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Scottish Currency

The independence referendum is, in a stark way, beginning to reveal the real lines of power and authority inside the UK, writes NEF’s James Meadway

The referendum on Scottish independence is provoking political convulsions in Westminster. With polls showing a population inching towards a “yes” vote, it’s clear that minds in London have sharpened by the prospect of Scotland going it alone. Following Cameron’s Olympian carrot-waving last week, the leaderships of all three pro-Union Westminster parties were to be found lining up to brandish sticks. Currency union, declared Osborne – Scotland using the pound after independence – was not an option. Nick Clegg and Ed Balls rapidly agreed, in a touching display of unanimity.

It remains to be seen whether the appearance of Moe, Larry and Curly to insist in unison that the pound cannot be shared will have quite the edifying effect on Scottish voters that is intended. But there are very good reasons to suspect that, for all the economic brouhaha, the drive to prevent Scotland managing its own economic affairs is more bluntly political.

A currency union is not the UK’s decision

First, Osborne’s apparent belief that he and the Treasury can simply decree the pound not to be used north of the border is arrant nonsense. Should Scotland wish to use the pound, post-independence, it can, just as it does now; there is nothing at all that can be done to prevent a freely-exchangeable currency being used by anyone else in the world, for whatever purposes they wish, and whatever its issuing authority may want. This is, as a moment’s thought suggests, one of the major advantages to having a currency that can be freely taken abroad: that it can be, well, freely taken abroad. Those in Latin America have had long experience in using the dollar, occasionally entirely replacing the domestic currency. Sometimes this is to Washington’s chagrin. But if dollars can be taken abroad, they can be used abroad. A de facto currency union can be created.

The same goes for sterling. It is, of course, possible that the Treasury might decide to suspend free exchange of the pound. Border patrols can be mounted on the A1, perhaps, or bag searches for contraband coinage introduced at Edinburgh Waverley. But since the Treasury’s Permanent Secretary, Nicholas Macpherson, was to be found, barely two months ago, lengthily declaiming the merits of free trade, free currencies, and the Treasury’s historic commitment to both, this seems a little unlikely. That Macpherson is also now busily supplying Osborne with the advice that a currency union can be unilaterally “ruled out” is a fine tribute to that suppleness of mind encouraged amongst Whitehall mandarins. The fact remains: if you don’t want a currency union, you can’t allow free exchange of currencies.

There is no other law or regulation that can prevent an independent Scotland continuing to use the pound. A failure to sign a formal currency pact would not prevent an informal currency union still operating. Westminster, for all its blustering, almost certainly realises this. The hue and cry is about the politics of independence, not a dispassionate economic analysis.

The politics of independence get us to the heart of the UK’s dysfunctional economy. We are dealing here with political economy: not just how the machinery of the economy fits together, but the all-important question of who benefits from its operation.

Scotland’s banks, London’s problem

The political economy question falls into two, mutually contradictory, parts. The first has been touched on, in Macpherson’s note to the Chancellor, and in some of the subsequent reporting. Scottish banks, relative to the size of the economy, are huge. Under a UK-wide regime, RBS and Bank of Scotland (prior to its merger) inflated themselves to eye-watering proportions – as did every other major UK bank. The UK, as a result, is one of the most heavily-indebted developed countries in the world – not, to be clear, because of its government debt, but because of the liabilities of its banking system.

On Treasury calculations, these UK-wide banks hold assets equivalent to 492% of the UK’s GDP.  Scottish banks, however, have assets equivalent to 1254% of GDP. This is a huge problem: if (or when) banks fail, we now have a well-established expectation that the state in which they are headquartered will bail them out. They are supposedly “too big to fail”, because the wider economic consequences are so huge. The bigger the banks, the bigger the eventual failure – and the bigger the bailout.

The Treasury are not slow in pointing out that Iceland, when its own financial system collapsed from 2007 onwards, had banking assets equivalent in value to 880% of GDP. The implication is obvious: you don’t want Scotland to end up a basket-case like Iceland. Stay in the UK. And, if you leave the UK, don’t expect us to pick up the tab.

That’s the real issue with the currency union. The question is over a banking union: do Scotland’s bloated banks, inflated under a UK-wide regulatory consensus, still benefit from UK-wide protection? Or are they left to fail alone? Lawrence Summers, deputy Treasury Secretary to the US under Bill Clinton, presented exactly the same argument at a Senate hearing on dollarization:

“..it would not, in our judgment, be appropriate for United States authorities to extend the net of bank supervision, to provide access to the Federal Reserve discount window, or to adjust bank supervisory responsibilities or the procedures or orientation of U.S. monetary policy in light of another country deciding to adopt the dollar.”

Washington then, and Whitehall today, do not want to carry the can: the difference here, of course, is that the can of was one filled by decisions taken in Whitehall, not Edinburgh.

But why, in that case, not simply let Scotland go it alone? The rest of us would have no reason to support Scottish banks in an independent Scotland. An independent Scotland could be allowed to suffer the consequences of its own presumed folly. The process could take some time, but extricating the rest of the UK from Scottish financial institutions is not impossible: bank assets can be allocated geographically, some appropriate consumer protection provided for remaining UK customers, and an amicable agreement reached on separation. This is broadly what the SNP hope for, with a gradual move out of the pound over a transitional period; under the circumstances, it might seem like a reasonable option.

Oil and the City

This negotiated settlement is, for now, absolutely ruled out by Whitehall as a result of the other major fact in the UK’s political economy. North Sea oil may be in decline, but it still represents an immense contribution to the UK’s export earnings. Depending on whose projections you believe, it will remain a viable source of substantial earnings for at least the next decade – and potentially further.

The significance of these earnings are not just the (hotly-disputed) tax revenues they represent. It is the foreign exchange they bring in. Oil is a massive contributor to UK exports, even if, since 2005, we import more than we sell abroad. The graph below demonstrates how important these export earnings are. It shows the current account (the gap between exports and imports) with North Sea oil included, and with North Sea oil excluded.

Scotiish Currency GraphThe UK runs a permanent balance of payments deficit – we always buy more from abroad than we sell to abroad. For 2012, this deficit amounted to 3.8% of GDP. This is the highest since 1989, and only the fourth time since 1948 that the deficit has been larger than 3%. With North Sea oil exports removed, however, almost every year for the last decade the deficit has been far ahead of this figure. By 2012, the deficit, minus oil, would have been topped 6.5% of GDP.

The balance of payments has been in deficit every year since 1983. We always buy more from the rest of the world than we sell. This position has only been sustained on the basis of consistently flows of capital from the rest of the world making good the difference between exports and imports: in effect, we borrow from the rest of the world so that we can carry on buying their products.

The extent of that borrowing has been reduced by export earnings from the North Sea. Oil exports have, in effect, enabled an otherwise very weak international position to be maintained. Remove those earnings, and the international position collapses.

Under normal circumstances, a country running a persistent balance of payments deficit would be forced to devalue – to have the value of its currency abroad pushed downwards as international markets attempt to balance the demand for exports in the rest of the world with the demand for imports at home. (Indeed, since 2008, this has happened to some extent, with the pound falling in value by about 20%.)

But without a high-value pound, the borrowing from abroad that can sustain the trade deficit looks harder to find. A strong pound means high returns from financial assets denominated in pounds; a weak pound, falling in value, threatens those returns. The City of London’s role as a world centre for money-dealing of all stripes is threatened by a falling currency.

Absent North Sea oil, and there should be no serious doubt that the pound will be faced with devaluation, potentially on a dramatic scale. As a part of a plan to rebalance the UK economy, creating decent work and removing its dependency on debt, this devaluation would be no bad thing. But as has become abundantly clear since 2008, no such plan exists: the economy will not rebalance, the pound will remain overvalued, and the debt-machine in the City will keep on running – indeed, will grow enormously, if Mark Carney’s aspirations are anything to go by.


It’s this, then, that – for now – helps drive the attachment to Scotland. The City needs the oil, since it supports an overvalued currency; and that, in turn, means that a currency union arrangement in which the UK loses Scottish oil revenues, but still has to look after Scotland’s London-regulated banks, is absolutely out of the question.

For Scotland, the choices may become more stark. The pound can certainly be kept after independence, but leaving one’s banks in the grip of a City of London regime that has no intention of derisking and deflating those banks is not a long-term plan. Better, if independence is attempted, to have a plan to exit the pound as soon as possible. The Treasury may want us all to shudder at grim tales from the north, but Iceland’s experience over the last few years shows in practice that a small economy with its own currency can allow fat-cat banks to fail while protecting depositors. A managed – rather than chaotic - decline of the Scottish banking system, shrinking it back down to reasonable and useful size, would be feasible if Scotland were not to be attached to the City’s own currency. A new Scottish currency would fall in value over time, as oil reserves dwindled, making a low-carbon transition easier: initial capital equipment imports would be cheap, but new exports would sell more easily.

The independence referendum is, in a stark way, beginning to reveal the real lines of power and authority inside the UK. It has the potential to pose a direct challenge to the peculiar political economy this country has developed over the last thirty years. Whatever the outcome of the vote, it is opening up a space to think about alternatives.

James Meadway

James Meadway

Radical economist James Meadway has been an important critic of austerity economics and at the forefront of efforts to promulgate an alternative. James is co-author of Crisis in the Eurozone (2012) and Marx for Today (2014).

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