Thursday, 13 February 2014

Why no Plan B?

Let me try again to clarify matters affecting the currency of an independent Scotland. Two issues are still being confused: on the one hand the right of Scotland to continue to use the pound and on the other the continuation of the present currency union.

The Eurozone is an example of a currency union of separate states. All of the partners have the right to create new money; this means that none of them is financially independent and a financial crisis in Greece inevitably drags in the Germans who have no crisis of their own.

UK ministers and opposition have indicated that they find the prospect of a similar currency union arrangement with an independent Scotland unattractive because it would mean the UK losing financial independence just as Germany has.  The Scottish Government reply seems to be, 'They can't stop us using sterling.' This is true, but it does not mean that we can force the UK to accept a currency union.

An independent country may use any currency it likes, including a foreign currency, subject only to its ability to get hold of enough of that currency to meet its needs. For example Ecuador uses the US dollar. The US could not prevent this, even if it wished to do so.

The point being confused in the independence debate is that a country in Ecuador’s position cannot create US dollars. Were it to attempt to do so, the US would simply decline to recognise them as legal tender. This means that Ecuador's only monetary policy option is the monetary policy of the US, which takes no account of Ecuador when setting it. For the same reason Ecuador must operate under tight fiscal discipline.

If an independent Scotland wants to use the UK pound then we cannot be prevented from doing so, but in the absence of a currency union with the UK we could not create UK pounds since we should no longer be part of the UK. We should be in a similar position to Ecuador, with no monetary and little fiscal autonomy.

We could of course create Scottish pounds, but we could not force either the UK or the international exchanges to accept these at parity with the UK pound. The most likely outcome would be the circulation of both currencies inside Scotland, though it might be some time before the Scottish pound was enthusiastically accepted externally.