A laser engineer argues we can have a fixed peg to Sterling

Dr Craig Dalzell (a laser engineer) published an article on Wings defending his report on currency options for an independent Scotland, and specifically his recommendation of a fixed peg to Sterling. 

You might wonder why a laser engineer was publishing an article on investment asset analysis and currency. So did I? It's not as if the two disciplines overlap. 

The effect was an article that moved from comedy to tragedy, not only showing that a peg was an incredibly risky option for an independent Scotland it also showed that Stu Campbell does not employ basic fact checking of the posts on his site. 

Here below I reproduce the article in full with my own comments throughout in italics. 

An empty quiver

This week I published, through Common Weal, a discussion paper on the potential currency options for an independent Scotland in light of the material changes in circumstances caused by the Brexit vote.

This paper examines some of the options open to an independent Scotland and concludes that, on balance, the best option for Scotland would be a Scottish currency, initially pegged to Sterling but with the infrastructure and mechanisms in place to move, replace or remove that peg if and when it proves advantageous.

Starting off with a peg and demonstrating that you are getting ready to exit is a sure fire way to make you a target for hedge funds. So if a peg was the best solution you have just fundamentally undermined it. 

(As the UK did itself in the 1980’s when the pound was pegged first to the US dollar and then to the Deutschmark.)

Sterling has never been pegged to the Dollar or Deutschmark in the 1980s. This is really not a good start, it did shadow the Deutchmark under Lawson as Thatcher wouldn't let him join the ERM. That was eventually concluded by entry into the ERM which was a quasi peg and we all know how well that ended up.

One of the requirements of an independent currency is that Scotland would need its own foreign reserve fund which would act as a buffer against trade imbalances and would be used to counter movements in exchange rate (particularly if we were pegged our exchange rate to Sterling).

And would be needed to warn off hedge funds and speculators betting against the peg. Therefore the reserve needs to be substantial. 

It was on this particular point that yesterday’s Scottish edition of the Daily Express chose to focus, in its characteristically measured, balanced and thoughtful manner.

Their piece describes it as a “huge body-blow to Nicola Sturgeon”, suggesting that it would be simply impossible for Scotland to find this “huge sum”, and Conservative MSP Murdo Fraser describes the setting up of such a fund as “totally unrealistic” and that it would somehow prove “disastrous” to the economy.

(It’s odd that £10 billion for a foreign reserve fund is a disaster but £20+ billion to pay our share of Trident renewal is not only essential but somehow a good thing.)

One is something you would need on day one of independence the other is over 40 years. So what is odd is why a laser engineer would think they are comparable. 

I mention in my paper a few ways that this sum could, in fact, be found for Scotland (the Express does grudgingly mention some of them in a single paragraph right at the bottom of the article where most readers never actually reach), but I thought I’d take the opportunity here to lay them out in just a little more detail.

The foreign reserve fund of most western countries lies around 5% of GDP. 

That's because most Western countries do not have a currency peg. They therefore have no need for such a substantial reserve. This really shows a lack of basic level of  the subject matter. You could conclude that this was a deliberate error to try to ignore a really difficult issue, but from what follows it’s clear that it's genuine ignorance. 

Scotland’s GDP, according to GERS 2014-15, is £153.3 billion. 5% of this figure is actually just £7.7 billion, but I rounded it up to £10bn both for simplicity and to give a little bit of flexibility should anyone tell us that Scotland was just such a volatile and mismanaged economy that we’d need a bit more.

That probably would be the reserve we needed, if we were free floating the pound. A peg on the other hand requires substantially higher reserves. Denmark for example has reserves of around 30% of GDP to support it's managed peg to the Euro. In line with Carney and Professor Ronald McDonald you are looking at reserves of £40bn to maintain a peg with credibility. 

This elementary error would not be made by anyone with a basic grounding in economics, investment analysis or trade. It's likely that laser engineering does not have sub-courses in either of these topics. 

Off the top of my head I can think of four ways that Scotland could begin life as an independent country and start life with the reserves we need.

They clearly we're off the top of Craig's head as they fall apart after a second’s thought. 

1. Shared Assets

The most politically co-operative solution would be for Scotland to negotiate a share of the UK’s movable assets when we leave. This would include a share of the UK debt, which would also be a significant financial burden (albeit one we’re already paying now).

The UK’s own foreign reserves total around £164bn, suggesting Scotland’s share would be around £14bn – more than enough to support our new currency.

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/534602/reserves_stats_june_2016.pdf

This figure is wrong on a number of fronts. Firstly Craig has not noticed that the debt figures published by the Bank of England are USD and not GBP! Let me just say that again, the hand picked expert cant tell the difference between his own currency and that of the USA. 

So just taking a 9% population share (if that were the correct figure) Scotland would have been entitled to 9% of GBP £127bn so £11.4bn. No were near enough to support our new currency. 

He’s also not noticed that what really matters are the net reserves, especially when it comes to warning off speculators. So closer to £2.6bn on a net basis. That’s about a quarter of the annual fiscal transfer from cUK to Scotland right now. 

2. Mortgaged Assets

Negotiating a full share of all of the UK’s assets in return for a full proportion of all of the UK’s debts may not be the most beneficial strategy for Scotland.

As an independent country we don’t need a 9% share of two aircraft-less aircraft carriers, we probably don’t need a 9% share of the London Underground (though I’d be tempted to claim the stop nearest Westminster and maybe hike the ticket prices a bit) and trying to claim our 9% share of Trident (14 warheads) may not be considered particularly diplomatic.

Instead we could start from a position of having no assets and no debt 

Oh dear. Craig hasn't worked out that you cant start with no assets, under independence Scotland has all of the geographic assets of Scotland! So whilst Scotland is getting 100% of Edinburgh trams he seems to think that we would be entitled to a share of London Underground! 

The fact is that separation of assets has been clearly stated by the UK as a population split of financial assets (and debts) and the geographic allocation of fixed assets. 

but then “mortgaging” the value of the assets we DO want against an equivalent share of UK debt. If we want a £10 billion foreign reserve fund, we take it from the UK’s reserve and claim £10 billion of the UK’s debt at the same time.

If Scotland wants £10bn from the UK’s net reserve then it would be taking all of Scotland’s geographic assets and over a quarter of UK’s debt! 

It turns out that apart from that and maybe a few military assets we likely don’t actually need all that much from Westminster. This could represent a significant saving on our current “bill” for the UK’s debt of around £3 billion per year.

It could if Scotland was going to mortgage it’s own geographic assets to the UK then there may be a point here but Craig’s naivety is just showing through here. 

3. Borrow it

So maybe Westminster just wants to take the ball (and the credit card they bought it with) home in a huff and refuses to part with a penny of foreign reserve assets. Fine. Scotland starts with a clean slate and no debt. 

I’d love to know how Craig thinks the UK will agree to Scotland not taking any debt. Given that any independence settlement has to go through the House of Commons first why would any cUK MP vote through a package that gives Scotland no debt. 

We’re now in a particularly advantageous position of being able to borrow on our own terms and raise the money that way.

Sure we can borrow on the market. Even at the height of the last crisis Greece could borrow, albeit at a crippling price. 

True, we don’t know what our initial borrowing rates will be but consider the situation that the UK is in right now. As of writing, the cost of borrowing for the UK is at a historic low of 0.72% but, due to still paying off older, more expensive bonds from prior to the 2007 recession the total average interest paid by the UK each year is closer to 2%.

What we do know right now is that the rating agencies have said Scotland will pay more in interest than cUK and that was before the oil price collapse. We would therefor be borrowing at a much higher rate. 

If Scotland’s initial borrowing costs are a little higher than the UK’s rate on the day of independence but lower than the average rate then we’d be better off simply borrowing the money on our own terms. 

I do feel sorry for Craig at this stage, as here he shows he also doesn't understand the interaction between the price of debt and the coupon rate paid on bonds. At a very high level if the interest rate halves then the price of the debt doubles (there are a lot of caveats to that but I want to illustrate the point so laser engineers have a chance of keeping up). Therefore the value of debt Scotland will receive will be equivalent to the rates paid by the UK.

Another advantage of this option would be that we’d owe Westminster no debt at all therefore they’d have no diplomatic leverage over us should they ever wish to use it.

Only in a fantasy world would we not owe any debt to the cUK, just like Ireland found out debt is not optional and if you want to avoid it you can default. But that comes at quite a price. 

4. Buy it

Our final option in the event that Westminster throws an almighty hissy fit, refuses to part with a penny and sends the financial world into so much of a mess that maybe we want to avoid borrowing money if we can avoid it.

In this case, Scotland would look to the effective monetary surplus that we’d gain on independence. 

This is going to be interesting….

I’ve already mentioned the £3 billion per year we’d save on debt interest. Our contributions to the UK’s military adventures, compared to what Scotland would actually need to defend herself, probably totals a billion or two, 

Well that’s £5bn of which £3bn isn’t a saving. Also under NATO membership defence spend should be 2% of GDP so Craig’s assuming that will be violated as we apply for NATO membership… OK.

and there’s likely more to come once we see the actual account books rather than the guesstimates we have right now.

“Guesstimates” GERS are full and complex estimates from the Scottish Government but I’d love to hear what the savings are going to me. 

All in, if we play our finances smart and accept that we’re going to have to invest in some high-priority items like fiscal security, we could probably raise the £10 billion within a couple of years of independence.


We have a deficit of £15bn, Craig has identified about £1bn in dodgy defence spending but someone he turns this into a surplus of £10 bn over 2 years. I really don't understand how anyone who understand’s numbers can come close to thinking this is credible. 

It’s not perhaps an perfect solution to not have that buffer on day one, 

Not a perfect solution? It’s suicide. The hedge funds would clean us out on day one. The innocence here is breathtaking, how this passed a proof reader I don't know. You can only conclude that the publisher of the blog didn't remotely understand any of this subject matter. 

but the likelihood of a speculative financial attack on a country is negatively correlated with the likelihood of prudent and sensible governance in that country. 

That’s not true, and certainly not a new state with a new currency and a huge deficit will attract the attention of speculators seeking to make a quick buck. 

Scotland, especially post-Brexit, has a particular reputation in this regard and this scenario would only come about due to disastrously incompetent governance down south.

This is almost funny, Craig seems to think that Scotland has a high regard in the world of hedge funds and as a consequence they will ignore obvious profits and give us a pass. This sort of romantic view of Scotland being special in the world has no place in a fairy story not least in a supposed paper on currencies.  The text is getting so embarrassing and incompetent that you would struggle to read any further, other than for the comic value (and it’s worth it). 

(I don’t think we’d be the first target of such an attack, although in this case I’d probably counter my own report by suggesting that we may want to reconsider that peg to Sterling. It might have a bit further to fall than we’ve seen recently.)

And again Craig gives up the ghost before he’s even started. This is a disaster waiting to happen and is exactly why you don't consult laser engineers about investment analysis and private capital. 

It’s natural that the Express would want to try to portray anything said about independence as a “setback”. 

That’s true but the Express didn't even begin to hit the mark as to how unstable and dangerous this sort of advice would be. 

It’s rather more difficult, however, to actually defend such a position under the most cursory of examination. Rather than a “setback” for independence, I believe that my work has shown just what a great opportunity we have ahead of us should we choose to embrace it.

It’s certainly shown that if we want a peg to Sterling then we are going to require a huge amount of austerity in an incredibly short space of time. Any rational analyst would immediately dismiss this as a viable option and conclude that the only option was a free floating Scottish Pound which you would need to be prepared to devalue rather quickly on independence. 

As some curiously strident pet-food salesmen might be keen to point out, I might not be in the traditionally, formally-trained sense an “economist”. 

You aren't an economist. This entire article shows you aren’t even close to one. @Kevverage who you are referring to here (probably on the insistence of Stu) at least understand the difference between USD and GBP and gross and net assets, something that the laser engineer clearly did not. 

But if even a mere laser physicist can see this opportunity, I’m sure that others – perhaps even some of the brighter Conservative MSPs – can spot it too.

This mere laser physicist does not understand economics and has raised far more risks than opportunities. All he has managed to spot was that he doesn't understand economics, currencies or international capital. Had this paper been submitted in an economics 101 class it would have been thrown back at him with a note on the margin saying “How did you ever get into this class”

No wonder Wings published it with glee, as I’ve said #YouCantTrustStu