With the referendum on Scottish independence fast approaching, the debate as to what currency an independent Scotland should use is becoming hotly contested.
Should Scotland Say Goodbye to the Pound?
Independence would mean the creation of a new, untested economy that investors may be wary of. The choice of currency is crucial to establishing economic stability in both the long and short term.
There are four options open to an independent Scotland:
• Keeping sterling in a UK-Scotland monetary union
• Unilaterally keeping sterling
• Joining the euro
• Establishing a new currency
The Yes Scotland coalition is split between a sterling monetary union (the preferred option of the governing Scottish National party) and establishing a new currency – favoured by the Greens.
Unilaterally retaining sterling is antithetical to Scottish independence – when the primary function of a government is to make tax and spend decisions, ceding control over monetary policy makes little sense. Meanwhile, in light of the eurozone crisis, and the predicament, for example, of Greece and the other programme countries, joining the euro is seen in a similar light.
A Sterling Monetary Union
The logic of keeping the pound is straightforward. Retaining an established, strong currency would do much to remove uncertainty around a fledgling economy. There would be no up-front, transitional costs as there would be in establishing a new currency e.g. printing new money, establishing a new central bank, negotiating transfers of assets, and there would be no new transaction cost in trading between Scotland and what would remain its biggest trading partner – the UK.
The potential downside for Scotland would be remaining tied to the Bank of England’s monetary policy. Any agreement between Westminster and Holyrood would likely also introduce strict fiscal rules on Scotland to ensure the continued strength of the pound, which would significantly limit the country’s economic independence.
Moreover, although the report by the Scottish Fiscal Commission Working Group – which includes two Nobel prize-winning economists: Joseph Stiglitz and Frances Ruane – makes a convincing case for the economic benefit of such a union to Scotland, there is scant mention of the advantages to the UK, an imbalance highlighted by both the current chancellor and shadow chancellor’s opposition.
Both are keen to point out that the smaller economy would have a disproportionate influence on the fortunes of the larger. A currency union would tie the rest of the UK to an economy largely dependent on oil and gas, making it highly susceptible to fluctuations in energy prices – the global price of oil being particularly volatile.
As such, a union may not be possible at all. And any agreement acceptable to Westminster could involve far more stringent fiscal conditions than Holyrood would find palatable.
The Scottish Pound
The creation of a new currency, popularly dubbed the ‘Scots pound’, certainly makes the most political sense. It would afford Scotland complete economic, as well as political freedom, and side-step difficult negotiations with Westminster, aside from on trade – which both sides would be keen to remain strong.
Economically it makes a certain kind of sense, the full suite of economic measures being made available to react quickly and flexibly to developments in, say, oil prices; a freedom that would be highly desirable for the undoubtedly turbulent times a new currency would experience.
That freedom makes the Scots pound the most appropriate option for Scotland long-term. However, investors are unlikely to be attracted to an entirely new currency at first, and Scottish residents themselves might even choose to retain their assets in the established pound sterling rather than a new currency.
This initial uncertainty means that a) any new currency will require very strict fiscal policy to prove strength to the markets – running significant budget surpluses for a decade at least and b) the short-term obstacles may prove insurmountable, making long-term considerations moot.
Debt Issues
Regardless of currency, a newly independent Scotland will need to be able to finance its debts on the financial markets. In a report published by the National Institute for Economic and Social Research, Dr. Armstrong and Dr. Ebell demonstrate that Scotland would face borrowing costs between 72 and 165 basis points above the UK’s if it was to retain the pound.
Further, Scotland would have to “run a budget surplus of 3.1% annually to meet Maastricht defined debt to GDP ratio of 60% after 10 years of independence” which the authors contend would be necessary to inspire confidence in investors. This is no small matter. They continue: “Given Scotland’s estimated average primary fiscal deficit of 2.3% over the period 2000-2012, running a surplus of 3.1% would represent a fiscal tightening of 5.4%.”
They argue that a new currency would require the same fiscal tightening but by providing greater flexibility would eventually lead to more stability. However, they also admit that a new currency places a greater burden of proof on Scotland to demonstrate its ability to reduce its debt burden.
It is this that everything hinges on. Retaining sterling reduces this burden, introducing the Scots pound increases it.
On balance, a new currency is clearly more aligned with an independent Scotland’s long-term political goals and would appear to offer greater long-term economic stability, should the first hurdles be passed. However, it is the bigger gamble. Early investment could provide large returns further down the line. But how many of us are willing to take that risk?
Tom Williams
Currency Analyst
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