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Scottish Independence Debate / Independence: new currency is best option

Tony Mackay.

The post referendum currency debate took a new twist at the weekend when an as-yet unidentified UK minister claimed Westminster was bluffing when it said an independent Scotland would not be allowed to share the £ sterling with the rest of the country.

Here Inverness-based economist Tony Mackay sets out his views on the currency debate, which are very different from those we have heard from Edinburgh or London.

The debate about what currency Scotland should have if the country votes for independence in the forthcoming referendum has intensified over the last few weeks. Unfortunately there has been much more “heat than light”.

There are three basic options:

  • retain the pound sterling (£)
  • join the euro (€)
  • establish a new currency.

The SNP government’s preferred option is the first of those, namely retaining the £. However, in the recent past their preference was to join the €. That changed because of the problems in the Eurozone area, which are still ongoing.

The recent developments included a strong statement from George Osborne, the Chancellor of the Exchequer, that the UK government would not agree to Scotland continuing to use the £ if we vote for independence.

His views were supported by the leaders of the Labour and Liberal Democratic parties, and also, in a milder form, by Mark Carney, the new governor of the Bank of England.

Others to express their opposition recently to the SNP’s plans include George Soros, the billionaire investor, who made a fortune by selling sterling on “Black Wednesday”.

I write a monthly column on the likely economic implications of Scottish independence for the Executive magazine, a business magazine for the Highlands and Islands. A few months ago I wrote about the currency issue.

Various businessmen, local MSPs and other people have told me that it was the most sensible article they have read on the issue. However, it was only about 650 words, so that limited what I could say. Some of it is reproduced below.

The SNP government has a high profile Fiscal Commission Working Group. It is made up of two well-known economists who have won Nobel prizes – Joseph Stiglitz and Sir Jim Mirrlees – plus Professors Andrew Hughes-Hallett (St Andrews University) and Frances Ruane, and chairman Crawford Beveridge, a former chief executive of Scottish Enterprise.

This group recommended the £ option. I am probably one of very few people to have read their report in detail and also subsequent papers.

The Working Group’s report is surprisingly poor. I find it hard to believe that distinguished economists such as Professors Stiglitz and Mirrlees contributed anything to it.

My contacts in the Scottish government are very embarrassed by the poor quality of the report and, more importantly, by the consequent decision to opt for continuing to use the £ rather than establishing a new currency. They fear that may backfire politically.

The currency we would use in an independent Scotland is an important issue. At the present time we use the pound sterling (£), the UK currency. Most countries in the European Union (EU) use the euro (€).

The SNP’s original proposal was for the euro. However, that would depend on Scotland being accepted as a member of the EU, which would not be automatic.

In any case, the SNP have backtracked on using the €, partly because of the recent financial and economic problems in the euro area. I used to be a strong supporter of euro membership, but as an economist I have been forced to change my opinions over the last few years.

The United States have a common currency, which seems to have worked very well. That is not the case with the euro. It is clear from the last few years’ experience that membership has benefitted the stronger economies, notably Germany, but disadvantaged the weaker ones, such as Greece and Spain.

There are many reasons for that but the main one is the inability of the weaker countries to use monetary policies to counter the competitive strengths of the likes of Germany. In the old days, devaluation of the local currency was often used to do that, but that is not possible within the euro.

The second option for an independent Scotland is to retain the £. That would require an agreement with England and the other UK countries, which may not be forthcoming, as recent events suggest.

Nevertheless, I believe that this would be a second best option. The Scottish government would have no control over the exchange rate of sterling, nor key monetary policy tools such as interest rates. In good times, there might be no problems but in difficult times there would definitely be.

The sterling exchange rate is very important for businesses in Scotland, particularly for exporters. The tourism industry is also heavily affected by the external value of the £ because it influences the numbers of overseas visitors.

The Bank of England mainly determines interest rates with most commercial rates being linked to the bank’s base rate. An independent Scotland using the £ would therefore have no control over them.

The SNP’s Fiscal Commission Working Group “glossed over” the problems of continuing to use the £, presumably for political reasons.

The third option of a new currency – such as the groat – seems to me to be the best option. Most countries have their own currencies and arrangements such as the € are unusual. A good example is Norway, which has a very strong currency in the kroner.

An independent Scotland should have a strong currency to begin with, because of North Sea oil revenues. However, as those revenues decline, which I expect to happen after 2017, the currency would inevitably weaken. That implies increases in import prices and higher inflation.

The groat would be a very small currency compared with the likes of the $ and €, and therefore susceptible to big fluctuations in the exchange rate. Nevertheless, many countries of a similar size to Scotland have to cope with these issues. An option would be to peg the groat to the $ or € but most economists now believe that is not a sensible policy and that allowing a currency to float is better.

The choice of the best currency for an independent Scotland would be a very important decision. It is also a difficult one and I have been disappointed by the quality of the debate on this issue so far. It needs to be much better over the next few months if a sensible decision is to be taken.