Scotland's Currency

A long time ago, when the earth was young and dinosaurs still stalked the uplands of Sliabh Mannan, I trained as an economist. I say this in order to justify a limited intervention in the independence debate. Mine is an economic commentary, not a political one. Substituting politics for economics was what led Europe into the débacle of its single currency and, since this precedent should not be emulated by the wise, I wish to examine the question of a currency for Scotland.

Any modern economy requires a currency. The fundamental choice is between one of your own and someone else's. Until recently, no-one was seriously suggesting that Scotland should adopt its own. In theory, creating your own currency is the only way to attempt monetary independence, since sharing a currency involves sharing sovereignty over monetary policy. In practice however, no open economy has full monetary sovereignty anyway, since the foreign exchange markets are too large for governments to control. It would not be impossible for Scotland to adopt its own currency. It would be expensive and it might be risky.

For a small and trade-dependent economy such as Scotland's, a new currency might seem an undesirable course, since it automatically introduces barriers to trade in the form of exchange costs. Unnecessary barriers to trade reduce the competitiveness of an economy and with it the standard of living in the country. To introduce barriers to trade with England, Scotland's principal market, would seem a bad way to start on an attempt to increase prosperity.

A new currency would also be vulnerable to exchange rate fluctuations. It would be more vulnerable than sterling to oil price changes, since oil is more significant in the context of the Scottish economy than that of the UK. An erratic currency handicaps trade by forcing buyers and sellers to protect themselves against unpredictable exchange rate changes.

The currency might well be discounted against sterling until traders became confident of its stability (and this discount would be greatly increased should the Scottish Government carry through its 2013 threat to refuse its share of the UK National Debt). It seems not unlikely that Scottish interest rates would have to rise relative to those of the residual UK in order to defend the Scottish currency. Investment would thus be adversely affected.

In all probability an independent Scotland would therefore be obliged to use an existing currency. Given that the majority of Scottish trade would be with England it would make most sense to use the pound. The only viable alternative would be the Euro, which is currently enduring an unresolved long term crisis, rather like a householder who pushes filler into the cracks in his walls and resolutely refuses to inquire why they have cracks in the first place.

In a future article I shall return to the economic implications of a shared currency.