#IndyRef: Rejigging Scotland’s currency arrangements requires restructuring (and damage)

So yesterday three ‘boys’ from Westminster went to face the man of Scotland. As it happens all four major party leaders have been immersed in the art of politics since young, but Alex Salmond’s has twenty years on his more ‘senior’ rivals. Time and time again it shows.

For much of the last three years whilst the ‘boys’ were in Westminster trying either to hold together or prize apart Her Majesty’s Government in the Palace of Westminster, there has only been one big job being done at Holyrood, and that’s the preparation of the battlefield.

The preparations could be worthy of the German Army of the first world war. There are brilliantly constructed deep trench systems so that no sooner than the big artillery of the Axis Unionist forces finished, than they’re back to the machine guns mowing down a hapless enemy.

Indeed yesterday, as Gary Gibbons pointed out on Channel Four News, their appearance in Scotland came just as London’s only genuinely dangerous Roarin’ Meg in this belated siege of Scotland ripped the plaster off Salmond’s currency promise of retaining the pound.

They certainly heard in the City of London. At the other end of Southwark Bridge, the FT scrambled Barker and Wolf for a quick conflab…

This is the issue I thought back in February (possibly wrongly) would finally scupper the Scottish effort to break free of the Union.

It has survived largely unexamined thus far courtesy of a mix of bluster from Yes, and the determination of the No campaign to use it as a blunt instrument of fear has meant that until Mark Carney’s eleventh hour intervention (when looks like the Scots might do what London never dreamed it would).

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Here’s what’s outlined of Plan A in the Scottish Government’s White Paper… And you will find the supporting argument made by the Fiscal Commission (which included Prof Joe Stiglitz no less) for why that was its final recommendation

It piqued my interest because at the moment, the one great experiment in running a currency union without the backing of a common fund and common spending rules of a fiscal union has virtually collapsed and heading inexorably towards a broader and more political union.

It’s certainly an amelioration of the sovereignty which the people of Scotland are being offered in this referendum, and presumably why the Governor of the Bank of England told them that it would be “incompatible with sovereignty”.

But this arrangement is not the only possible scenario going forward. When Alex Salmond says no one can stop iScotland from using the Pound he is right.

Like Ireland in 1922, Scotland can remain open for business for a pound pegged to the Sterling, because as Tim Worstall rightly says, “no one at all has the power to make it not happen”.

[Yay! – Ed] Yes, but roll back a wee bit. No one can make it not happen, but it is not what the Scottish Government wants to happen. Nor I imagine does anyone else on these islands. As Tim points out…

…it would mean that independent Scotland would have no control over interest rates or the money supply, be unable to issue its own currency or even borrow in a currency it controlled.

[Eek! – Ed] Exactly. But relax. No one wants to see Scotland try to run a modern complex economy by funding it entirely out of its own savings. Apart from anything else it could be a disaster for everyone else involved.

Okay, so what about Plan A?

Well despite the quite genuine jitters in finance (which, along with business, accounts for 25% of Scotland’s onshore wealth), and even the pronouncements of the Governor of the Bank of England, the Scottish Government’s Plan A is the feasible of all other possibilities.

Francis Coppela provides an outline for the sort deal being sought:

At present, Scottish banknotes are 100% backed with UK sterling reserves at the Bank of England, which means they are exchangeable at par with UK banknotes. What the Scottish government wants is for Scottish pounds to continue to be exchangeable at par with UK banknotes after independence.

The Scottish government’s preference is for the rest of the UK to remain in monetary union with an independent Scotland. But the UK government, Treasury officials, the Bank of England and all UK political parties – mindful of the problems caused by monetary union without fiscal union in the Euro area – have opposed this.

The latter prompted high profile commentators like Paul Krugman to say that such an arrangement is undesirable, in the process taking issue with Joe Stiglitz who argued that it would..

The plain fact is that Scotland’s banking assets form a cool 1200% of its GDP (enormous by international standards). To effect political independence (and retain the majority of those banking assets) Scotland needs the Bank of England to cover them come what may.

Ambrose Evans-Pritchard blogs a recent note from Credit Suisse that takes a very hard view of the short term prospects

Currency options: We place a 40% probability on a peg to the pound (which we think would ultimately not hold) and a 10% probability on a freely floating currency. We place a 50% probability on a currency arrangement which would avoid devaluation against sterling: of this, we place a 25% probability on a formal currency union and a 25% probability on a Hong Kong-style currency board. We see a 1% chance of a Euro peg.

Significant deposit flight would require Scottish banks to offer much higher deposit rates, which would in turn increase borrowing costs for Scottish entities and individuals. This, in our view, would increase the risk of a severe economic downturn in Scotland post-independence.

Truth is that even a minimal amount of disruption in currency will inevitably lead to some damage. The question is how much, for how long will it continue, and what long term advantages (and they may be quite profound) are likely to accrue from the re-structuring involved?

Scottish devolution has by far been the most successful of all four experiments under both Labour and SNP administrations. The NHS in Scotland has managed to thrive over their southern neighbours and in Scottish Water has the most equitable and effective solution to the investment problem.

Evans-Pritchard for his part thinks it could work in the long run, but with a caveat in the tail…

I happen to think that Scotland could prosper eventually as an independent “Nordic” economy, just like Denmark. But there are a great number of analysts from across the world who fear that it will be an almighty fiasco for the next decade unless Britain props it up.

In my view, Britain will be forced to prop it up. Excuse me for feeling a slight irritation about this, as a Welshman.

The truth is that the banks really are nervous. It really isn’t just – as some people seem to think – because they are all mates with the British PM. Money and capital are nervous, ephemeral and ultimately cowardly creatures.

Any standoff in the post #IndyRef currency negotiations are more likely to prove a case of the dramatics with Hook and Smee than Eck takes on the Sassenachs… The Markets will demand an unsentimental outcome…

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  • Holby18

    Why should I as a taxpayer fund a foreign state?

  • mickfealty

    Because not doing so will in the short term cause us a lot of pain and a huge opportunity cost in helping to create a poor neighbour?

  • terence patrick hewett

    I believe this article has made some important points: in no particular order.

    Firstly: highlighting the fact that: “the one great experiment in running a currency union without the backing of a common fund and common spending rules of a fiscal union has virtually collapsed and heading inexorably towards a broader and more political union.” The implication of this is that the only thing on offer by the EU is the subsumation of the constituent countries into one state. It is this fact that must in the end be faced. Yes or no: no ifs no buts.

    Secondly: highlighting the fact that Salmond is running rings around the three professional political leaders. People like Salmond and Farage are simply better at politics because they are engaging in all those areas that politicians used to engage in. As the correspondent “Bergen” from the Guido website says:

    What would Churchill make of Cameron?

    What would Lloyd George make of Clegg?

    What would Attlee make of Milliband?

    When the press dismiss these two as “populists” there appears to be a great deal of good old fashioned intellectual snobbery at work.

    Thirdly: Is the economic argument a bit of a red herring? Is there a price on freedom? For if there is, then you don’t want self-determination you want something else. If you truly wish to be shot of the Union then you should be more than willing to take the pain.

  • mickfealty


    For some there is no price for freedom. The question is really for the swing voter. Besides, as Tim Worstall points out shipping some of the big banks out of Scotland would actually help Scotland become fitter for the actual purpose of independence… http://goo.gl/kkNtZq

    I think you make a good point about the importance of populism in the sense that mythering along in the halls of Westminster, Holyrood or Brussels is not much use if you cannot translate that in something meaningful in the eyes of the people who send you there…

    But you do also need to be able to offer something more tangible than opposition to the way things are…

  • terence patrick hewett

    I have always felt that when commercial and manufacturing companies exclaim that (in the words of Spike Milligan’s character Minnie Bannister of Goon Show fame) “we’re all going to be murdered in our beds” if either Scotland withdraws from the Union or indeed the UK withdraws from the EU: they should be taken with a large pinch of salt.

    These companies have their own agendas (and nothing wrong with that) but these agendas should not reflect on important political decisions: it reflects upon the legitimacy of democracy and in any case there are precedents that the effect on the economies is over-estimated:

    In 1989 the big six South African commercial institutions; SAB, Anglo/De Beers, Billiton, Old Mutual et al, started preparations to leave. After independence in 1993 they launched themselves on the international markets and became significant global players and reduced their South African exposure. This was an act of prudence since they were well aware of South African political realities; it also removed a source of temptation from the newly emergent political class. South Africa did not sink into the sea as a result of this: although it has to be said that the country has vast mineral wealth as a buffer but significant internal tensions and an industrial level of corruption.

    This is not reflecting upon the sagacity or worth of the move, which may or may not be a wise one but only that if government expose themselves to what is essentially blackmail on the level of a B-movie (do what I say or the kid gets it) and makes decisions of this nature on the say-so of commercial enterprises then they deserve everything they get.

  • chrisjones2

    That assumes that the UK has a strategic interest in a rich Scotland. Objectively it does but this is politics and having divested themselves the English may feel otherwise

    I am not advocating this – just commenting on the possible blow back

  • kensei

    I think the banks are more nervous of the potential disruption to rUK rather than iScotland.