Currency Pound for pound, it’s the defining issue

The economy has been the beating-heart issue of the entire referendum campaign.

At times it has been a dry trawl through areas which should only really excite dusty academics but, much like the 2008 financial crash was a tough beginner’s lesson in economics, people get how important this is.

How much money an independent Scotland could raise and spend, as well as how much money people would have in their pockets, are the two biggest issues facing most undecided voters. The stand-off over the pound means a definitive answer on this issue before polling day is not coming; instead voters are left to decide which set of politicians they trust more with their polar opposite assertions over a currency union.

The “pound in your pocket” remains a phrase that resonates today just as it did when Harold Wilson first excuse the pun coined it back in 1967.

The argument over what currency an independent Scotland would, or could, use has been one of the fiercest, dominating both of the TV debates between Better Together leader Alistair Darling and Yes campaign figurehead Alex Salmond.

But, despite the months of argument, we are not really any further forward.

When Chancellor George Osborne, his shadow Ed Balls and Lib Dem Chief Secretary to the Treasury Danny Alexander all lined up in February to rule out a currency union, Alex Salmond accused the Westminster parties of “bluff and bluster”.

The SNP claim that it’s not up to the Treasury, that the pound belongs to Scotland as much as England.

Scotland can use the pound (as Alistair Darling has belatedly conceded) but the more important question is not so much whether an independent Scotland keeps the pound but whether there’s a currency union.

That is where both sides sign up to an agreed set of rules on monetary policy and are bound by the decisions of an independent central bank, in practice the Bank of England in London.

Monetary policy means using interest rates on savings and loans in order to boost or cool down the economy.

Currency unions are generally accompanied by some level of political union, but this one would be arranged on the back of a political union breaking up.

When something similar was agreed between the Czech Republic and Slovakia following their split, the currency union lasted just 38 days instead of the six months planned. Part of the reason for this was that the markets don’t like uncertainty.

Similarly, the Treasury has rejected a currency union on the basis that the Scottish Government is not ruling out switching to another option in effect a new currency as the only other option, the euro, has been ruled out somewhere down the road if that suits it better (Salmond’s recent chat about “transition arrangements” will not ease those worries).

Scotland’s ability to make its own choices some might call it independence works against a currency union on other levels.

For example, any union would require one side to help the other out in times of trouble. The remaining UK would have the resources to rescue Scotland if need be but, should the City of London need to be bailed out, even if the Scottish economy had the wherewithal to step in, might a separate Scottish parliament decide the nation’s best interests are served by walking away?

Then there’s the banking sector overblown in the UK and way out of proportion as part of the Scottish economy. The Treasury cited that imbalance as another element in its decision to spike any plans for a currency union, though in truth the big banks switching their HQs to London would solve this (a move which banking sources admit would involve job losses but not wholesale transfer of operations).

The difference in size of the Scottish and UK economies is one of the big problems with any plan for a currency union. Even if, as the SNP suggest, Scotland were to get a seat on the Bank of England board that decides monetary policy, that representative would always be out-voted eight to one on the nine-person body if there was a difference of opinion on what’s best for the rest of the UK versus what’s best for Scotland.

Currently, the Bank of England has a duty to consider the welfare of the entire UK economy. But in practice there’s a suspicion it tailors policy to what’s best for London and the south-east of England. And what sort of independence would it be if Scotland’s interest rates were set in another country?

The SNP dress it up as pooling and sharing risk but privately admit they are willing to cede control over monetary policy in return for full control of the fiscal levers determining Scotland’s levels of tax and spending.

Trouble is, if they pull those levers too hard slashing corporation tax and airport passenger duty and spending on free childcare, for example London policy-makers might take fright.

One economist likened it to a marriage. “If the husband starts spending more and more on the shared credit card the wife might ask herself if she wants to keep a shared bank account.”

Salmond, under heavy fire from the No camp, has moved from a tub thumping “it’s our pound and we’re keeping it” approach to a more conciliatory tone, now seeking a “mandate” to get the best deal for Scotland on currency. But his problem with this mandate is it doesn’t cover the much larger partner he wants in this currency union, namely England and Wales.

So if a currency union is a non-starter, for political or economic reasons, what other options are there?

The SNP were committed to joining the euro. They are not now and that one seems totally off the table.

So-called sterlingisation using the pound but without the oversight of the Bank of England appears to be the SNP’s plan B (though Salmond offered three plan B’s in the last TV debate). But like all the options it carries problems.

Critics and supporters alike point to Panama that uses the US dollar without a currency union with America. But Panama is an insignificant fraction of the entire dollar area. Scotland would make up in the region of 10% of people using the pound yet would have no say at all in how monetary policy was drawn up, leaving it at the mercy of the markets and fluctuations in the economic weather.

That leaves one other option for an independence Scotland creating its own currency.

The currency would have no history which might mean Scotland would have to pay more to borrow on the international markets. That could be a problem in the short term with John Swinney admitting the new nation would need to borrow heavily to get set up and meet spending commitments aimed at kickstarting the economy. If it wasn’t pegged to the pound it could wreak economic havoc if there was an exchange rate between Scotland and the rest of the UK.

The flipside of that is the SNP argument for a currency union that it wouldn’t make sense for the UK to refuse to share the pound and put up barriers for its own businesses trading into Scotland.

Certainly to do so would run counter to the general direction of economic policy which is towards free trade. It would seem odd for the UK to be pushing hard for a trade deal between Europe and the US while putting up a barrier with its closest neighbour.

And the SNP claim that while the eurozone was undone by too many economies that were too divergent, the Scottish economy is so well aligned with the rest of the UK that a currency union would be as seamless and it is sensible.

There are valid arguments politically and economically both for and against setting up a currency union should Scotland vote for independence.

The trouble for the Yes campaign is that there already is one. It’s called the UK.