Guest blogger Rob Rose writes on currency prospects for Scotland, in the event of a separation from the United Kingdom.
On the 18th September 2014 Scottish voters will be able to decide on a referendum on their independence. This is no small decision, in fact it is one of the biggest decisions in the history of Scotland and the United Kingdom (UK) as a whole. If the vote does go in favour of the Scottish National Party (SNP), where does that leave the Scottish economy and, more importantly, their currency?
Since the Treaty of Union in 1707, which created the UK, Scotland’s official currency has been Pound Sterling (the fourth most traded currency in the world). Any departure from the UK would, by default, leave Scotland without a currency and facing a need to arrange a (new) currency and fiscal policy for the newly created state.
Realistically there are four possible options; create their own currency, join the Euro or continue with Sterling either through a currency union or dollarisation. If Scotland chose the first option, they would need to raise a significant amount of debt in order to partition the share of UK national debt. A new central bank without any monetary policy experience would lead to substantial instability in the exchange rate and the likelihood of investments/savings flowing out of the country.
In regards to the Euro, as Scotland is no longer part of the UK, it will need to apply for European membership. As a result, Scotland will face two major hurdles to enter the European Union; fulfilment of numerous economic and political conditions known as the Copenhagen criteria as well as the agreement of each of the existing members. If it were to fulfil the conditions, the second hurdle may prove more problematic.
Even if the UK supported Scotland would all the members do so? For example would Spain accept Scotland at the risk of setting a precedent for Catalonia and Basque Country if they were to take a similar route? Others may also veto their membership due to the support Scotland would require in early years. If Scotland were able to go down the Euro route, they would need Euro lending/bailout to pay off their share of UK debt. Furthermore, due to Scotland’s size it would have limited influence on the monetary policy in EU, which possibly would entail pressure on Scottish fiscal policy and, therefore, put similar constraints on Scotland as are faced by other small Euro area countries.
The SNP favours a formal Sterling currency union with the UK. In the result of such a Union, the Bank of England would act as a common central bank to both countries. This would result in monetary policy removed from Scotland’s control and, as illustrated within the Euro zone, the scope for fiscal policy to respond in a crisis can be greatly limited. The lack of control of fiscal policy has been one of the main reasons for the UK’s reluctance of joining the Euro; therefore it is highly likely that constraints on economic and fiscal policy would be placed upon Scotland if a currency union were to take effect.
The SNP are proposing that Scotland buy a share of the Bank of England, and could appoint delegates to represent Scotland on the Monetary Policy Committee. This would mean the people of Britain giving up sovereignty in part over the Bank of England. Speaking at the launch of a Treasury report in Glasgow, George Osborne the Chancellor of the Exchequer asked: “Why would 58 million citizens give away some of their sovereignty over monetary and potentially other economic policy to 5 million people in another state?” John Swinney, the Scottish finance secretary countered “A sterling zone is also in the overwhelming economic interests of the rest of the UK every bit as much as it is in the interests of Scotland. An independent Scotland using the pound will mean Sterling’s balance of payments will be massively supported by Scotland’s huge assets, including North Sea oil and gas – which alone swelled the UK’s balance of payments by £40bn in 2011-12”
If a formal Sterling currency union cannot be agreed, an independent Scotland could simply adopt Sterling without a formal deal with the Bank of England, similar to Panama’s and Ecuador’s use of the US Dollar. This will allow The Bank of England to continue to operate with a focus on its formal area of responsibility without taking account of Scottish economic conditions and provide Scotland with a stable currency. However, it would leave an independent Scottish state with extremely limited control over its monetary policy and without a currency to call its own.
It is hard to see how Scotland’s economy could not become inherently weakened under independence; by joining the Euro, creating its own currency, the creation of a currency union or simply using Sterling without any deal will each create its own risk and or remove full control of its monetary policy. In the absence of a currency union, it is hard to see which way Scotland can go.
