Salmond v. Darling

[Sam Slater]

Just read this post on the Guardian comments section regarding the currency issue. A great post:

---------------------------------------------------------------

You've got to sympathise to an extent with Salmond's problem: that when it comes to currency for an independent Scotland, there really is no good option. Recent experience in the eurozone has already demonstrated that currency union without political union is unworkable, and that's why the UK government has taken it off the table. Similarly no-one is seriously suggesting the euro, once the SNP's favoured option, as a desirable or realistic option. You hear some people suggest a separate Scottish currency, which would at least permit control over monetary and fiscal policy.

But let me break down the reasons a Scottish currency isn't being discussed seriously:

The first thing you have to understand is that an independent Scotland wants trade and investment. In particular, it wants to attract foreign investment in Scottish industry and to export more than it imports. Potential investors and buyers of Scottish exports are put off by two things: expense and risk.

If a currency is strong, that means Scottish products are more expensive to import and investment is more expensive; if it is weak, they are cheaper. If a currency is volatile, this makes investment and trade more risky. There are several reasons to suppose that a freely floating Scottish currency would be both excessively strong and particularly volatile:
One is that new currencies are always relatively volatile.

The other is oil. The demand for a country's currency is derived from the demand for the goods and services that country sells, and by the attractiveness of investment opportunities there. The exchange rates of the currencies of small countries in which exports of natural resources (usually oil) dominate the balance of payments, as Scotland would be, closely match changes in the demand for that export. These are sometimes known as petrocurrencies.

Because of the demand for oil, a Scottish currency would be very strong. This would be bad news for exporters, e.g. of agricultural produce and whisky, whose products would be much more expensive abroad as a result. Investment would also suffer for the same reason. This phenomenon is known as Dutch disease after the stagnation of Dutch industry following the discovery of natural gas there.

Also because of the demand for oil, a Scottish currency would be volatile. This is because the price of oil itself is very volatile.

The currencies of large countries, like the UK, are not as susceptible to these problems. The demand for oil, significant as it may be, doesn't affect the strength of sterling nearly as much as it would a Scottish currency. Neither does the volatility of oil prices affect the stability of sterling nearly as much, in part (again) because demand for oil is a much smaller component of overall demand, and partly because the risks are partly diversified away against a much larger and more diverse industrial base.

The option of pegging a Scottish currency to the pound (or euro, etc.) isn't attractive either. The volatility of oil revenues could force the Scottish government/central bank to intervene, for which massive currency reserves would be required. An independent Scotland would not be able to defend the peg against speculators for long.

Think of the recurring balance of payments crises under the Bretton Woods system, the 1997/1998 financial crises in Thailand, Indonesia, Singapore, the Philippines, Malaysia (and others to a lesser degree) and the eurozone crises in Greece, Spain, Italy, Ireland and Spain: all in small to medium economies which tried to maintain a currency peg or currency unions without political union.

A currency peg or currency union without political union would, sooner or later, lead to a Scottish financial crisis, and before long, an austerity programme would be imposed by the UK, the IMF, or both, as in Greece's Troika of the IMF, the European Commission and the ECB.

It seems therefore, that an independent Scotland would end up sliding into the unsatisfactory Sterlingisation option, in which the Bank of England would set monetary policy without regard for Scotland's macroeconomic situation. There's a deep irony to the Sterlingisation option too, that hasn't been picked up on yet: that the Scottish commercial banks, currently permitted to issue their own distinctively Scottish banknotes, would surely lose that privilege, so that a newly independent Scotland would likely see Robert the Bruce, Sir Walter Scott, Robert Burns and the rest disappear from its banknotes.

----------------------------------------------------------