Thursday, 11 September 2014

No independence of Scotland with the pound

No independence of Scotland with the pound

The desire of a nation to be independent is eminently respectable. If the Scots decide in a referendum to make the step towards independence, there is very little an outsider like me can object to. What is surprising to me is that the proponents of the Yes vote attach to their desire for independence a desire to keep the pound as the currency for their future nation. Surely, as anybody who has studied the functioning of monetary unions will tell, the maintenance of the pound will severely limit the independence of the new Scottish nation.
Why is this? When the future Scottish government will issue bonds (as all governments of independent nations do) it will do this in pound sterling. But this will be a currency over which the Scottish government will have no control. For all practical purposes the pound will be like a foreign currency from the point of view of the Scottish government.
The implication is far-reaching. It means that the Scottish government will not be able to give an ironclad guarantee to its bondholders that the cash (pounds) will always be there to pay them out at maturity.  As a result, when the Scottish economy experiences bad times and the Scottish government budget deteriorates, the fragility of this arrangement will become manifest. Distrust and even fear may be set in motion in financial markets leading to large-scale sales of Scottish government bonds precipitating a liquidity crisis.
Is this a far-fetched scenario? This is exactly what happened in countries like Ireland, Portugal, Spain, Greece; all countries, member of the Eurozone, that have given up their monetary sovereignty and have taken over a currency over which they have no control.
The core of the problem of these countries and of the future Scotland is the absence of a lender of last resort in the government bond market. The Scottish government will not be backed by a central bank that can be forced to provide unlimited amount of liquidity support in times of crisis. Therefore it will not be able to give a guarantee to bondholders that the cash will always be there to pay them out at maturity.
The British government enjoys such a backstop. It can and it will force the Bank of England to provide the support in times of crisis. The Scottish government will lack this power. As a result its power as a sovereign nation will be limited. It is surprising that the proponents of Scottish independence are so much insisting on creating a nation with limited independence.
How limited this independence will be can be gauged from what happened to “independent” nations of the Eurozone. We have seen that when these countries where hit by deep recessions and resulting budgetary deficits, the liquidity support that was provided by the other member-countries was highly conditional. The “Troika” (i.e. a group of foreigners) travelled to the countries in question (Ireland, Portugal, Greece) and dictated the terms under which liquidity support would be given. These terms were so intrusive that it is no exaggeration to say that these countries lost much of their sovereignty in the process.
If Scotland becomes independent and keeps the pound it could negotiate the terms under which it will obtain the support of the Bank of England in times of crisis. But these terms will necessarily involve budgetary rules dictated by Westminster, pretty much like the member-countries of the Eurozone have to accept these budgetary rules set in Brussels.

Why the proponents of Scottish independence want to subject themselves to Westminster rule is a mystery to me. True independence for Scotland can only be reached if that country creates its own money. In the absence of monetary independence, Scotland will remain the slave of somebody else. Westminster if it choses the pound; Brussels and Frankfurt if it choses the euro. 


  1. I think that Salmond & Co are forced to say that they will keep the pound because they are afraid of massive capital outflows from Scotland to England and other foreign countries. In fact it is reasonable to think that a Scottish currency would be expected to be weaker than the English pound. This means that everybody holding liquidity in Scotland would prefer to move their money abroad to gain over a weaker Scottish currency in case of independence.
    Eventually, after a "yes" vote, Salmond would indeed announce that Scotland will have its own currency to be completely free. Could this be the case?

  2. It's kind of a moot point. I don't think Scotland will get its currency union. Not if the UK politicians involved value their careers.

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