Monday, 15 September 2014

Reasons to oppose Scottish independence, #9: currency craziness

The ninth and perhaps most important reason why 'Public Policy and the Past' would hope for a 'no' vote in Scotland's independence referendum is the crazy currency uncertainties that have been allowed to creep into the debate. Now we wouldn't have been quite so categorical as the UK government in saying 'Scotland can't keep the pound. That's it'. It depends what you mean by 'the pound', what kind of timeframe we're talking about, and how it's all organised. Still, the wilful ignorance that the Scottish Government in particular seems to be indulging in has been if anything even worse than this organised hard-man act - for it seems to be hell-bent on setting out on the worst possible course.

Any formal Currency Union (CU) between the remaining UK (rUK) and Scotland is very unlikely except as a short-term expedient to preserve confidence during a transitionary period. It's not just the two likely UK Chancellors (George Osborne and Ed Balls) who've ruled it out. That'd be one thing. Politicians can go back on their words. But the Bank of England and even the officials at the UK Treasury (not given to explicit political pronouncements) have also said that it's not a runner. Mark Carney, the Bank's Governor, would clearly have to resign if there was a CU imposed against his clear and explicit wishes. So would many top-ranking civil servants. They won't have to. It's not going to happen, for two simple reasons. First, a CU between a very large, relatively diversified economy such as rUK's and Scotland's much more specialised, petrol- and financial services-reliant business sector is just not going to happen. It would require London to fine-tune the rUK economy in far too dramatic and stop-start a way to be sustainable. Interest rates shooting up and down with the oil price and the constant demand that the Scottish Government cuts spending (see our last blog) is just not a situation that can be allowed to happen. On either side. Secondly, a CU would require an 'independent' Scotland to give all her powers straight back to a joint currency board - without Scottish Members of Parliament or Scottish staff in the Bank to look after her interests at a more humdrum day-to-day level. The country would have even less power than now - faced with a set of rUK decision-makers who, politically and economically, have absolutely no incentive to help them out.

So two options are left. The first is known technically as 'sterlingization' or the 'Panama option'. The second is a new Scottish currency. The first is very, very risky indeed, and just involves using sterling whatever the Bank of England says. It is possible - though the Scottish Government's own working groups on independence ruled it out. But it's fraught with nasty surprises. Once again, Scotland would have no power over its monetary fate. It would have no control over its own interest rates, and precious little opportunity to bring pressure to bear on the Bank of England to take account of its views. It would lack a central bank as Lender of Last Resort, and although London would probably step in if there was another banking crisis (as it did in Dublin), there's no guarantee of that. In the interim, Scotland would need to build up quite large reserves - of maybe £40bn to £50bn - to defend itself in the event of a crisis. Where would all that come from, when you can't print your own money and only maybe £4-5bn comes to you as your population-based share of the UK's reserves? Out of Scotland's public sector budgets, that's where - from nurses, doctors, teachers, lecturers, firefighters and the police.

All this is, by the way, the main reason why financial services companies such as banks are preparing to leave Edinburgh if there is a 'yes' vote - because, legally, they have to have recourse to a Lender of Last Resort, and a state has to have one anyway to get into the European Union. Sterlingization would be okay for a few months, a year or two at most, but Scotland would be far too exposed to the inevitable storms of international capitalism to make it stick year-in and year-out.

Which brings us to the likely outcome in a few year's time. The Scottish Government will set up Scotland's own central bank. It will issue its own currency and apply to join the Euro (which Scotland will probably have to do anyway if it's to get into the EU). This, too, is fraught with problems. The first is the inevitable devaluation and lower credit rating that a new currency will be subject to - 10% to 15% is likely. But that's not the worst part. Scotland's exporters would be rubbing their hands with glee, likely to do well out of a weaker currency. That would more than offset the transaction problems of dealing with rUK buyers and sellers. No. The problem would be the interest rate hikes that Scotland would have to impose to defend its new currency, all the steeper because the flight of banks and other finance institutions might have robbed her of up to 15% of her trade in the first place. The 'yes' camp always says 'yes, well, these are brass plate operations - the jobs won't move'. But the trade will. It'll be registered in rUK - forcing interest rates ever higher to attract capital and depress consumer spending, a necessary step to divert resources to desperately-required exports.

The main distraction here has been that Alistair Darling, the leader of the 'no' camp, allowed the phrase 'of course we could use the pound' to escape his lips during the second televised debate in late August. What he actually said was 'we could use any currency, even the ruble, but we wouldn't want to on these terms'. He was right. But from that moment, the Scottish National Party and its allies battened down the hatches, put their hands over their ears and said 'la la la, that's settled, can't hear you' and the like. Alex Salmond, Scotland's First Minister, says that 'we'll share the Bank of England', 'we'll both have the pound' and (in his more expansive moments) 'it's Scotland's pound'. Except it's not. It's not an asset. It's legally an institution of the continuing state, rUK, which can do what it likes with its monetary infrastructure if and when Scotland does actually leave. That's the harsh reality. Mr Salmond can threaten to default on Scotland's share of the UK's debts (actually, he seems to have been downplaying this recently), but it's not a bluff that can possibly be taken seriously. A new state can't default on its debts. It would be an act of financial self-harm unparalled in the developed world's recent history.

Mr Salmond wants to ignore all this. He wants to say that the currency issue has been answered. Except that it hasn't. It remains a real and present danger to Scotland's prosperity.

It is not the least of Mr Salmond's many blunders during these long debates that he has not been frank about this from the start. The 'no' camp's official campaign has been rightly denigrated, focused on saying 'no you can't' do this that and the other from the start. Complacently not organising on the ground until it was nearly too late. Losing lots of the set-piece debates on television. But Yes Scotland has made a series of own goals as well. Had the 'yes' campaigners said from the beginning that 'we're (eventually) going to have our own currency', and/ or accepted that this was but a stage on the way into the Euro, then this blog - and many other commentators - would have had much less problem with their entire case. But they couldn't and wouldn't say that, because they knew the Euro was unpopular. So they've got themselves in a mess. If they win on Thursday, they'll have got all Scots - and their mortgages, savings, shareholdings and jobs - in a similar tangle.

The fog of battle will take some time to lift, but when it does after a 'yes' vote we'll witness many years of hardship for the Scottish public sector, burdened by a lower credit rating, budget cuts to reassure investors, the requirement to build up a big foreign exchange reserve and the need to make space for export earnings that have in some cases fled south to Newcastle and London. That's why Nobel Laureate (and favoured lefty) Paul Krugman has begged Scots to vote 'no', in their own best interests: because the network of efficient, well-funded public services on which their successful economy has increasingly come to rest might be threatened in the inevitable chaos. The 'upward spiral' of Scandinavian-style Nordic welfare capitalism, which depends on just such high-quality public goods to bring together different interest groups and businesses - encouraging them increasingly to co-operate with and trust one another - will be critically imperilled at the very birth of the new state. Many years might pass before an opportunity comes along to glue them back together.

Scotland can 'keep the pound'. It's just that there'll be fewer of them to go around - and that the bitter realisation of the 'yes' camp's false prospectus will darkly colour and infect the first independent years of a divided people.

With this, the analytical and factual case rests. We hope that we have, respectfully but decisively, dissected most of the 'yes' camp's claims. Next time: the emotional case for the Union. Stay tuned.