As the date of the Scottish independence referendum approaches, a key issue is the question of Scotland’s currency if it were to become an independent nation. The policy advocated by the Scottish National Party is to maintain a currency union with England, a proposal that is causing increasing concern among many economists, myself included. I put these concerns to Scotland’s First Minister, Alex Salmond, at a meeting just before Christmas, and in fairness he did make a couple of valid points in response:
1. His Council of Economic Advisers, which includes Nobel laureates James Mirrlees and Joseph Stiglitz, has concluded that Scotland and England constitute an “optimal currency area”.
2. Evidence that Scotland and England constitute an optimal currency area is provided by the current performance of the two nations. Mr Salmond argued that the Bank of England’s monetary stance, with Base Rate at a record low of 0.5%, could be regarded as too loose for London – whether the labour market is tight and property prices are soaring – but too tight for the north-east, where unemployment remains high and house prices depressed. But it seems to be about right for Scotland.
Notwithstanding these points, I am not reassured, and set out my concerns in a letter published in the Financial Times on February 5th 2014:
In article, “England must reject currency union with Scotland” (January 31st), Martin Wolf exposes the flaws in the SNP policy of a currency union with England post-independence. It can only work with a banking union and shared fiscal resources. But these are incompatible with independence.
At a meeting with the First Minister just before Christmas, I put this to him and pointed out that, while the currency proposals in the Independence White Paper – under which an independent Scottish Government would be a shareholder in the Bank of England and have the right to nominate Board members – were all very well, the hard fact is that they have been rejected out of hand by the Westminster Government. In response, Mr Salmond argued that, if his proposals were rejected, an independent Scotland would simply refuse to accept a share of the UK’s National Debt. The Scottish Government then claimed victory a few weeks later, when the UK Government announced that it would underwrite all of Britain’s National Debt, irrespective of the outcome of the Independence Referendum.
But the Scottish Government’s policy is not credible. If an independent Scotland simply refuses to accept a reasonable proportion of the UK’s national debt, its ability to borrow on international markets will be fatally compromised.
I suggested to the First Minister that a preferable alternative would be to adopt the strategy discussed by John Greenwood in his FT article on January 16 (“A hollow independence if Scotland keeps sterling”). Namely, that Scotland should follow Hong Kong’s line in creating its own currency board. The Hong Kong currency board has operated successfully for 30 years of financial turbulence and radical constitutional change, and there is no reason why a Scottish currency board could not do likewise, guaranteeing the convertibility of a Scots Pound, initially at parity with the £ Sterling, but with the ultimate ability to adjust upwards or downwards against the £ Sterling as domestic economic conditions within Scotland require.
This would not be an easy option, as Mr Greenwood quite correctly points out. In order to sustain a currency board, an independent Scotland would have to maintain strict monetary discipline, as has Hong Kong. However, over the longer term sound money would deliver significant economic benefits compared to the alternative of a currency union dominated by England. An independent Scotland could survive and indeed thrive – but only if it has ultimate control of its own currency and monetary policies, as do Norway, Sweden and Denmark, which are frequently cited by the Scottish Government as comparators.
If it is to avoid being skewered on this issue as the independence debate evolves this year, the Scottish Government should have
the courage to propose that a currency board option is a viable “Plan B” in the event that its own “Plan A”, of full currency union with England, proves impossible to deliver on the terms it wishes.
Other authorities are expressing similar concerns. The Governor of the Bank of England, Mark Carney, summarised the issues that would need to be addressed in order for a currency union to be sustainable in a balanced and judicious manner, carefully avoiding political comment, during his visit to Edinburgh last week. And yesterday, the Chairman of the House of Commons Treasury Select Committee, Andrew Tyrie MP, stated that he did not believe that a currency union would gain parliamentary support from an English Parliament in the event that Scotland became independent. He proposed that it should therefore be rejected outright at this stage.