You've got your Scottish pound - why don't you use it?

Scottish independence campaigners are understandably upset by the rest of the UK’s (rUK) cross-party move to keep them out of the Sterling zone. The Bank of England can’t stop the use of its currency in an independent Scotland. But rUK parties insist that if Scotland leaves the political union, it also leaves the currency union. Scotland will be ‘sterlingised’ in the way that Ecuador and El Salvador are ‘dollarized’: free to let the currency circulate but not included in the monetary arrangements that set its interest rate, stabilise the banks that borrow and lend in it, and manage its exchange rate against other currencies.

However, the Westminster government (and opposition) case against maintaining present currency arrangements after Scottish secession is one of sound economics, not political belligerence or bluff.  The Bank of England could not justifiably factor an independent Scotland into its monetary policy decisions, or act as its lender of last resort to banks it could no longer (if still based north of the border) supervise directly. If it wants to be part of a larger currency union, Scotland can only look to the Eurozone. That’s a distinctly unappealing prospect given its present trade and investment integration with the Sterling area, and mounting concern that faults in the Eurozone’s design will condemn it to permanently restrained growth if they do not break it apart.

Scottish pound downsides

Amid this brawling over Sterling, the third option – Scotland preserving its own pound, and making it a sovereign currency – is oddly neglected. At first sight, the objections to a separate Scottish Pound (S£) seem obvious and numerous. It would need a new (or re-created) Scottish central bank. Lacking any history, this would struggle to get anything like the investment-grade credit ratings the Bank of England and UK Treasury enjoy, so Scottish borrowing costs would be higher. Because Scotland would have to walk away from its share of the UK national debt, or re-denominate its share into an unknown new currency, there’s a risk its creditworthiness could suffer even more. Outside the monetary union with the rUK, Scotland’s bank assets (if not relocated to London by scared shareholders) would be an unusually high proportion of its GDP – a recipe for loss of confidence in the financial systems of Ireland, Cyprus and Latvia after 2008. 

If the S£ floated against the Pound Sterling and the Euro, it would create extra exchange rate uncertainty for producers in Scotland and investors outside it. But if the S£ were fixed against the £, it would lose the advantages of flexibility without the elimination of exchange risk achieved by actually having the £ in circulation. As a petro-currency, the S£ could easily be dragged upwards in value by oil exports, making Scotland’s other exports too expensive  and squeezing-out its non-oil sector. (The SNP’s proposed sovereign wealth fund might counteract this by investing oil revenues abroad, but the fund’s creation is 30 years too late, with over 60% of the oil already extracted and burnt). Chief No campaigner Alistair Darling probably speaks for many in the Yes camp when dismissing the idea of a new Scottish currency as “plain daft”. 

Scottish pound advantages

Yet small countries can gain from having independent currencies. Ireland transformed into the Celtic Tiger after it stopped fixing its own pound (punt) against Sterling in 1979, allowing it to stay at a sensible level while the UK overvalued its pound (due to the oil surplus) and lost much of its manufacturing.  Slovakia’s surprise resurgence, after a break from the Czechs which most commentators thought would hurt it, owes a lot to its creation of a separate currency – which also showed that a newly created central bank can quickly gain credibility even in a country previously dominated by a bigger neighbour. 

Switzerland has used the flexibility of its Franc against the Euro to bring it down (and save its exporters) when capital inflows threaten to make it too strong – an escape route the Scots may also need, if their resources prove as attractive as the nationalists suggest. Pro-independence campaigners may be missing a trick when they focus on the example of Norway, whose exchange-rate fix against the Euro is a safeguard against current overvaluation which Scotland won’t need if its North Sea oil production falls as recent forecasts indicate.

Few economists on either side of the border have spoken out in favour of an independent Scottish pound. The endorsement of Bloomberg – a financial hub used by traders who love multiplying currencies ()  – may not have helped its cause. 

Strong case for

But the case for creating one, free to adjust against the UK pound and Euro, is surprisingly strong.  To those who argue that keeping Sterling is essential because over two-thirds of Scottish exports go to the rUK, advocates of an independent Scottish pound reply that this is one of the distortions that independence should correct. Steer sensibly between the Sterling, Euro and Dollar zones with an independent currency, they say, and Scotland will get a much better balance in its production and trading patterns.  

Perhaps the strongest argument for an independent Scotland to have its own pound, under a re-established Bank of Scotland, is the economic advantage enjoyed by countries that issue their own money. “Modern Monetary Theory” is still fighting for the centre ground of economics; but its case for countries to keep their own currencies and avoid tying them to others is gaining ground. The US, which did so, is now free of a global financial crisis that Eurozone countries, which gave theirs up, are still struggling to escape. The message to the Yes campaign is: if you want the full benefits of political sovereignty, be prepared to reclaim your monetary sovereignty as well. 

For all his combative strengths, Alex Salmond will never be the world’s best pound-for-pound fighter. Floyd Mayweather and Andre Ward still have stronger claims in the middleweight division. But canny politicians don’t pick unnecessary fights, and the battle to stay within the Sterling zone may be one of these. If support for independence keeps falling after the announcement that Scotland can’t keep the UK pound, the SNP can revive its campaign by showing the Scots how they don’t need to – and making the case for re-inventing their own. 

Further reading

The Herald: Currency furore over mystery of missing memos

The Herald: Latest Indyref polls Yes 41% No 46% Don't Know 14% [Apr 6th 2014]