Scottish independence: the question of currency

Strictly speaking, a country only has rights over its currency within its own boundaries. Any country may use as its own currency a portion of any other country’s money supply that is available externally. Panama, for example, uses the US dollar, as did Zimbabwe for some years.

There is, therefore, nothing to stop an independent Scotland using the pound sterling, the yen or the Zambian kwacha except the difficulty of getting hold of enough money supply to serve all her economic needs.

However, a problem that arises for countries without their own currency is that they cannot create additional money supply for themselves and so they must run a balance of payments surplus (acquire more money supply) before they can expand their economies other than by the short term expedient of running down their foreign currency reserves.

In passing, it should be noted that Scottish banks already need to back their note issue with sterling on a 1:1 basis, but it is unlikely that this licensing arrangement would survive independence, so all notes circulating thereafter in a Scotland still using sterling would probably have to be Bank of England notes. Of course, the great bulk of money supply is not notes anyway, but bank deposits, etc. The principle is essentially the same.

A second problem is that there is absolutely no obligation on the country of origin of the currency to take account of the needs of the unofficial user when setting its own monetary policy. This effectively enforces fiscal rectitude on the secondary user, which cannot simply ‘print’ money, unlike a country that has its own currency. Quite often this is the reason for using a foreign currency: a country which, for political reasons, finds it hard to control its spending and thus risks severe inflation can force itself to ration the available money supply if it can’t make any more.

So, whilst no-one could force an independent Scotland to abandon sterling, a consequence of retaining it would be allowing monetary policy to be dictated by the UK government and restricting fiscal deficits to the size of available new sterling supplies. That’s not very independent, frankly. In fact, it’s probably less independent than the present degree of Scottish devolution.

On the other hand, starting a new currency involves a lot of irrecoverable sunk costs. These may be one-off, but they still need to be financed. And borrowing in the new currency would initially have to be very cautious, because otherwise its forex value could be volatile.

I don’t want to get started on the consequences of adopting the Euro. No, seriously, don’t ask.