Saturday, 2 November 2013

Sharing a Currency

A modern economy is based on achieving efficiency by specialisation and then exchanging produce with other specialists. A currency facilitates exchanges because it gets round all the problems of having to barter. You might therefore think that in principle it would be good to share a currency with as many as possible of those with whom you hope to trade. The problem is that a currency has to perform other functions too. For example it measures value and value is not the same everywhere and to everyone.
The Euro was the EU's response to the failure of attempts to fix exchange rates between EU members by means of the so-called 'Snake'. The Snake was overwhelmed by market forces. Politicians believed that this could not happen to a currency union. The truth is that a currency union does not make the market forces go away, it simply diverts them into other channels.
The Euro is not a currency in which all members are equal. For most of the Eurozone's members it is effectively a foreign currency except for the absence of exchange costs. Market forces do not give equal weight to small economies and big economies. This means that all along the Euro has been in reality a Deutschmark-lite.
If you use a foreign currency you also accept a foreign country’s monetary policy, whether it is appropriate for your economy or not. You cannot simply demand that the foreign country takes account of your needs if they conflict with its own. 
Inappropriately low Euro interest rates before 2008 therefore fuelled unsustainable credit expansion and property booms in several weaker economies than Germany that needed more monetary discipline. This contributed to a series of crises as soon as the currency union came under serious stress. Meanwhile for Germany the Euro offered an artificially lowered exchange rate that allowed faster export-led economic growth than was justified by German costs of production.
Just like the Euro in Ireland or Greece, the pound will be effectively a foreign currency for an independent Scotland whether or not a Sterling Area is agreed and whether or not parity of status is claimed by politicians.  RUK is about ten times the size of Scotland.   An independent Scotland using the pound will have to accept what will essentially be the RUK's monetary policy.
The claim that an independent Scotland would become entitled to a seat on the Bank of England's Monetary Policy Committee is misleading at best. The independent status of the Bank (since 1997) precludes any government exercising influence over the MPC, which comprises Bank executives and independent economists. The UK Treasury representative who attends its meetings is not allowed to vote. Who could imagine that a Scottish government representative, even if allowed to attend, could have a greater role?