Why Scotland should reject the Sterlingisation option and instead create its own currency
The Sustainable Growth Commission’s report is out and opens up a platform for healthy debate around Scottish independence. The report argues that Scotland is best to stay within an unofficial currency union with the rest of the UK, also labelled Sterlingisation. This gives Scotland’s monetary sovereignty to the Bank of England, which is effectively controlled by Westminster.
From the view of a Modern Monetary Theorist this makes very little sense. Therefore I would like to make the case as to why Scotland should reject the Sterlingisation option and instead create its own currency.
If Scotland were to become a monetary sovereign nation then it cannot go bankrupt in regards to its own currency. How can they when they are the monopoly supplier and own most of their debt? The debt and deficit are irrelevant to the issuer’s ability to service that debt, provided it is denominated in its own currency. For monetary sovereign countries we do not see many investors increasing yields to compensate that specific risk.
Take the example of Japan. Japan’s debt stands at one quadrillion Yen, yet because it owns most of the debt it has low interest rates, low yields, low inflation, increasing employment and healthy demand for bonds. The ability to control interest rates and the money supply is absolutely vital. It means we can better tackle debt interest payment and control inflation.
By giving up monetary sovereignty to the rUK post-independence we open ourselves to real bankruptcy and a liquidity crisis. That sort of scenario is what will push investors to increase yields, whilst others may be hesitant to purchase government bonds.
The Growth Commissions also recommends that Scotland follows the EU’s Growth and Stability Pact, which limits government deficits at 3% of GDP and debt at 50% of GDP. But there is no need to follow this rule, because it is in fact not enforced for non-Euro countries. It is a recommendation. Countries outside the Eurozone who break the pact face little to no backlash. The UK has broken the Growth and Stability Pact numerous times.
So why limit ourselves to only a 3% deficit spending and 50% debt levels to GDP? The real constraint for a monetary sovereign country is the real economy. We can’t spend beyond our labour or resources, because then we create real inflation.
What if Scotland has a large trade deficit? If we have a trade deficit above 3% of GDP or supply is greater than demand then we need to have increased levels of government spending to make up for the shortfall. This is to make up for the outflow of our currency or to get consumers spending.
If we do not have the fiscal flexibility to spend, in order to balance the real economy, then consumers will begin to build up levels of private debt. Individuals cannot own their own debt the same way governments can. Increasing private debt leads to recessions.
If an independent Scotland does not have an independent central bank then it will struggle to join the EU, which is made clear in Chapter 17 of the Aquis Communinitaire. For new EU members it states “economic and monetary policy contains specific rules requiring the independence of central banks in Member States”. Sterlingisation also means we cannot use monetary levers for price stability, since we are not a monetary sovereign country. Scotland could ask the BoE to negotiate on our behalf. But the BoE is essentially owned by the UK Government. The UK is just leaving the EU. This lacks credibility ane makes joining the EU politically tricky.
But Scotland have its own central bank with a floating exchange rate, as suggested by Nobel Prize winning economist Joseph Stiglitz. The fluctuations within the UK economy can be damaging to Scotland, but floating our currency will reflect our productivity and domestic costs, whilst giving us the central bank we need.
Many point out that mortgages/liabilities are held in sterling, therefore Sterlingisation makes more sense. But legislation is already in place to deal with these difficulties, such as the EU Mortgage Credit Directive. Under this legislation mortgage lenders would have to offer mechanisms to protect borrowers against exchange rate risk up to (and including) giving them the right to redenominate a foreign currency mortgage into the currency of their country of residence or of their income.
The EU Mortgage Credit Directive is baked into UK law, and would presumably be carried into Scots Law. Scottish residents would have the right to have their mortgages converted into the new currency for an independent Scotland or some other forex risk protection would be applied.
The Growth Commission puts forward the question “Would a separate currency meet the on-going needs of Scottish residents and businesses for stability and continuity of their financial arrangements and command wide support?”
The answer is yes.
Various forms of tax, that need to be paid in a new currency, create demand as businesses and households must accumulate the new currency. You can also use a Job Guarantee programme to maximise idle resources and labour, increasing our productivity and the value of the economy.
What about foreign exchange reserves? This really depends on how large we want out reserves to be. If we want to copy the UK at around 5% of GDP then we could take our fair share of the UK’s foreign reserves (£11-14bn). That covers the £10bn cost. Unionists would struggle to complain; after all they do see Scotland as a mini-UK, right? The think tank Common Weal has also produced their own paper as to how Scotland can accumulate a larger foreign exchange reserve beyond 5% of GDP. I highly recommend political activists add it to their reading list.
If we wish to move away from the UK neoliberal paradigm, with increasing levels of private debt within a credit bubble, then certainly there is an even greater case for Scotland to be a monetary sovereign country.