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The currency of freedom: An independent Scotland’s currency options explained

On Scotland’s post-independence currency options, the Fiscal Commission Working Group’s 2013 report asserted: ‘It is this decision, above all others, that has the greatest implications for an independent Scotland’s macroeconomic framework. Yet, as the September 18th independence referendum edges closer, both sides of the campaign have steadfastly refused to move beyond the somewhat narrow confines debating whether a ‘Sterling Zone’ currency union is feasible.

The idea that alternative currency plans are being drawn up in private has been gaining traction. Yet, as Yes Scotland and Better Together publicly tread and re-tread well-worn arguments for the sake of remaining on-message, the wider media and public conversation ought to move beyond the blanket statements of ‘It’s Scotland’s pound too’ and ‘Britain says No’.

Currency Union: Equal and opposite forces

The currency union debate erupted in the media at the start of the year, with all of the main UK parties stating that they would not agree to a post-independence Sterling Zone. Sir Nicholas Macpherson, the civil servant who published the advice which UK party leaders cited, stated that the primary reason for his concern was the ‘travails of the Eurozone’. The scope of variation seen in the economies of the Eurozone, with countries like Greece recognised to have bent the rules of accession, renders this comparison somewhat flawed, at least in terms the currently similar states of the Scottish and UK economies. However, if Scotland and the UK’s economic situations began to diverge in the future, this would place strain on a potential currency union. This could become a real concern, as the current UK Conservative government is intent on shrinking the state to historically low levels, whereas the Scottish government’s white paper on independence invokes the Nordic, welfare-centric model of governance. However, this potential future strain on a currency union with members pursuing divergent fiscal policies despite a shared monetary policy relies on speculative policy promises, which are dependent, among other things, on the winners of the UK and Scottish elections in 2015 and 2016 . Moreover, these concerns would not hinder the creation of a currency union as a short to medium term solution for Scotland to ensure continuity and a more gradual currency transition for businesses.

As for the discourse which has sprung up to counter the UK party leaders firm ‘No’, the Yes campaign have largely stuck to repeating that a currency union would be in the rest of the UK’s best interest, and that the UK party leaders are ‘bluffing’. Indeed, a currency union would eliminate the transaction costs which a separate currency would incur, transaction costs which would be felt across the whole of the UK. This line of argument was given succour by UK Defence Secretary Philip Hammond’s comment in The Herald that ‘everything’ would be negotiable in the event of a Yes vote (later claimed to have been solely in reference to defence issues), and an unnamed UK government minister’s assertion that ‘of course’ there would be a currency union.

However, as Sir Nicholas MacPherson’s assertion of the dire consequences of a Sterling zone rests on questionable comparisons, this unnamed minister’s leap to ‘of course’ is likewise suspect. Focussing on whether or not maintaining a Sterling zone is in the ‘best interests’ of the UK, or is ‘common sense’, ignores the fact that common sense and Realpolitik do not always prevail in politics. The relative stability of a currency union would have to be weighed against individual preferences and public opinion. At the height of the currency issue’s media coverage in February, an Observer poll saw 46% of Britons disagree or strongly disagee with the notion of Scotland being ‘allowed to keep the pound’, compared to 31% agreeing or strongly agreeing. This is doubly crucial as the proposed 18 month negotiation period between a Yes vote and what would be Scotland’s Independence Day includes the May 2015 UK general election.

The likelihood of a currency union can neither be dismissed out of hand nor asserted with confidence. This ambiguity is reflected in Scottish polls, with 37% of respondents to a Daily Mail survey in February believing that the Westminster parties are ‘bluffing’, and another 37% believing they are serious. This uncertainty is perhaps partly intentional on the part of the Better Together campaign, with Alastair Darling adding extra variables to the debate, such as suggesting that the rest of the UK’s electorate would require a vote on a currency union.

So, the Yes campaign’s focus on common sense in their currency union argument cannot resolve the debate, as even if the definition of common sense were agreed, there is always the potential for irrationality. Short of pre-negotiating the currency agreement, which the UK government’s insistence that they are not preparing for independence precludes, the feasibility or otherwise of a currency union is intractably resistant to certainty. In this context, it seems sensible to stick a pin in the Sterling Zone debate, as it were, and consider the other options.

Use the Pound Anyway?

The Scottish National Party’s deputy leader Nicola Sturgeon has acknowledged in passing that Sterling is a fully tradable currency, and thus Scotland could continue to use the pound without the permission of the UK government, if also without any input into the governance of the Bank of England and its monetary policies, which control the production of Sterling.

Moreover, First Minister Alex Salmond commented on the Today programme in February: ‘It’s not a question of keeping the pound. It’s a question of whether there would be an agreed currency union.’ This suggests that, although the Scottish Government’s line remains that a currency union is inevitable, using the pound without input into the Bank of England’s governance is an option which has not completely escaped consideration.

What’s more, in a February 2014 Panelbase survey this option garnered 12% of Scottish support, much lower than the 46% saying that they would prefer a currency union, but still the second most popular option.

The Fiscal Commission’s report also briefly mentions this option, but does not give it serious consideration or its own section of the report, instead mentioning as an aside that it’s problematic due to the lack of control for Scotland and the loss of a ‘lender of last resort’, meaning that if the banks failed again the ability for them to be bailed out would depend on Scotland’s reserves. Moreover, this weakened economic position would be a barrier to negotiations surrounding Scotland’s potential re-application to the European Union (the need for which is another argument).

Indeed, Scotland as an advanced economy with a large banking sector appears out of place alongside international examples of long-term currency arrangements of this sort, such as Panama, which has used the US dollar this way for over a century, Ecuador which adopted the US dollar in 2000, or Montenegro which uses the Euro, despite remaining outside of the European Union, as it adopted the German mark in 1996.

The informal use of Sterling is clearly not a long term solution. However, in the case of a stalemate in post-independence currency union negotiations and a reluctance on the part of the Scottish government to consider non-Sterling options (which, given their discourse of strong preference for continuity, does not seem altogether fanciful), this could provide a short-term, if problematic, option for Scotland, extending the available negotiation and transition time for a new currency settlement.

A New Scottish Currency?

There has also been some discussion surrounding the possibility of setting up a new Scottish currency. Gavin McCrone’s suggestion that Scotland reissue an historic currency was picked up by some media outlets, with articles focussing on the potential of the ‘Merk’ as an alternative to Sterling. The focus on the Merk, in circulation in the sixteenth and seventeenth centuries, brings with it an air of the archaic. Although historically removed from William Wallace’s fourteenth century lifespan, the Merk’s very historicity is enough to conjure associations with the jingoistic, Wallace-esque historical nationalism which the Yes campaign is trying to distance itself from. This connotation is especially toxic in the context of the currency debate, as the financial world seems ever more futuristic and unsentimental.

However, regardless of the name chosen, Scotland could set up its own currency, avoiding the complicated separation of fiscal and monetary policy present in the previous two options. This new currency could be pegged or unpegged, meaning that its value could be dependent on that of another currency, such as the pound, or it could float freely on the market. If this new Scottish currency were pegged 1:1 with the pound, and given a reassuring name, like, say, the ‘Scottish pound’, this would ensure continuity for businesses and the public, whilst giving Holyrood greater control and setting Scotland on the road to having a fully independent, unpegged currency, thus full control over economic policy. There are also several international examples of pegged currencies. Bosnia, for example, pegged its currency to the German mark then to the Euro, and Hong Kong dollars are pegged to US dollars.

The idea of setting up a new currency has also garnered some political support in Scotland, with the Scottish Greens and former SNP deputy leader Jim Sillars among those in favour. However, there would be set-up costs associated with this option, including the establishment of a Scottish Central Bank. Estimates of this cost vary wildly depending on the affiliation of the source, so this is essentially an unknown cost.

Another factor is that new currencies are at the mercy of the market. Pegging would offset this, but it would be something to consider before floating any new Scottish currency on the market, a move required to give Scotland full economic independence. However, the ravages of the market are not reserved for new currencies, as the financial crisis demonstrated, and equally apply to currency unions. As McCrone notes in his recent book on Scottish independence, the Czech-Slovak currency union of 1993 lasted only a few weeks, after the market effectively gave it a vote of no confidence. This risk is therefore not unique to the option of setting up a new currency.

The Scottish Government’s White Paper on independence states that those like the Greens who would prefer a new Scottish currency would have the opportunity to implement this if they gain support in the first post-independence Scottish election. However, this election is scheduled to take place at the end of the proposed eighteen month transition period, so the interim arrangements will most likely be negotiated by the current SNP Scottish government.

In the flux of the transition period, there would potentially be room for the SNP to soften its stance against the set-up of a new currency, preferring instead the long term increase in sovereignty which this option brings. This full control over economic policy is particularly crucial if the SNP are committed to the extensive welfare programme they have proposed, a welfare programme which could possibly struggle to thrive without full flexibility to control interest rates.

The Dreaded Euro?

The Euro has become something of a toxic brand since the financial crisis, consistently garnering the least support in Scottish opinion polls, with only around 5% backing it as their preferred currency option for an independent Scotland. Given the persistence of claims to the contrary, it’s worth reiterating that Scotland cannot be ‘forced’ to join the Euro if it has to re-negotiate its membership of the EU. In re-applying to the EU or reconfiguring its membership, agreeing in principle to enter the Eurozone would probably be necessary. However, this paper agreement doesn’t guarantee entry.

Among the conditions which must be met in order to join the Eurozone, the proportion of the UK’s debt acquired by Scotland would possibly affect Scotland’s eligibility under the debt and deficit criteria. Regardless, and as the Fiscal Commission noted, to join the Eurozone countries must opt in to the EU’s Exchange Rate Mechanism (ERM II), which is voluntary, and be a member for 2 years. Scotland could simply defer opting in to ERM II, as Sweden has done for several years. Moreover, the two year membership requirement means that, if the eighteen month transition period is met, it would be impossible for Scotland to meet the criteria for Eurozone membership before Independence Day.

It seems, then, that the financial crisis has undermined the viability of Eurozone membership as a political choice, whilst accession criteria preclude immediate Scottish membership and cannot force eventual membership. The Euro as a potential currency could therefore only possibly be adopted after a period of transition using one of the previously discussed options. To become a viable currency option for Scottish politicians, there would also need to be a sizeable shift not only in the strength and stability of the Euro, but in public perceptions of its strength and stability, as the mistrust left by the banking crisis runs deep.

All of Scotland’s currency options come with unknowns, positive features and negative ones. Non-economic issues, too, will be key to the outcome of the Scottish referendum, with issues of democratic accountability and Nordic-style welfare at the heart of the debate. The question may now be whether voters are willing to accept the potential downsides of the currency options explained above in the hope that these are not so severe as to undermine the realisation of the lofty ideals of democracy and fairness.

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