Show me the money

Jim Walker, chief economist at Alethia Capital in Hong Kong, looks at the currency question for an independent Scotland

One of the most frustrating arguments about a future independent Scotland is centred on the question, “What currency would you use?”. This question has different meanings for the extreme-Unionists and pro-independence supporters.

Let’s dismiss the silly argument first. If the unionists who trot out this inanity could please just remove their insular blinkers for a second and look at the world around them, their question would be answered immediately.

Every country in the world uses its own currency, or one tied to a fully-convertible counter, and finds no trouble in doing so. An independent Scotland would use whatever currency it wished. Its citizens would use whatever currency was accepted in shops, bars, online shopping, investments and tax payments. That’s it.

It is even conceivable – and I for one would highly recommend it – that multiple currencies could be used in an independent Scotland.

Sterling, the euro, the dollar and the Scots pound (maybe even Bitcoin) could all play a part. The technology is there to handle multicurrency transactions, banks are perfectly capable of issuing multicurrency accounts (I have had one in Hong Kong for 30 years) and people are smart enough to know which currency best suits their needs. As recently as 2010 it was possible to walk into a bank in Ho Chi Minh City at closing time and find the tellers balancing their tills in dong (the Vietnamese currency), dollars and gold.

In short, to anyone with experience in international economics, a question about trading and investing in a specific currency is simply trivial. Of all the economists and analysts I have been involved with in all the countries in Asia I know intimately, none would think the question worthy of two seconds thought. The answer is just obvious: use whatever suits your needs and whatever currency you trust. In most well-managed countries that is the domestically-issued money.

But much more vexed seems to be the argument within the pro-independence camp. It was widely held that a key weakness of the case for ‘Yes’ in 2014 was the advocacy in the Scottish Government’s White Paper of a formal currency union between an independent Scotland and the remaining parts of the UK. The debate became bogged down as to whether or not the rUK would “let” Scotland keep the pound. The Yes side failed to address this issue satisfactorily.

But the debate has moved on. A formal currency union is no longer the Scottish Government’s central case for an independent Scotland.

The new central case, put forward in the Sustainable Growth Commission (SGC) report, is to retain sterling for an extended period but for there to be no formal currency union. The key sentence in the report is: “It [the sterling shadow] also provides certainty and continuity concerning existing arrangements and contracts.”

This option has been attacked by a number of commentators, most notably Common Weal (in its White Paper Project report, How to Make a Currency), Dr Tim Rideout and Professor Richard Murphy, two leading proponents of Modern Monetary Theory (MMT).

The Common Weal proposal is for a new Scottish currency to be introduced three years after an independence vote (this timeframe is based on experience in other European countries, most notably the Baltics). Sterling would continue to be a feature of contracts and investment for some time thereafter.

The author of the report correctly concedes that there would be parallel currency holdings, because of contracts such as mortgages and pensions, post the introduction of a Scots pound. The biggest problem with the proposal is the arbitrary nature of the three-year transition. This will continue to frighten existing pensioners and asset holders.

Tim Rideout and Richard Murphy would push for an immediate adoption of a new, separate currency in order that the Scottish Government could then adopt an MMT approach to the fiscal accounts i.e., to print money, via a new Central Bank, to cover the government’s deficits.

This would indeed be a bold departure from current policies (in the UK and everywhere else in the world) and has many potential pitfalls, not least a possible crash in the currency’s value in short order unless the new independent Scotland, like China, was willing to impose capital controls on its citizens and businesses.

MMT is gaining traction around the globe as a direct result of central-bank policies since 2008 but it has many failings, not least its reliance on macroeconomic aggregates to prove its efficacy.

But what are the facts, both palatable and unpalatable?

1. Scotland would be perfectly free to continue to use sterling (or a one-for-one equivalent) after independence. This was the chosen path of the Irish Republic post 1922. The first post-independence currency, the Free State Pound, was introduced in 1928 (six years after partition) and remained fixed 1:1 to sterling until 1978 when Ireland joined the EU’s Exchange Rate Mechanism but the UK did not. In other words, an independent Ireland essentially used the pound for 56 years after declaring independence even though it could claim to have its own currency.
2. Equally, there is nothing to stop Scotland introducing a new currency post-independence. There are numerous examples of new currencies being adopted worldwide and the technical, legal and financial know-how is available in abundance. That said, it makes absolutely no sense at all to set the conditions, timeframe and objectives of the new Scottish currency ahead of the “Withdrawal Agreement” that will be negotiated with the rUK in the transition period. Poker players don’t lay all of their cards face-up on the table at the outset of the game if they are hoping to win the pot.
3. It has to be recognised, though, that a new, independent currency will not give the Scottish Central Bank anything other than very limited control over monetary policy. We live in an integrated world and, unless the advocates of an independent currency also wish to establish capital controls, there will be only very modest scope to stray from international interest rate and monetary management norms.
4. Given that existing investments, pensions and mortgages are all contracted in sterling it is essential to give people, 1) a guarantee that their existing assets will be maintained at the value of sterling (easily done with a sterling 1:1 link), 2) a long (depending on circumstances that might be as short as two years or as long as ten years) transition period to move their assets to a new Scottish currency if they so choose, 3) confidence that they will not lose out financially if there is a divergence in the currencies. These are significant and possibly expensive guarantees and undertakings to make, especially in the short term. This is what makes the promise of a longer transition period attractive. It is simply human nature that further into the future a potentially concerning change is pushed, the less frightening it becomes.
5. One thing which must not be allowed to stand is the threat made to pensioners during the first independence referendum, i.e. that independence would threaten their existing income. Pensions are legal contracts between employers/governments and pension recipients. They are not bargaining chips and they cannot be rescinded when it suits the paying partner. The UK Government, just as it does with citizens who live in Europe or other countries, has to pay its contractual obligations. The same goes for private companies. Those obligations will stretch right up to the date of independence. Payments to Scottish pensioners who have contributed to National Insurance or company pension schemes would be enforceable in law regardless of the relationship between an independent Scotland and rUK.

If the aim is to give the greatest confidence to existing stakeholders (in respect of assets and pensions) the position in the SGC report is eminently sensible. The slow-transition proposal would calm the nerves of many, especially in older age groups.

Whether we like it or not, sterling contracts are ubiquitous and the status of them following independence is the single biggest concern for older residents in Scotland, whether existing or prospective pensioners as well as all homeowners with a sterling mortgage.

The transition period can be accelerated after independence through good economic management and sensible policy decisions that would encourage existing sterling asset holders to swap out of their current holdings into a stronger currency.

While many independence supporters now favour a new Scottish currency (as do I), they are being naïve as regards how hard a sell it will be to much of the population.

As for giving up our ability to have a much more active monetary policy than would be the case under a ‘sterling-shadow’, that game has long been a bogey for small, open economies in an integrated world.

We Nationalists need to get real as to the international realities of currency management as much as the Unionists have to understand that their “Which currency?” question is just arrant nonsense.