SNP’s sterling retention policy on thin ice

30 January 2014. In the first of a series of views ahead of the Scotland independence referendum vote I would first like to thank the Governor of the Bank of England, Mark Carney, for spelling out that currency union only works if you have fiscal and political union too! In other words, to take advantage of low borrowing costs to finance debt and benefit from low transactional costs that currency union with the rest of the UK requires, Scotland would also need to accept fiscal, economic and political union as well. Such notions are not exactly what the SNP’s leader and First Minister, Alex Salmond would like to hear. Even so, I doubt that he will be put off by the serious words of caution expressed by the Bank’s governor in respect to an independent Scotland retaining sterling as its currency.

There are surely more than enough lessons to be learned from the crisis that has left the ill-disciplined Euro currency union in the self induced coma that it now in. The ‘all that it takes’ money printing strategy of ECB chief Mario Draghi may have saved the Euro from complete collapse  but the Euro crisis is far from being over yet. Indeed, I suspect that the Euro will remain in intensive care until each and every cent of bail-out debt loaned to the likes of Greece, Portugal, Ireland, Cyprus and others has been paid back. The lesson from the Euro and for its future is loud and clear – currency union without political, economic, monetary and fiscal policy union does not work. The same would be true of an independent Scotland’s attempt to retain sterling and some sense of monetary union with the rest of the UK.

Now that Mr. Carney has let Scotland’s currency union plan out of the bottle it seems that the SNP’s policy of sterling retention is now all but dead in the water. Certainly it is a blow for the SNP as to see its key economic policy for independence lying in tatters. Scotland’s people are of course entitled to vote on the potential of moving away from the ‘Union’ but they must also now understand that if they do there can be no possibility of sterling retention unless they also accept political and economic union as well. That, should the vote go the way that the SNP would prefer to see, rather defeats the object! The status quo must remain because the risks are far too great for both sides in this debate; with no sensible or workable agreement on currency union between an independent Scotland and the rest of the UK possible without full political, fiscal and economic union as well it is difficult to see how a Sterling backed ‘independent’ Scotland would exist.

To put it another way; interest rate policy, taxation and the vast majority of public sector spending activity in an independent Scotland (which retained sterling) would need to be fully in-line with that of the rest of the UK. Interestingly in its research analysis published last year, the UK Government concluded that – in the event of the SNP winning the Scotland referendum – key UK institutions such as the Bank of England would continue to operate on behalf of the rest of the UK with no mandate to act in the interest of an independent Scottish state. Indeed, in the report ‘Scotland Analysis: Devolution and the implications for Scottish independence’ the conclusion was that there was no obligation to even create the structures necessary for an ‘independent’ Scotland.

As an independent country Scotland would rank in terms of GDP roughly similar to Portugal, Finland, Greece, Denmark, Ireland and about half the size of Norway, Sweden and Belgium. As a nation Scotland would need to borrow on international markets not only to fund the inherited level of debt that it would be forced to take on but to fund some of its more grandiose policy plans such as defence.

If Scotland was to be allowed to retain sterling it is clear that over time monetary policy set as necessary and required by the Bank of England would not only become less appropriate for Scotland itself, but the danger is that it could also have serious implications for the rest of the United Kingdom as well. It would be hard to imagine that over time institutional and policy divergence between Scotland and the rest of the United Kingdom would lead to a weakening of economic integration.

As one United Kingdom we are still a relatively strong economy and one that retains a strong voice in world affairs. Clearly as demonstrated by world economic events in the aftermath of the banking and financial market crisis, the UK is not immune to global trauma. But as one nation we are able, with strong Government, to absorb fluctuations and deliver relatively stable economic conditions. The UK may, along with many of its EU peers, be considered a mature economy but it is nonetheless a strong one that has ample opportunity. Economic stability is the foremost delivery point that Government provides to the nation – if it can; an independent Scotland would not in my view be able to deliver the kind of stability that, as a newly independent nation, its people deserve.

Given the clear difficulties and impracticability of the SNP’s current intention to retain sterling as its currency (and the short-term collapse if the alternative offered by the Euro) the risks to this path are enormous. Firstly I suspect that transactional costs would prove to be significant and that exchange rates would quickly be out of kilter and prove unacceptable. The cost of doing business would rise along with inflation as the rest of the world would probably question economic management and discipline. Enter the IMF no doubt but then having paid nothing in, Scotland may well be denied the sort of assistance that ECB and the IMF have provided to some members of the Euro-zone.

Of course, Scotland does have natural resources such as North Sea Oil and Gas and, despite these declining, they are still both highly prized and valuable. Scotland has some prized industries too such as those making ships for the Royal Navy and its massive involvement in the drinks industry. There are many other industries too and the investment in areas of new technology has not passed Scotland by. But are these enough to sustain the Scottish economy in the long-run and will they all remain beacons for investment when international markets start questioning the viability of the Scottish economic plan?

So we come back to where we started, noting that membership of any currency requires a unified monetary policy. It would mean that in the independent nation which the SNP would love to see interest rate policy would be set by someone else – someone in London. An independent Scotland could, as a result, find it very difficult to borrow let alone transact and there could, without formal economic, fiscal and political union with the rest of the UK, be a very heavy price for the people of Scotland to pay regarding; jobs, employment and future FDI. Monetary union might sound like a sensible idea but it just doesn’t work without economic, fiscal and political union.

Last but by no means least is the pain, cost and risk involved in creating the institutional framework required that will lead to the establishment of what the SNP would like to see in an independent Scotland. The risks are enormous and I fear the potential rewards are far too far away to be seen as likely to benefit Scotland’s population today.

Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
Tel: +44 7710 779785

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