Currency for Scotland

The Initial spat between the politicians based in Westminster, (aka the United Kingdom Parliament) and those in Scotland, has been over the issue of what the currency will be used by an independent Scotland.

http://www.bbc.co.uk/news/uk-scotland-scotland-politics-26251277

The arguments have varied, but a considerable of name calling has taken place.

As I understand the situation to be going forward, an independent Scotland will need to have a currency. So far so logical. The question is what should that currency be. The basic options are:

1. Retain the Pound Sterling and the services of the Bank of England
2. Create a New Scottish Currency and a New Scottish Central Bank
3. Join some other currency such as the Euro and the associated infrastructure
4. Utilise some currency without formal agreement of the “owner”

 

Retain the Pound Sterling and the services of the Bank of England

This is easily perceived to be the simplest solution. There is no need to change any of the current arrangements and everyone is already familiar with the currency. There are pros and cons against this both for Scotland and also the Rest of the United Kingdom (rUK – abbreviation borrowed from the Economist).

		Scotland	Rest of the United Kingdom (rUK)
Pros		Internationally Known currency No Cost for design and production of own currency Simplifies details of negotiations with rUK No Foreign exchange risk when dealing with rUK. No need to reconfigure vending machines to utilise new coinage/notes No need to establish a nominal exchange rate between Scotland’s currency and the Pound Sterling Initially benefit from the UK Credit Rating No Need to set up a “Central Bank of Scotland” and its associated capital requirements	Simplifies details of negotiations with rUK No Foreign exchange risk when dealing with Scotland.
Cons		Minimal / no Control over currency and interest rates No perception of Independence	Bank of England (rUK) acting as Lender of Last resort to Scotland Minting and paying cost for distributing currency to Scotland.

 

 

On initial analysis, and this is by no means complete, this arrangement would seem to make sense for Scotland. My perception of this arrangement is that Scotland is the greater beneficiary. The arguments that are put forward by the pro-independence proponents do not seem to address the fact that the Bank of England and by extension rUK are effectively acting as guarantors for an Independent Scotland and their banks. Since the financial crisis of 2008, most of the banks in the UK have needed to raise additional capital. It is interesting to note that the 2 biggest bailouts from the UK government (RBS / HBOS) have been banks which have their head office in Scotland. I know that some people will say that Lloyds Banking group have needed the bailout, but this was only due to the shotgun marriage arranged by the previous Labour government of Gordon Brown, between Lloyds and HBOS.

Additionally the major parties based in Westminster, have advised that they will not be negotiating a currency union with Scotland. This solution would therefore seem to be a dead duck!

 

Create a New Scottish Currency and a New Scottish Central Bank

Assuming that the scenario of a currency union is not likely to be a realistic proposition, then those voting for Scottish Independence need to consider a plan B. This therefore is one possible option.

The creation of a new currency will require a significant amount of work. It will require some of the items identified below to be considered

• Selection of New Currency Name

• Design of new Bank Notes
• Design of New Coins
• Tendering for the “minting ” of the new currency
• Allow sufficient time for the process to be completed
• Setting an initial exchange rate between Scotland’s New Currency and Pound Sterling (all other exchange rates will be derived by the markets)
• Communication of when the new currency takes effect
• Allowing time for the conversion of vending machines and suppliers
• Establish a new Central bank of Scotland with the associated capital and necessary infrastructure

The biggest challenge will be the setting of a market exchange rate to Pound Sterling which reflect what the markets are likely to see as being realistic. There is little point setting a rate of 1:1 for the new currency and then the markets say believes that the exchange rate should be 12:1, as it was the last time the Scottish Pound was replaced by the Pound Sterling. All current bank notes issued by the banks in Scotland (Royal Bank of Scotland, Bank of Scotland and Clydesdale Bank) are currently guaranteed by the Bank of England – once Scotland goes independent those banks will need to have the capital base to support those issued notes.

Join some other currency such as the Euro and the associated infrastructure

The basic problem with this scenario is that someone has to be prepared to join to Scotland in some form of currency union, with the following challenges

• no history of working with Scotland
• No credit history for Scotland
• No framework for managing a currency union
• No understand of the debts that will be associated with the independent Scotland
• Ability of the Independent Scotland to pay its debts

Utilise some currency without formal agreement of the “owner”

There are a number of countries which utilise another currency such as Andorra, Monaco and San Marino using the Euro and Liechtenstein using the Swiss Franc. In the scheme of things, those countries represent a minute part of total GDP of the currency. Scotland would represent a significant increase in the currency required and associated note/coins. It would also mean that Scotland would have no influence on the interest rate or financial policy of the currency owner. I cannot see an independent Scotland would be happy to move from a situation of having limited influence to having none.

Other observations

The recent discussions between the Scottish Parliament and Westminster and the pronouncements made by Alex Salmond are not helping the discussion regarding the future currency of an Independent Scotland. The announcement of the Westminster Parties, that a future Rest of UK parliament would be unwilling to discuss the possibility of a currency union, has led Alex Salmond to indicate that a future Scotland might refuse to pay their contribution towards the existing United Kingdom debt. Such a move can only be seen as abject folly, as it would indicate to the financial markets that Scotland would refuse to pay its debts if it did not get its way – hardly an auspicious start for a new country.