The Currency Question
As the currency debate dominated the 2014 Indyref and it is neither feasible nor desirable to opt for a currency union based on pound sterling, I have outlined a few basic questions and answers on why an independent currency is the best option for #Scotref.
Why should Scotland adopt a new currency after independence?
An independent currency allows Scotland to have more control over its economy. This means more control over what the Scottish government can spend on and invest in. It means the ability to better deal with changes in how much Scotland buys from and sells to the rest of the world. It would also allow Scotland to set the interest rate that is most suitable for the Scottish economy. This would also give Scotland more control over what type of economy it wants to have. Controlling your own currency also allows you decide how to deal with global economic problems like the banking crisis of 2008. An independent currency would allow Scotland to respond to such events in the way that is best for Scotland, it would free Scotland to pursue the policies it deemed most appropriate, an example is People’s Quantitative Easing.
Why not the Pound?
The simple point is that the best monetary arrangement is one government making spending decisions for one currency zone. The pound would mean that interest rate decisions would be made for Scotland in a post-Brexit rUK with potentially a very different economic strategy. Not controlling your currency can strongly damage your exporting businesses and put you at a disadvantage when trying to attract foreign investment.
Why not the Euro?
The same problems apply to the Euro only more so. The problems of the Eurozone are in large part because it is one currency that needs to deal with lots of governments making different spending decisions. This has worked well for some countries such as Germany, less so for others such as Italy and Greece. The reason there was never a “dollar-zone” crisis in the US, also a large block of differing regions under one currency is that in the US the Federal Government redistributes from surplus states to deficit states. This stopped the type of situation happening whereby, for example, Alabama would have to negotiate a bailout from California. There’s a very good argument to say that the euro will eventually either have to be split up or become even further integrated under one European budget authority that redistributes from surplus countries to deficit countries, just as the US Federal Government does with the states, if the present economic problems of the Eurozone are to be confronted.
How do you create a new currency?
There are many ways of going about this, but in principle it is a relatively simple process. A new Central Bank of Scotland would have to be established that would regulate the new currency and supervise the Scottish banking system. As Scotland already has different banknotes, it’s really a simple matter of legal decree to change those from being pound sterling to being a new currency that’s “pegged” to the pound. This would also apply to all contracts and debts falling under the jurisdiction of the Scottish government that had originally been denominated in sterling.
A “peg” is where the central bank would act in the financial markets to ensure the new currency would remain at a 1:1 exchange rate with sterling. This could be done unilaterally by the Scottish central bank, but it would be mutually advantageous for the Bank of England to collaborate with this as part of the independence settlement as financial stability is part of its’ mandate. Many countries already keep their currencies pegged to other currencies, most commonly the dollar or the euro. The pounds in your pocket are basically just debt that the Bank of England owes you. A banknote is just a “promise to pay” or an IOU. The argument could easily be made that when it comes to independence, if Scotland must accept a portion of the sovereign debt of the UK, then it is only logical that this means Scotland is entitled to a similar portion of the debt of the UK central bank (The Bank of England), which is Scotland’s share of the money supply.
This process would mean that there would be no immediate disruption from creating a new currency. Scottish pounds would simply be considered a different currency on a 1:1 exchange rate with the rUK pound. There would be the same interest rates and the same foreign exchange value with other currencies. Eventually as the Scottish and UK governments started to follow different economic strategies this peg could be cut and the two currencies would be free to have different values and different interest rates. There are benefits and drawbacks to both a low value and a high value currency in terms of foreign exchange. The peg should be considered as a transitional arrangement, pegs can have negative economic impacts in the long run and an independent free-floating currency is the best option for a country that is pursuing its’ own unique economic strategy.
What if the new currency falls in value?
This is a good thing for any Scottish business that plans to sell to the rest of the world. All around the world whisky and salmon will become cheaper and oil revenues will be worth more domestically. It will make imports and holidays more expensive. It would also negatively impact Scotland’s financial services industry.
What if the new currency rises in value?
This will make imports and traveling abroad cheaper. It is also good for Scotland’s financial services sector. It is bad for any business that wants to sell to the rest of the world as Scottish goods would become more expensive abroad.
What about Scottish Government debt?
It makes far more sense for a government to control the currency it’s debt is denominated in. Controlling your own currency means that in the strict sense your government can never run out of money. There are other constraints on what a government can choose to spend on however, but it is generally true that an independent currency places a country in the best position to deal with this. Also it is important to note that most of the economic problems we face are caused by private sector debt. In this case, having higher levels of government debt is actually desirable because it allows the private sector to pay down its’ debt and because, unlike the private sector, the government can draw on its own bank to create more money when necessary, there are fewer risks associated with government debt than with private debt.
Would Scotland face higher borrowing costs?
There is no way of knowing this for certain. Because of the actions of central banks all over the world since the Financial Crisis, governments in the developed world which control their own currencies have faced historically low borrowing costs. Scotland’s borrowing costs would reflect investor sentiments on the strength of the Scottish economy and would merely be another incentive to implement a robust and sustainable economic development strategy. The debt of a government that issues its own currency from its own central bank is in general considered the safest asset class as a central bank cannot run out of its own currency.
How much does government debt matter?
The issue of government debt is one of the most widely misunderstood political or economic ideas in public discourse. Government spending is one source from which money comes in the first place and in general the purpose of taxation is not to actually finance the government as such but to control the currency. There is also a very important economic fact that comes from simple rules of accounting: if the government is not running up debt and there is an export deficit then the private sector has to be going deeper into debt. We should view government borrowing in a more positive way in our present times of historically high levels of private debt such as mortgages and business debt. If the government were to attempt to “balance its’ budget” in these conditions it would cause a crisis for the private sector, unless it somehow managed to boost its’ exports by stupendous and unfeasible proportions.