In the early exchanges on the referendum, the No Campaign made some noise by claiming that Scotland would be forced to adopt the euro and that the UK Government would refuse to let Scotland, as an independent country, use the pound (sterling) as its currency. It remains one of the major questions I am asked when giving talks on the economics of independence but, the plain fact is that neither the EU, the UK Government, or the Bank of England has the ability to affect those outcomes.
No Euro, even if we wanted to
In order to adopt the euro a country needs its currency to be committed to the Exchange Rate Mechanism (ERM) for two years. Scotland doesn’t have a currency to commit to the ERM, and as Scotland plans to keep the pound, we therefore cannot adopt the euro, even if we wanted to, and so certainly can’t be forced to either.
Alistair Darling has said we would have to reapply to the EU from outside, and that means being forced into the euro – however that is inaccurate and even David Cameron can’t help but say he was wrong.
Not really independent?
It has been argued that Scotland wouldn’t be independent if we kept the pound, however, France, Germany, The Netherlands, Belgium etc have a shared currency and are independent of each other – the list is almost endless. Although Scotland wouldn’t be able to set independent interest rates, all the other more easily utilised fiscal tools would be available to the Scottish Government, and the joint interest rate would also help the English and other home nation economies.
The Scottish Government’s Fiscal Commission Working Group of leading economists, including former White House Chief Economic Adviser Professor Joe Stiglitz, has said that Scotland can agree to currency zone financial parameters the type of which any financially prudent developed nation should have following the lessons of the financial crisis but which do not mean a lack of flexibility to grow the Scottish economy.
Sterling is a fully convertible currency, this means that if any country in the world wants to use sterling it can. Examples of a fully convertible currency being used by other nations include Panama and El Salvador using the US dollar. Using the pound for a period, is a well proven route for countries leaving British rule (New Zealand/Ireland/Australia etc). However Scotland’s right to use sterling is stronger than other countries due to the fact that Scotland owns a population percentage share of the Bank of England (BOE), and so we will just be using a currency and services of a bank that we part-own with the other UK countries. So all that is being proposed is that Scotland will maintain the currency union that we joined hundreds of years ago and still works whilst leaving the political one that doesn’t.
But why use the pound rather than launch our own currency?
I was one of the first economists to suggest this, and agree with the Scottish Government policy. Like most people my heart says launch a Scottish currency, but my head says keep the pound, at least for a transition period – here is why:
The other home nations will, after independence become our largest export market. It makes sense not to put a currency barrier in way of trade. The No campaign is trying to get us to vote against a form of independence (they call it separation) which isn’t on the ballot paper. My independence, the Yes campaigns independence, and the SNP’s independence, is one that maintains the appropriate levels of economic interconnectivity, interdependence and social, cultural and yes – currency ties. Crucially, however, we will be making those decisions to share services as a sovereign country because we believe it to be in our interests. We’ll be making the choice, not London, and we can change our choices when we want.
Why a shared currency?
A Scottish pound would likely be a very strong currency – with oil, gas and renewables, a smallish population, a strong balance of payments, a far better financial position versus rest of UK and an almost guaranteed AAA credit rating. This would mean that the Scottish pound would buy a lot of rUK pounds, a lot of Euros and Dollars etc.
This would mean that for a short time imports would be cheap, the finance industry would grow and holidays would be cheap. Unfortunately this would mean that England, the other home nations and most of the rest of the world couldn’t afford our food, whisky, oil technologies, energy or even services, so we would risk a significant downside to our exporting industries with our own currency.
Why not just devalue?
It has been tried, and Switzerland in particular with all of its financial muscle has been unable to stop the rise in its currency. Uruguay the ‘Switzerland of South America’ has been devaluing to keep its currency a pace with its largest trading partner, Argentina, but Argentinas over reliance on quantitive easing (printing new money) to buy dollars, is in danger of weakening the currency and creating inflation in a low growth economy (stagflation). My point: large scale currency manipulation exercises no longer work, they are a thing of the past, globalisation of markets has diminished any governments power to manipulate currency values.
Many people think that quantitive easing is a great way to increase the money supply, but it amounts to less than 3% of new money created in the UK (so has a limited effect) and strangely, still has an oversized inflationary pressure attached to the practice. Controlling fiscal policy is very different to economic policy – devaluing the currency and setting interest rates are blunt tools, but more targeted economic levers such as reducing landfill taxes, corporation tax, air passenger duty etc, can be targeted in support of specific economic policies and that is why not launching our own currency has no relevance to being truly independent or not.
Plan A (keeping the pound) as set out by the Scottish Government is better for all concerned within the UK as long as both sides reach an amicable agreement. However as a plan B, launching our own currency and devaluing if required is a credible option and over a period of time may well become the best option.
Our friends and neighbours
The rest of the UK has a massive balance of payments deficit problem, we buy in too much, and export too little – this is a hangover from decades of keeping the pound strong for the finance industry, the all eggs in one basket strategy.
A few months ago I did some work that compared the deficits as a percentage of GDP in 2011 (last reliable figures available). Using an average of Eurostat, IMF and CIA projections it was found that out of 170 sovereign states the UK debt level (the amount spent in the UK more than was raised in taxes) was poorly placed at 150th.
The really bad news is the UK is 188th out of 192 nations in terms of the strength of its current account balance. We have a critical balance of payments problem that is in danger of sinking the UK economy without a trace. That is a direct result of keeping the pound strong to help the finance industry (predominately based around the city of London) and this also led to deindustrialisation in Scotland and the UK regions. In 2007 and 2008 I met with Bank of England representatives including Monitory Policy Committee (MPC) members and urged them to curb the excess lending from the finance industry. I was told in no uncertain terms that, Scotland had never had it so good. The words eye, off, and the ball, come to mind.
Upsetting the balance
If you were to take oil, whisky and food exports out of the sterling zone, the balance of trade deficit could cause sterling to sink like a stone, and so would the English economy. Not only would that be bad for Scotland, but it would be bad for our friends in England and that is reason enough – we will still be from Britain (it is an island) after independence, and England will probably always remain our best friend, and trading partner. The rUK would also need to purchase between 30-40% of its energy from Scotland (oil and gas included) and if those trades were from sterling into another currency zone, then there would be no benefit from buying from Scotland, and not another EU country (especially after the EU super-grid has been completed).
Who owns sterling?
So if we keep the pound and the Bank of England (which under international law an independent Scotland owns roughly 9% of) we would leave the ability to set interest rates to keep inflation low with the BOE, it is generally considered a good thing to have similar levels of inflation and the same currency as your trading partners. But roughly 90% of the economic policy levers we would differentiate from the UK would move into Scotland’s control (we already have the rest via devolution).
Equally the UK Government and the Bank of England, in the event of independence, would naturally want what is best for the UK sterling zone and its citizens and would want (actually need) the backing for sterling that Scottish oil and other exports would provide. But, crucially in this new scenario, all of the effective fiscal and economic levers that we might want to vary, would be under the control of the independent Scottish Government.
Keeping the Bank of England, and the pound sterling, still gives us a choice to launch our own currency in the future should that be the right decision. Interestingly we don’t have the option to join the Euro (if we ever wanted to) until our own Scottish currency has been launched and has participated in the exchange rate mechanism for at least two years, but remember you can’t be formed in.
So, far from the scare story of being forced to join the Euro, we couldn’t join, even if we wanted to. Launching our own currency would be more costly and more difficult than agreeing a currency union at the outset of independence, but it would also upset the trade balance with our friends in the rest of the UK by making cross border trades also a cross currency trade. If this damages the rUK economy then that isn’t in the rest of the UK’s best interest, but could be compensated for within Scotland’s economy with the additional fiscal tools that our own currency would bring independence can be a boost to all the nations of the UK economically and democratically.
The economists who work for the UK Government and in the treasury know all of this, and would move heaven and earth to ensure an independent Scotland kept the pound – everything else is just political manoeuvring in the hope of maintaining control of Scottish taxation at Westminster but worse case scenario is the benefits of our own currency could outweigh the transitional issues.