes the “dollarised” economies of Latin America – Panama, Ecuador and El Salvador – arguing that they provide strong evidence that banking systems do better without central lenders of last resort.

The No campaign has argued strongly that following the Panama model would be disastrous for the Scottish economy because it would hand control of monetary policy to a foreign country and leave Scotland’s large financial sector without the back-up of a lender of last resort.

The report is published amid growing signs that Mr Salmond is moving towards acknowledging use of the pound without Bank of England support as his Plan B. The likelihood of this was further encouraged this week when his economic adviser, Crawford Beveridge, claimed it was a “viable option” and could form a transitional currency arrangement.

Mr Beveridge said that a formal currency union remained the Plan A. But he also conceded that pro-Union politicians could keep their promise to refuse to allow an independent Scotland to enter a formal currency union with the rest of the UK.

Mr Beveridge’s remarks led Mr Salmond’s opponents to renew calls for the First Minister to come clean on his Plan B.

Meanwhile, last night, the SNP welcomed remarks made by the Nobel Laureate economist Joseph Stiglitz, who serves with Mr Beveridge on Mr Salmond’s fiscal commission, examining Scotland’s currency options.

In an interview in Germany, Professor Stiglitz suggested that Westminster’s refusal to enter a currency union was a negotiating stance. “The position of England today is obviously bargaining, trying to change the politics of the electoral process,” he said. “Once they get independence, if that happens, then I think there would be a very different position.

“Countries can work with many different monetary arrangements. The concern here really is, can they achieve a stable transition? I think it’s in the interests of the UK, of England and everybody to have that kind of stable transition. And I think that can be accomplished.”

Last night, SNP Treasury spokesman Stewart Hosie said: “There is perhaps no economist in the world that is more respected than Professor Stiglitz – and so his comments are a stark reminder to the No camp that the experts, just like the people of Scotland, can see through their bluff on the pound.”

The Adam Smith Institute paper Quids In: How Sterlingisation and Free Banking Could Help Scotland Flourish recommends reforms that remove protections from established banks while allowing competitive banks to issue their own promissory notes without restriction. According to the report, adaptive sterlingisation would allow private banks to issue their own promissory notes backed by reserves of pounds – or anything else, including US dollars, gold, index fund shares and even crypto-currencies such as bitcoin.

With each bank given powers to expand and contract its balance sheet, this system would be highly adaptive to changes in money demand. This would prevent recessions in modern economies such as the ones that led to the 2008 “Great Recession”.

Report author Sam Bowman refers to Scotland’s successful history of “free banking” in the 18th and 19th centuries and the period of remarkable financial and economic stability that accompanied it.

Under sterlingisation, Scotland would lack the ability to print money and establish a central bank to act as a lender of last resort. But the paper pointed to evidence from dollarised Latin American countries which suggested that, far from being problematic, this constraint forces banks to be prudent, significantly improving the overall quality of the country’s financial institutions.

It cites Panama, claiming it has the seventh soundest banks in the world. “Scottish independence is a complex issue with strong arguments on both sides,” the paper said. “On the question of currency, however, Scots may find that their own history shows how a financial and monetary system can flourish if banks and the state are both stripped of monopoly powers.

“‘Adaptive sterlingisation’ may prove to be a model for how a country can thrive when its financial system is stable, competitive and free.”

Better Together disagreed with the paper’s argument. A No spokesman said: “Using the pound informally in the way Panama uses the US dollar would be a disaster for Scotland.

“It would bring about unprecedented spending cuts to our schools and hospitals and mean we would have no say over interest rates. This would push up the cost of credit card bills, car loans and mortgage repayments for Scottish families.”

He added: “Alex Salmond needs to tell Scots his Plan B. Today we have the absolute reassurance that comes from the financial back-up of being part of the UK. Why put that at risk?”