Salmond's rate of exchange

Douglas Fraser
Business and economy editor, Scotland

  • Published
euro coin and £10 noteImage source, Getty Images
Image caption,
The SNP has said Scotland would retain sterling until such time as Scots choose to join the euro

If there's one issue that's causing Alex Salmond more difficulty than any other as he builds the case for independence, it's Scotland's currency.

Which banknotes would Scots be using if they voted for independence? And linked to that, what implications would there be for fiscal and monetary policy?

He had to concede yesterday that an independent Scotland using sterling would have to look to the Bank of England to act as 'lender of last resort', if its banks got themselves into another crisis and credit dried up.

The answer to the currency question goes to the heart of what independence really means, because the lesson from the eurozone crisis is that sharing a currency means compromising, co-ordinating and losing independence, rather than gaining it.

The SNP's answer so far is that Scotland would retain the pound sterling, until such time as Scots choose, in a referendum, to join the euro.

Currency options

That's been the position for years, since the days when the euro seemed attractive to this trading nation, when a referendum seemed something that would follow before too long.

But of course, joining the euro looks rather unattractive right now. And if the crisis is to be resolved, it'll be by more fiscal and monetary integration of its members. So it's going to become much more unattractive to the brave hearts for genuine independence.

The first minister has been strangely silent about the implications of the eurozone crisis. Perhaps he'll have more to say today with his latest consultation on independence.

So what are the currency options?

A couple of weeks ago, there was a stushie about the Chancellor, George Osborne, raising the question of whether an independent Scottish could use the pound sterling.

It was a nonsense. He didn't raise that question. He simply refused to answer it, the way politicians tend to do, preferring to question how attractive euro membership would be to Scotland.

It's also a nonsense to think that the Treasury could stop Scots using the pound. Westminster could hardly stop Scottish companies, or any others, accounting in sterling.

And to stop pounds circulating in Scotland, the RUK (rest of the UK) would have to shake down anyone crossing the border into Scotland, or the rest of Europe, to ensure it can't make it into Scotland. At the risk of under-statement, that seems a bit unlikely.

Robust co-ordination

The question, then, is whether sterling would be used in Scotland without any say over the RUK pound, or if a currency settlement would have to be agreed between an independent Scotland and the RUK.

If the latter - similar to Latin American countries that use the US dollar, without having any power over the US Fed's policy - Scotland would simply have to take whatever monetary policy was laid down at the Treasury and Bank of England in London.

If a deal were sought with the RUK, it would be a small version of the euro common currency. And what we're learning from the crisis is that there have to be robust systems for co-ordinating fiscal and monetary policy.

Think through that negotiation on fiscal and monetary limits between an independent Scotland's finance minister and the Chancellor of the Exchequer. It's not just about setting up the rules of engagement at the outset, but a permanent process of co-ordination - or of conflict.

The deal-making would put a limit on each partners' borrowing limits, and the deficits they're allowed to run up. It would mean limits on how much money could be printed, and it's hard to see Scottish banknotes continuing to hold the same value as Bank of England ones.

So what do you think: would the London or the Edinburgh minister have the stronger negotiating position?

London or Frankfurt?

The same issues are raised by the prospect of an independent Scotland's membership of the euro. If the euro survives, not only will the new, improved regime require much tighter co-ordination, probably including approval in Brussels of each members' budget plans and oversight of how well they're being implemented, but the signs are there of closer integration of tax regimes.

If the Germans get their way, that would remove Ireland's advantage of attracting business with a lower corporation tax. And it could block an independent Scotland from even starting to cut business tax, as the SNP says it would like to do.

Then, who decides on monetary policy? The European Central Bank sits in Frankfurt, and looks to the interests of 17 member state economies which, as we've learned the hard way, are anything but convergent. How big a voice would an independent Scotland have in that forum? More or less than it would with the Bank of England?

So, given these challenging questions about sterling and with the euro, what about Scotland creating its own currency?

I'm told it's an option that's being kept in reserve, even if the SNP leadership is not talking about it.

It certainly has its attractions for those who argue for independence. There must be a good reason why Norway, Sweden, Denmark and Iceland have stuck with their own currencies.

But it's hardly an easy option, particularly for a new nation setting up a new currency - either something entirely new (say, the Scottish groat) or more likely, a Scottish pound with a guarantee from Scotland's government and central bank that it will keep parity with the RUK pound.

Scotland and Slovakia

It would require all the hard infrastructure of setting up a central bank, of building up reserves, or negotiating with the Bank of England to get a share of the UK's reserves.

But more significant, it would require the soft infrastructure of a credit rating, building up credibility with the bond markets. The Financial Times' Lex Column reckoned Scotland could start in a similar position to Slovakia, given its population and fiscal position, which would mean a lower credit rating than the UK, and a 4.5% yield on 10-year bonds, compared with the UK's 2%. That would mean more than doubling borrowing costs.

But it can be argued that Scotland's oil and gas reserves could put it in a stronger position. That's if Scotland were generating consistent surpluses with oil continuing into the foreseeable future. Neither is true.

To demonstrate its fiscal and monetary discipline, and in the interests of trading stability, an independent Scotland would almost certainly have to set a course of pegging the currency to another, larger one, so that businesses operating across boundaries could have some predictability in pricing.

Without that stability in its links to sterling, the euro or even the dollar, it would mean high transaction and hedging costs for business. And of course, pegging your currency to another - as Britain found out to its cost in 1992 - forces some unwelcome disciplines, and some heavy costs of keeping it there if economies are diverging.

This isn't just an economic question. It is, of course, highly political. It makes sense for Alex Salmond to reassure Scottish voters that the pound is secure in their pockets.

Telling Scots they're going to have to exchange their pounds and earnings for another currency - while their debts would remain denominated in sterling - introduces an element of uncertainty that looks quite a hard sell.