A Unionist tries to help out the Nationalists - Part 2 (Currency)
In the first part of my note on the case for independence I noted real questions GERS begs of the nationalist movement. I now turn to the soft underbelly of the case for independence in 2014: currency.
Currency is probably the most fundamental decision that a new government could take. Get it wrong (like Argentina or Greece) and you can kiss goodbye to your economic growth for a generation.
Before getting into this it's worth noting that trying to disparage Sterling won't cut any ice with a No voter, the retention of the Pound was the cornerstone of the nationalist case for independence in 2014. The much hailed (by the SNP) Fiscal Commission Working Group concluded, strongly, that the retention of the Pound was very much in Scotland's interest. To pretend that the Pound is now not the best option for Scotland is just not credible.
However we all know now that a currency union is off the table. The Currency Union refusal by the three main Westminster Parties was not a bluff and the policy has been quietly dropped by the SNP and they, quite rightly, openly speculate about alternatives.
Therefore a Sterling Currency Union isn't an option (ditto joining the Euro), similarly just using (not keeping) the Pound isn't an option either - so it seems we are just left with a new currency.
As highlighted here, finding a new currency is not an easy task.
The Peg
A pegged currency would provide some nice window dressing to the case for independence.
Scottish Pounds could be exchanged easily in the UK for Sterling as they were guaranteed by the Scottish Government, indeed it would feel much like the position we have now when we shop in England with plastic cards or Scottish notes.
However it comes with great costs and great risks as I outline in detail. The concept of borrowing is largely out of the window and Scotland would need to run a surplus to get there. That has huge implications for the decisions that a new Government would need to make in respect of spending cuts and tax rises. It would also make Scotland a tempting target for speculative attacks.
None of this is appealing however if supporters of independence think that they can make the case for this then it would be one I would love to hear. I think it was telling when the SNP's economics expert George Kerevan proposed a pegged currency (warts and all) he was rather obviously instructed to disown it as party policy.
The Float
Alternatively rather than a peg Scotland could adopt a free floating currency. A perfectly viable option but one that the SNP campaigned hard against during the independence referendum. Salmond dubbed the costs of a free float to business (around £500M) which he dubbed the "George Tax". This time it's likely to be the "Derek Tax".
The uncertainty surrounding a free floating new Scottish Currency would be significant, especially if the Scottish Government couldn't answer the questions related to tax increases and spending cuts. This would all disrupt trade in what is a tightly integrated single market in the UK. It would all have, as Nicola sturgeon says, "deeply damaging and painful consequences" and would make Brexit look like a walk in the park.
None of this is appealing however if supporters of independence think that they can make the case for this then it would be one I would love to hear. I think it was telling when the SNP's economics expert George Kerevan proposed a pegged currency (warts and all) he was rather obviously instructed to disown it as party policy.
The Float
Alternatively rather than a peg Scotland could adopt a free floating currency. A perfectly viable option but one that the SNP campaigned hard against during the independence referendum. Salmond dubbed the costs of a free float to business (around £500M) which he dubbed the "George Tax". This time it's likely to be the "Derek Tax".
The uncertainty surrounding a free floating new Scottish Currency would be significant, especially if the Scottish Government couldn't answer the questions related to tax increases and spending cuts. This would all disrupt trade in what is a tightly integrated single market in the UK. It would all have, as Nicola sturgeon says, "deeply damaging and painful consequences" and would make Brexit look like a walk in the park.
Furthermore to maintain some sort of stability between Sterling, the Euro and the Scots Pound Scotland would be forced to maintain a similar deficit to that of the cUK and Eurozone members. That's a significant practical curtailment of Scottish sovereignty and places great pressure on an incoming Scottish Government in respect of tax increases and spending cuts.
The Sterling Surrogacy
Now whilst I ruled out keeping the Pound as an option for an independent Scotland, I think there is a viable way for an independent Scotland to keep the Pound. The trouble is I don't believe that this option would be popular many nationalists : the formal adoption of Sterling within a UK currency zone through a Currency "Surrogacy".
The Sterling Surrogacy
Now whilst I ruled out keeping the Pound as an option for an independent Scotland, I think there is a viable way for an independent Scotland to keep the Pound. The trouble is I don't believe that this option would be popular many nationalists : the formal adoption of Sterling within a UK currency zone through a Currency "Surrogacy".
This may sound like a Currency Union but it's not. A Currency Union means that final decisions over monetary and fiscal policy as well as areas like banking regulation are decided by agreement between members of the Union. So both Scotland and cUK would be tied by the decisions of some joint body, say a British Economic Council and Bank of Britain.
A Currency Surrogacy on the other hand means that Scotland would have no say whatsoever over such decisions with all of them lying with the cUK.
In practical day to day terms this would mean that the Scottish Government would continue to use the Pound but monetary policy would be set by the cUK government only taking into account cUK circumstances. Scotland would have no representatives on the Bank of England and would have to go along with what was decided by the cUK. To protect the currency and approve its use the cUK government would insist that Scottish Budgets were legally obliged to be approved by cUK before enactment. This would be to ensure that there is no question of the Scottish Government borrowing to excess and endangering Sterling. This effectively means that the Scottish budget deficit would have to be at least as good as that of the cUK.
To stop financial services organisations either having to relocate their official operations to cUK (that's much more than a brass plate), which would have substantive effects on GDP and tax revenue the Scottish Government, would also have to ceed control and regulation of financial services to the Bank of England (again with no Scottish input).
It's a description of independence that Osborne (in his Sermon on the Pound) argued would be the only way for a Currency "Union" to work but one that would be unacceptable to nationalists.
A Currency Surrogacy would still need agreement from cUK but by basically not making any demands on Westminster and giving them control over Scottish fiscal policy limits they would likely agree (as pp64 of the Treasury Analysis of a Currency Union points to).
The worst of both worlds
It's tempting for a nationalist to argue that Scotland currently has no say anyway so why shouldn't we go ahead with this. Whilst it's good rhetoric it would be a step change from having a direct say, having MPs speaking on our behalf and voting on such matters and Scottish Ministers in government making these policies, to being completely shut out for good and dependent on the decisions of a foreign state.
That's not a step forward in my view nor is it close to independence. However it would be "independence" for some nationalists (it is perhaps similar to the independence that of Greece in recent years) and some may well be perfectly happy to argue for it.
But worst of all, for me, a Currency Surrogacy is effectively the current arrangement without the fiscal transfers, that help pool and share the risk and rewards of the United Kingdom. That means an arguable reduction in democracy for Scots along with a substantial reduction in our living standards. Surely that is the worst of both worlds?
Creative destruction
Independence can be achieved but as I've tried to show over both posts it would be at a considerable price. Some may argue that is a price worth paying. A sort of premium for ideology. That's absolutely fair enough.
All of the above currency options are viable but each has considerable drawbacks and directly impact on the ability of an "independent" Scottish Government to act like an independent entity.
They also severely restrict the Scottish Government's ability to borrow and lose Scotland access to the fiscal transfers that are a key part of the single market. That places the focus right back on the tax and spending decisions that an independent Scotland would have to take.
For the record can I also point out that at no point have I argued that Scotland can't become independent, it's just that it would be achieved at some considerable cost and I'd like to know how that would be paid.
For someone, like me, who lived through the creative destruction of the miners strike I have a great disdain for the concept of premium for ideology. So it would take a very convincing case make me believe that independence was worth it right now.
I'd like nothing more than to see a coherent, well thought out and realistic case for independence, maybe, if they are serious about winning independence it's about time the SNP started to present one.
Interesting concept, I do however have a query as to how this would work where cUK is not in the EU but Scotland perhaps, is.
ReplyDeleteI'm not really sure that would be possible Ron. It would breach the Fiscal compact for instance.
DeleteCan I just thank you, Neil, for your work on this. I think it is invaluable.
ReplyDeleteWhile reading your posts I've been conducting something of a thought experiment as to what would happen on day one of 'independence', assuming a) there will be a new Scottish currency (which would seem to be the only logical option, not least as it will be required for EU membership), and b) that the UK government will not offer parachute payments to the Scots government to soften the landing from the loss of the fiscal transfer.
In these circumstances, I think the outlook for Scotland will be even worse than most people believe. Because not only would the Scottish government be looking at a black hole of £15 billion, we'd also be looking at an immediate contraction of the economy of 10%. Now, Nicola Sturgeon blithely says that we can borrow and tax our way out of this. But the problem with the latter (even setting aside the hit that it would have on growth, investment and employment) is that that it will not address how the 10% contraction can be mitigated (ie, higher taxes will just circulate the existing money in the economy in a different manner, and will not actually replace any of the lost cash). And the problem with borrowing is: where is she going to borrow from? Assuming that there will not be an adequate foreign exchange market for the Scots £ in the early days, if she borrows domestically (eg, from the banks, whose sterling deposits should have been converted to Scots £s), again, that will not plug the gap in the economy. She could borrow in dollars or sterling, I suppose, but she would then have to exchange these domestically for Scots £ - again not increasing the money flowing into the economy (although, granted, it should, if those dollars and pounds are used by the purchaser for imports, staunch some of the Scots £ flowing out). The only thing I think she would be able to do to keep the show on the road would be to get the central bank to print money. Although this could work temporarily - ie, by keeping cash flowing through the economy at the previous rate - it would, of course, be inflationary, and would lead in short order to a collapse in the exchange rate and to skyrocketing interest rates.
I'm not an economist and therefore not entirely sure if my thoughts stack up. Am I on the right track? Or are there are means by which an Indy Scot government could in any way stave off a recession/depression, assuming my starting point at top?
Thanks, Georges
No you are about right, printing money is not a solution it would mean international lenders wouldn't touch Scotland and the effect would be inflationary as well as sending the Scottish Pound into a tailspin. The truth is there just isn't anything close to an easy solution to this. There is a silver bullet and it's called immigration and I'll cover that in Part 3! Watch this space (well the blog anyway)
DeleteHaving lived through 40 odd years of adult life listening to SNP claims, cries and promises I'm not overly confident that a realistic (honest) case for independence will ever be made. It'll be more of the same as last time I fear.
ReplyDeleteExcellent presentation - and explaining your bias, or lack thereof, adds to your credibility.
ReplyDeleteOn your point re ideological premium, I have one.
Brexit means borders; it means turning our backs on friends who now have to fill in forms to have permission (not the right) to live, study or work with us; it means rolling back the years to some time warp before 1972 (and I fear we do not know just how far back) apparently with ounces and pounds to the fore; and critically, in my view, it is all based on a "British" attitude that we are somehow more equal than 27 other countries. There is more than a whiff of arrogance about it in that, somehow, we are different and wish to be seen to be different not least because we believe we are still a major economic and political player in the world.
I don't subscribe to any of that I place an ideological premium on ensuring peaceful relations with our EU 'club members, safe in the knowledge that peace in GB is assured. If that means Indyref2 and subsequently going through the pains of Scottish austerity with a weak currency, so be it. I would prefer the outward looking, EU embracing Scotland than the megalomaniacal UK/Britain that I fear we may very well become (as support for the reference to megalomania, I cite Dr Fox and Mr Johnson to name but quite a few).
I realise that this has little to do with economics and a heck of a lot to do with emotion, but I suppose my challenge to you is the: do you not fear the direction in which the British boat is sailing? And are you sitting comfortably on one of its deckchairs?
And last thing, you'll note I mentioned peace in GB. I did not say UK. Why? Because Brexit will lead to troubles (with a small t or a big T?) in Northern Ireland. See what I mean about peace?
My bias: personally and professionally wedded to the EU (despite all of its many and obvious failings) and a yes supporter at heart but not a tub thumper.
Thanks Peter and I appreciate your comments.
ReplyDeleteAs someone who is committed to the EU (I'd have the UK join the Euro if I had my way) then clearly I am not comfortable with the direction of the U.K. In leaving the EU. I campaigned for Remain and was bitterly disappointed when they lost. But I accept the position and am now hoping for as good a deal as possible to maintain free movement and trade links with the EU.
However my disagreement with the direction of the U.K. On this does not then follow that indepdence is the answer. Indeed that is the caricature that many nationalists are creating for themselves with their "the answer is indepdence, now what is the question" philosophy. At the end of the day the difficulties that Brexit will cause are as nothing to those that indepdence will cause.
Even a Scotland that is a member of the EU but outside the UK will still go through a considerable level of "deeply damaging and painful consequences" all in the name of an ideology as far as I can tell.
But I'm interested that you believe that the pains of austerity and a weak currency would be worth it then fair enough, but what is "it" - what is the thing you are fighting for that makes the pain worth it? It sounds like a lot of pain because you just don't like the Tories in WM. Fair enough but aren't their lots of other remedies to that which don't involve this sort of pain, such as campaigning for PR or a credible opposition in WM?
I think this comes down to my point that we're back to this caricature that indepdence is the answer no matter what the question.