Scottish Referendum:Currency Plan B (for Broke?)

This is the text of my letter,  published in The Falkirk Herald last Thursday:

"It's Scotland's pound and we're keeping it," they say. We are still being treated like children who do not understand economics.

The pound is the currency of the union. It is not Scotland's pound, nor is it England's, Wales' or Northern Ireland's pound. Scotland proposes leaving the union. You cannot divorce and expect to retain the joint account. When you're single again you must establish your own account and pay your own way.

It's no good repeatedly telling your ex-partners that it's somehow in their interest to continue underwriting your debts; after the 2008 crisis they won't believe you.

If Scotland used the pound unilaterally we would have to accumulate pounds by trade, since our government could not create for itself an increased supply of a foreign currency. Failure to generate a trade surplus would thus preclude the blithely promised fairer society. You might want it, but you can't have it if you can't pay for it.

Without a central bank, borrowing would become more expensive, especially if the Scottish government followed through on its reckless threat to throw over responsibility for its share of the UK National Debt. Remember a Scottish Chancellor under a Scottish Prime Minister recently increased that debt to rescue The Royal Bank of Scotland. No-one lends cheaply to those perceived as defaulters.

Loss of financial sector jobs could easily run into tens of thousands, reducing tax revenues, increasing the Scottish government's need to borrow and raising interest rates still further.

Using sterling without agreement has costs. It's not just a matter of thumbing our noses at the rest of the UK and saying we'll do as we like.

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.

Scotland's Future

Imagine that you are a banker. (If you are not already a banker this may be hard, but please try.) On a certain day you have appointments with each of a newly divorced couple, both of whom require loans to help them on their separate ways. The divorce has been acrimonious and reported in the press. Partner A has repeatedly threatened to accept no responsibility for the debts incurred on their joint account, not even those incurred in making purchases on his own behalf. He has now changed his mind. Partner B has gone on settling all debts as usual. Bearing in mind that, as a banker, your first responsibility is the security of your own funds, to which of the couple will you be more inclined to lend?

Amongst all the sound and fury surrounding the launch of the White Paper 'Scotland's Future', one figure has received surprisingly little attention. It is projected that in the first year of independence the Scottish Government will require to borrow £4.4 billion.

This is the same Scottish Government that:

1. has repeatedly threatened not to accept a share of the UK national debt,
2. denies Scotland's responsibility for the actions of a Scottish Chancellor in raising the UK national debt in order to bail out failing Scottish banks,
3. is already spending beyond its means,
4. has promised yet more spending in pursuit of a fairer society,
5. is about to destroy Trident-related jobs by the thousand,
6. is committed to a currency union and thus will not be able to set its own monetary policy.

Are you still imagining that you are a banker? You are not of course a Scottish banker, since the major Scottish banks are no longer Scottish owned. You are a foreigner and this Scottish Government is asking you for £4.4 billion. This year.  Alternatively you could lend to the RUK government which also needs a loan.

Bearing in mind that, as a banker, your first responsibility is the security of your own funds, what will you do?

Scotland and The National Debt

Alex Salmond has once again (19 November) threatened that non-compliance by the rest of the UK with his demands to 'share' sterling and The Bank of England after Scottish independence could lead to Scotland refusing to accept its share of the UK national debt. I realise that this is campaign rhetoric. It is nevertheless misguided.

The markets are listening.  They want to know what to do if they have to deal with an independent Scotland in the future.  The more likely a ‘Yes’ vote becomes the more they will trawl through the backlog of such remarks for guidance on future Scottish financial policies.  They will not like what they find.

Let us be clear. There are three important reasons why this demand is misguided.

1. Firstly, sterling is not an asset it is a national currency.  A currency is a claim on goods and services within an economy; it is not itself a good or a service. I have already explained in an earlier article the problems that are likely to face an independent Scotland that seeks to share a currency with its much larger neighbour.
2. Secondly, The Bank of England is the official banker to the UK government and an instrument of UK monetary policy.   Although its terms of reference are laid down by UK law, its independence from direct UK government control has been guaranteed since 1997.   Scotland is seeking to leave the UK. SNP ministers claim to want control of the economic levers for themselves. In what way would this purpose be served by 'sharing' an institution that does not take orders from government?
3. Thirdly, and most importantly, governments must never suggest defaulting on debt.  They must not imply it, or hint at it, or say anything that may be misinterpreted as an implication or a hint.  Everything that a First Minister or Finance Minister says is market sensitive.

The reason is that governments always need to borrow money.  Even governments running a surplus on the budget need to borrow money, because, just like you and me, the timing of their income does not coincide with the timing of their payments.  People who lend money to governments are sensitive to anything that makes them the tiniest bit afraid they might not get it back.  Every such unguarded remark could add half a per cent or so the Scottish Government's borrowing costs after independence.

We may end up with a Scottish currency whether we like it or not, for reasons outlined in my earlier article.  In any case, foreigners will have to hold Scottish paper with confidence.  The more suggestions there are that Scottish ministers don’t understand the markets and are careless or glib with financial pronouncements, the more reluctant foreigners will be to hold Scottish currency or bonds.  Scottish interest rates will have to rise to compensate for this perceived increase of risk.  In consequence, Scottish investment will become more expensive and therefore Scottish economic growth will fall. 

Is a point or two in the opinion polls today worth a point or two on the Scottish government's borrowing rate for years to come?