Currency unions are like joint accounts

I really did not intend to devote so much space on my blog to the economics of Scottish independence.  I feel obliged to do so because political spin doctors have been engaging overdrive in an apparent attempt to obscure the issues and reduce popular understanding. I have no problem with people making an informed choice.  I do have a problem with people being misled.

In my letter published in yesterday's Falkirk Herald I used the same metaphor that I have previously used on this blog.  When I compare a currency union to the joint bank account of a married couple, I do not of course mean to suggest that they are the same thing, merely that they have a number of helpful similarities.

Not many non-economists have a clear grasp of the nature of currency unions.  Indeed the history of the Eurozone suggests that either a fairly substantial number of economists did not understand these principles either, or that political confidence overwhelmed economic objections.  The disparate economies that were enclosed in the straitjacket of the common currency were simply not sufficiently closely aligned.  A certain number of conjuring tricks were employed to make the figures look reasonably convergent in the qualifying year, but everyone should have realised that the important issue was not the statistics but the underlying reality.

A decade of growth camouflaged the problem; it did not make it go away.  The long rolling series of near defaults was always going to happen. The fact is, that  two divergent macroeconomic policies cannot be accommodated within a single currency zone.

Non-economists will, I hope, find the problem simplified by my analogy.  Like our divorcing couple separating their bank accounts in order to prevent one party from spending the other's money, two countries each need their own currency in order to operate any approximation to an independent monetary policy.  The Eurozone went for the joint account first and  loveless political marriage seems bound to follow if they will not reconsider their mistake.

Scotland is a tenth of the size of the UK and any currency union between the two would never result in her being able to underwrite UK debts.  The UK would have no partners in underwriting Scotland.  In return for taking on unlimited liability the UK is offered freedom from exchange costs that at most would amount to a little more than 1% of what it cost the UK to bail out RBS alone.  Can anyone seriously claim that represents a good deal for the UK?

There is no economic justification for divorcing London in order to marry Berlin.  The Eurozone is going to tighten its political integration.  Unofficial use of sterling can only be a short term stratagem since it would deprive Scotland of any effective monetary policy at all. 

Independence means a new Scottish currency.  There.  It wasn't so hard to say it after all.

Less Heat, More Light, Please.

Since last Thursday the currency issues in the independence debate have been, perhaps deliberately, obscured by emotional language. As I've said, we really do need to distinguish between a formal currency union and the informal use of the UK pound by an independent Scotland.

A currency union's price is financial interdependence because each member state may create new money. In the Eurozone we see a practical example. The short version of the lesson is: when some members overspend, those which do not overspend have no effective choice but to bail out their partners or risk the collapse of the whole system. 

The Eurozone is now being compelled by economics to pursue exactly the sort of political integration that is the opposite of the objectives of the 'Yes' campaign. 

The failure of the UK to agree a currency union with Scotland would not lead to exchange costs for UK businesses. Such costs would in fact result from a Scottish decision to adopt a currency other than sterling, as I discussed on 13 February.

Informal use of the UK pound by Scotland would be unlikely to lead to much greater financial flexibility however, since we could only obtain more money supply by means of a balance of payments surplus / net inward investment.

Quoting my article of 7 November 2013, "My judgement would be that a Scottish currency is the least of the evils, but that it requires preparation to start yesterday and much statesmanship from Scottish ministers."