The big issue, pound for pound

The future of the ‘cash in our sporrans’ is proving to be one of the biggest questions of the referendum debate

‘The pound in your pocket’ remains a phrase that resonates 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, have has been one of the fiercest. And it’s had the most obvious effect on the polls.

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 it had an inevitable impact. Scots who don’t like being told what they can and can’t do flocked to the Yes camp in new numbers.

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.

Which is kind of true. Scotland can use the pound come what may.

The important question is not so much whether an independent Scotland keeps the pound but whether there’s a currency union that is 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 and the supply of money in order to boost or cool the economy.

Currency unions are generally accompanied by political union … 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 the euro or its own currency somewhere down the road if that suits it better.

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 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.

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 outvoted 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.”

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.

Over the last few years the fate of the euro has not been a great advert for currency unions. When some countries couldn’t meet the conditions of being in the club the whole edifice threatened to come down.

The danger of countries exiting the euro seems to have passed and new states are joining up again. Latvia started using euros this year.

So-called sterlingisation using the pound but without the oversight of the Bank of England appears to be the SNP’s plan B. 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. Which leaves another option Scotland creating its own currency.

At a recent seminar of expert economists all favoured this option, as it would give Scotland full control of its own monetary and fiscal policy.

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.

But the markets aren’t terribly interested in economic history, they are interested in whether something works. And with oil and gas to back it up a new Scottish currency would probably quickly be established as durable.

Yes Scotland chairman Dennis Canavan and the Scottish Green Party favour a separate Scottish currency. Why doesn’t the Scottish Government?

First, because it’s a harder political sell. With most Scots still to be convinced of the benefits of independence according to the polls, asking them to go through the hassle of binning their pounds and pence for a Scottish groat is not going to go down well.

Second, it would wreak economic havoc if there was an exchange rate between Scotland and the rest of the UK. The rest of the UK remains Scotland’s biggest export market, so it does not make sense to create extra expense through exchange rates that could make Scots goods more expensive everywhere.

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.