Wednesday 1 May 2013

The million groat question - why the currency matters

"The referendum isn't about party politics"

"Don't want one of your bastard English pounds!"
A common refrain from both campaign teams in the independence referendum. Usually as soon as it's inconvenient for Better Together to get tarred by the record in government and policies of the three main Westminster parties, and by Yes Scotland whenever they're tarred by the SNP's record at Holyrood or their policies. Of course, it's not illegitimate for them to do this for the most part. A good referendum which debates this issue properly would try to dissociate it as much as possible from party-politics, albeit that's probably politically not viable in the quite hostile environment of Scottish politics. When the UK had the referendum on the EEC, there were multiple campaign groups and the issue was dealt with on its own merits rather than through the prism of inter-party disputes (albeit it did expose intra-party ones!). Moreover, there will be good arguments for independence and for the union on all regular sides of political divides: left versus right, liberal versus authoritarian, progressive versus conservative.

Where this is not true, however, is in respect of questions of transition and the mechanics of setting up an independent Scotland. These issues ought not, in the long-run, to affect Scotland's ability to be prosperous and broadly to hold its own in the global market and community. But they are important in making sure we set-up an independent Scotland on the strongest footing possible. A good referendum is one which pits the strongest arguments for a reformed British state against the strongest, most thought through vision for setting up an independent Scotland.

The sovereign state has become a far more complex beast than when self-determination first came in-vogue in the aftermath of WWI, and even since the fall of the Soviet Union. States do exist in a global market, where wealth flows more freely and where decisions are made by reference to multi-national organisations. I don't wish to dwell too much on the latter (perhaps for another post) but understanding economics in a global perspective is critical to articulating a coherent vision for an independent Scotland.

SNP matter more than YesScotland with this question

The SNP have said (at least since the Eurozone crisis) that their intention with the currency is to retain the use of the pound (£), the GBP, and to be part of a currency union with the rest of the UK. Note, of course, that there is no pre-existing provision in UK or international law that provides "independence events" (call it a secession, a separation, whatever) lead to currency being shared in such an arrangement. There is a heavily entrenched norm that sovereign states have the right to issue currency, and to delegate that power to bodies as they see fit (whether domestically by a central bank or to an international organisation as with the Euro). In practice, currency is issued by sovereign states or quasi-sovereign states as the forbearance of a sovereign state. It will, therefore, have to be something that is negotiated if it is to exist. But who negotiates? In whose interest do they act?

There seems to be an implicit understanding that the Scottish Government, or some related delegation, will represent Scotland in any domestic negotiations, and that some sort of UK Government derived delegation will represent the interests of rUK. This means that the fate of the currency from 2016, in the event of a yes vote, depends on these two groups agreeing something. As such, it really doesn't especially matter what YesScotland thinks about the currency. Any long-term decisions about whether we join the Euro, the pound, or another currency union, or have our own currency, would ultimately fall to future political debate, and there is nothing wrong with those on either side disagreeing with one another about what those long-term trends should be, whether within the UK or in an independent Scotland.

Our central bank could issue these
if we keep BoE notes in reserve

But with an independence event, the situation is different. When currency is issued based on the exercise of a sovereign right, and you are looking to create a new sovereign state, there has to be an explicit statement about what happens to that sovereign power. The interim arrangements matter, therefore the opinions of the respective prospective negotiators matters, in facilitating the situation on Day 1 of our brave new world.

The UK Government came out last week and said that they did not believe a currency union would be an especially viable proposition, and that it may be contrary to the interests of rUK to agree to sharing this sovereignty, at least without stringent fiscal controls. They are perhaps weary of the effect that fiscal divergence within a currency union, of which the Euro is far from the first example. You can agree or disagree about whether their fears are founded, and whether they have ulterior motives to unsettle the Yes campaign by being deliberately unconstructive, but the message here is that they are not prepared to share sovereign power in this way with an independent Scotland. And the Scottish Government/SNP/Scotland can't make them do that, either.

So even if a currency union is the SNP's preference, they can't just shout about the benefits of such a union (such as Scottish oil, drinks and renewable energy exports being positive to the balance of payments). They have to accept that such an arrangement is contingent on an agreement being reached, and to acknowledge that, in the absence of such an agreement, there has to be a contingency plan to facilitate an independence settlement, which does not depend upon Scotland being able to agree something substantial with the UK.

The alternatives to currency union

There are a number of options here, and they all need carefully considered.

1. Using the pound unilaterally

This isn't unprecedented: many countries use the US Dollar and the Euro unilaterally, for ease of trade with regional and/or global partners and because a local currency would be too weak and vulnerable to speculation. The drawbacks are that we would have zero control over monetary policy, which would be set by the rUK central bank, the Bank of England, and we would lack our own lender of last resort. This significantly limits the fiscal options that we can pursue in an independent Scotland, as we could not compensate with other "economic levers" (to borrow part of the SNP's popular narrative).

As a very superficial aside, such a situation would not protect "Scottish banknotes", as the right to issue those notes would depend upon rUK law surrounding the relationship between the Bank of England and those having the right to print currency. RBS, HBOS and Clydesdale might well continue their arrangements of depositing Bank of England notes in lieu of the notes they print for circulation in Scotland, but such an agreement is out of the hands of any independent Scotland's government.

2. Peg the Groat

Another option is to have our own currency, but to peg it to the pound, making it exchangeable at par. Some currencies already do this: for instance the Isle Of Man holds a large amount of Bank of England notes with its own central bank (as an indirect form of "reserve"), and issues the same amount of Manx notes. Note that this option also gives Scotland no real control over its monetary policy, thus by extension constrains its fiscal policy, as it has to maintain its reserve to notes ratio. The premise that we maintain something, perhaps called the (Scots) pound, freely exchangeable at par value with the currency used by the rUK part of the British isles, assumes that we constrain significant aspects of fiscal and monetary freedom, the very powers that are at the core of a lot of the "prosperity" arguments made by those in favour of independence. Denmark sort-of pegs its currency to the Euro, within a defined range, and relies on a mixed set of deposits in its central bank, that allow it to fluctuate minimally where circumstances require. This has the benefit of stability for economic planning, and encourages its economy to stay reasonably convergent with the Eurozone as a whole, but at the expense of full fiscal and monetary freedom.

3. Float the Groat

The final option is that we have our own currency and make no interim commitment to peg it to the pound. We would therefore have full control over our monetary and fiscal policy. The down-side to this is that currencies which float may prove a practical inhibitor to trade with the rest of the UK, as the volume of transactions might decrease a little.

In both the second and the third options, there would have to be some sort of transitional period facilitating the introduction of a new currency side-by-side. Some sort of fiscal controls would also have to be put in place during that period, in Scotland, to ensure that there isn't any capital flight. This, to my mind, is exactly what the period between the referendum and independence day should be for. Shadow institutions, including a central bank that holds deposits, whether of Bank of England notes, or another reserve (Scotland would be negotiating a pro-rata share of UK assets including value equal to reserves of (e.g.) gold kept in the Bank of England as security against the issue of GBP).

Since a division of assets will have to be agreed anyway in advance of independence, it seems to me to make more sense to sort-out the structural issues with the currency at that point, and to make sure that as few issues as possible require consent from a (reluctant) rUK negotiating team. It is clear they do not want a currency union, and all that having a currency union means is that if we change our mind later down the line we have to facilitate a transition to a different currency anyway. The Czechs and Slovaks found within a solitary month that their currency union was not viable, and had to decouple from one another as a result. You will probably find that the UK, if it didn't want to share a currency union, would seek to reduce the physical amount of reserves in the Bank of England, to prevent the value of the pound suddenly jumping as Bank of England notes fell out of circulation in Scotland. By presenting the issue as a question of simple asset division, it is less likely that rUK would object to Scotland claiming "its share" to set up its own currency.

Why you should give a damn

The bigger point here is that the SNP have tangled themselves up in knots over this issue. Their government is likely to be negotiating on Scotland's behalf in trying to settle these issues. We should be concerned that their attitude towards this is not to make clear their plan and their contingencies, and to spell out what "keeping the pound" actually means and what the alternatives would mean, rather to fall into the trap of lazy politicking about Better Together talking Scotland down. They have form for this type of siege mentality overriding what is in essence sensible policy.

Perhaps most importantly, their policy of currency union undermines some of the strongest economic arguments for independence. Far from giving us the fiscal levers to make our own decisions, a currency union shackles us to, if anything, more stringent fiscal demands than some proposals like DevoMax, where at least there would be in-built fiscal transfer mechanisms to cope with disparities. In a currency union in particular where one party would almost certainly court significantly disproportionate influence, the terms of the fiscal pact they'd have to agree would not be even that enjoyed by stable and strong Eurozone countries. And actually, a currency union expends more political capital than many of the practical alternatives. It probably makes sense to look to peg a new currency to the pound for a couple of years, to satisfy the markets that an independent Scotland would be fiscally trustworthy and therefore to facilitate a favourable environment in which bonds could be issued internationally. But we don't need a currency union to do that. We don't need a currency union to have a freely exchangeable currency at par to the rest of the Union. We can do this ourselves.

Stop being a fearty, Eck! Use all the fiscal levers.
We can do this ourselves. It's the most compelling message the independence camp has to articulate if it is to win. And the SNP are undermining it. Their approach to this question is half-baked and half-hearted. They are afraid of arguing the strongest case because they aren't confident enough in their own ability to argue that independence is about a break with the status quo. They want to make it look as similar to our way of life as it is now: all of the benefits but no squaring of the circle of how we get there. There are significant opportunities that accompany the risks of independence. But many won't believe us about the opportunities if we aren't completely transparent about the risks and what steps we plan to take to mitigate them.

The currency question won't stop people like me who have already decided they're voting yes from continuing to do so. What it will do, though, is cement perceptions that the case for independence is inadequately thought through, especially for neutrals and pro-union voices and particularly for those who have come to associate independence and the Yes campaign with "the SNP". This is one of a handful of situations where what the SNP believe matters for an independent Scotland is actually relevant to the wider debate. By having a half-hearted answer to this question, it creates a semblance of a regime which is a shambles. And for a party whose raison-d'etre is Scottish independence, not to have discussed these issues in detail and to have this information ready for the public is negligent. It suggests they don't know what they're talking about, and I don't trust them to play Scotland's hand at its strongest. Whether we like it or not, competence will play a part in swaying people's views in the referendum. Salmond's party's bluster on this can take them only so far.

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