The Currency Question

The debate over independence is plagued with speculation about how the economic system will adapt and whether a constitutionally independent Scotland will deliver better economic outcomes for Scots than the Union. Within this wider debate, the issue of what money will look like is becoming more prominent, and has generated significant heat, if not much light, in recent days. The SNP’s policy for some time was that Scotland would join the Euro ‘when the time was right’ and only after asking the permission of the Scottish people. The right time seems to be receding into the future, however, and staying in a sterling area monetary union is now the preferred option. This is no longer an obscure or technical discussion; in particular, strains in the Eurozone since 2010 have highlighted the difficulties of operating a single currency across a range of sovereign states.

So, Scots will have some choices to make in the wake of a Yes vote in 2014: stick in a monetary union with the UK and keep the pound, move into the Eurozone or launch a new national currency. That these are the three options is the one thing that is largely uncontentious, and they were reiterated by George Osborne when he presented the Treasury paper in Glasgow in April. In fact, however, these choices are not as distinct as they might appear. In a globalised economy, a country like Scotland that profits from international trade, seeks to attract international investment and wants free movement of workers across borders already has significant limits to its economic policy sovereignty. Constitutional independence will not deliver economic independence, if by independence is meant an absolute right to do as you please without consultation and agreement with neighbours and partners. So some measure of interdependence is inevitable. This is true for all states engaged with the global economy, including the UK. But there remain shades of difference among the three currency choices.

Adopting the Euro could facilitate trade and payments with Europe and lend credibility and confidence to investors who trust the European Central Bank’s monetary policies. While Greece, Cyprus and other Eurozone states have faltered through not ensuring fiscal balance and diverging from the healthier economies in the Eurozone, there is no need for Scotland to fall into this trap. Scotland’s economic performance for some time has been such that it could sit comfortably in the ‘core’ Euro group of countries, and its debt levels (below those of the rest of the UK) would give comfort to other members. On the other hand, with Eurozone GDP contracting and the future of the Euro uncertain, 2015 does not seem a good time to join.

What about introducing a separate Scottish currency? Recent examples of currency disintegration are not very numerous: after constitutional independence in the 1950s and 1960s, a range of former British colonies introduced separate currencies as emblems of their new status but in practice they pegged the exchange rate to the pound, so the amount of monetary independence they achieved was limited. In the same way, new currencies followed the collapse of the Soviet Union and the creation of new states in eastern Europe during the 1990s, the division of Yugoslavia into Slovenia and Croatia in 1991, and the separation of the Czech and Slovak republics in 1992 (Slovakia and Slovenia subsequently adopted the Euro). In each case there were disruptive effects on trade and payments that were expensive and hurt economic performance for both partners. The lessons from earlier episodes, such as Malaysia and Singapore in the 1960s suggest that a gradual approach of disengagement with a common currency and then free transfer and convertibility of separate currencies across borders at par and then management of a stable exchange rate is likely to be most effective. The separation of Malaysia and Singapore in 1963 was fraught with political hostility, but the successful transition to independent currencies was co-operatively managed over 10 years during one of the most volatile decades in the global economy. Two things emerge from this analysis. First, it can be done. Second, it takes some time and a mature attitude to negotiation in the interest of both states.

Given that both the Euro and a separate currency will constrain policy-making, perhaps the simplest and least costly option is to stay in a currency union with the pound. The Scottish Government’s fiscal commission was very clear that this was the sensible and pragmatic choice: it reduces uncertainty in the short-run and provides security to cross-border investors and producers who might otherwise be concerned about the impact of independence. But the lessons of the Euro-area need to be heeded – which is why George Osborne consistently used the phrase ‘Euro-style’ to describe the option of a continuing currency union. It would require that Scotland abide by the interest rate policy set by the Bank of England, which historically has responded more to economic conditions in the Southeast of England than the regional needs of the UK as a whole. The implied fiscal constraint is real, though not necessarily disastrous. Scotland and the rest of the UK have very similar economies and meet most of the tests applied to define Optimum Currency Areas. A continuing currency union would also offer substantial benefits to the rest of the UK by continuing to link sterling to the considerable balance-of-payments benefits afforded by North Sea oil. Within a currency union, the Scottish government would have policy flexibility, and would be able to make independent spending choices – within the agreed overall fiscal envelope.

This is where the economic argument lies, and there are two sets of risks that need to be considered. First, John Kay argued in a recent lecture at the University of Glasgow that the stresses induced by divergent policy choices around education, social welfare etc. could, in the long-run, result in pressure for Scotland to adopt a different exchange rate or interest rate policy. Secondly, Jim Cuthbert’s recent contribution to the debate has pointed out that economic instability in the rest of the UK could be seen as a major risk to the Scottish economy if it remains tied through the currency union. The IMF’s criticism of Osborne’s austerity policy and downgrading of British debt suggest that the international community is also starting to doubt London’s economic priorities. In the longer term, the freedom to make appropriate currency adjustments could be in Scotland’s best interests. The status quo already meets the needs of a distinctive national representation on currency notes that could evolve into the first stage of a gradual move toward disengagement (we can dismiss the reported difficulty in continuing to issue Scottish sterling notes in the short-run – it is not clear why the Bank of England would refuse to accept the assets which currently support them), but this is likely to be a long process begun well after constitutional independence once the current global recession and uncertainty are behind us.

Three things are clear from this discussion: first, there is little space for independent monetary policy for a small open economy such as Scotland, no matter what currency option is chosen by the post-independence government. This is an inevitable consequence of the need to engage in the global economy and is true to some extent of every country. Second, a continued currency union between Scotland and the rest of the UK is the sensible and pragmatic option in the short term, giving as it does a level of security to investors in both countries. Third, the right to pursue independent policy choices is one of the key goals of independence and it is conceivable that these choices might eventually lead to significant pressure to decouple from the rest of the UK and float an independent currency. Alternatively, without continued access to North Sea oil wealth, it is possible that the r-UK deficit will lead Scottish policy-makers to the view that continued stability requires a decoupling from sterling. In the short-run, therefore, sterling is sensible and good for both countries. In the long run, an independent Scottish currency may well be the best way forward.

Catherine Schenk and Duncan Ross
University of Glasgow

Catherine Schenk is Professor of International Economic History, University of Glasgow, and author of The Decline of Sterling (Cambridge 2010).
Duncan Ross is Senior Lecturer in Economic History at the University of Glasgow.


There are 13 comments

  1. Peter A Bell

    In today’s Herald, Ian Bell argues that “Osborne’s threat shows independence is viable” ( Not that this matters to those of us who consider independence to be the default status of nations and something that is not, therefore, conditional on any contrived economic test. But the arguments advanced by Osborne and others to persuade us of the impracticality of a currency union also prove something else.

    If these arguments are accepted as credible – admittedly a bit of a stretch – they prove that the kind of devolution involving fiscal autonomy that the British parties talk about, but assiduously avoid actually promising, would also be impractical. And, from Scotland’s point of view, a considerably less attractive proposition than participation in a sterling zone as an independent nation.

    As an independent nation Scotland would be free to negotiate the terms on which it would be prepared to join a currency union with the rest of the UK (rUK). We would be free to reject terms that we considered excessively onerous. Unionist arguments on this issue assume that Scotland would go into negotiations powerless and be forced to accept whatever form of arrangement the rUK government decided to impose. And, from all that has been said, we can safely assume that the terms would be punitive – driven by a sour vindictiveness that is all too evident in everything Better Together and its increasingly dubious allies say on the subject.

    But, as less emotive commentators point out, Scotland would in fact be in a very strong bargaining position. The reality is that rUK would need that currency union at least as much as Scotland. Perhaps more. Because, while Scotland would have other options, e.g. it’s own currency, rUK would have none. It would be stuck with a pound bereft of the support offered by Scotland’s resources.

    As an independent nation Scotland would also be free to leave the putative sterling zone should participation cease to be in the best interests of Scotland’s economy and people. While the two economies are presently sufficiently in tune to make a shared currency and monetary policy perfectly feasible, it cannot be assumed that this will remain the case indefinitely. Indeed, we must assume that the economies of Scotland and rUK will diverge as the two governments pursue distinct fiscal policies. At some point this divergence would inevitably make currency union inappropriate. That is the real lesson of the Eurozone. At that point, an independent Scotland would be free to withdraw from the sterling zone.

    As a devolved part of the UK with something akin to full fiscal autonomy (FFA) Scotland would be irrevocably bound to a monetary union under terms imposed by Westminster and with no possibility of escaping despite the fact that FFA would have an almost identical tendency to lead to economic divergence.

    The kind of devolution that is the subject of unionist jam tomorrow promises leads to a Eurozone-type crisis. Independence is the way Scotland will avoid that fate.

    1. Doug Daniel

      Precisely! I don’t understand why people can’t see that it is Scotland that has the choices here. The future of Sterling depends largely on what Scotland decides to do, and I suspect people like Osborne are only too aware of this fact, hence the determination to make it sound like rUK would be doing Scotland a favour by “letting” us continue to use Sterling, as if it’s their decision to make.

      It makes sense for Scotland to stick with Sterling at the moment. From there, we can do what we like, and it’s almost inevitable that we will end up with our own currency, because if the two economies haven’t diverged in a few years, then we’ve clearly wasted the opportunities independence will bring.

      (Or rUK has elected a progressive-minded party that rejects Chicago School economics, but that’s clearly not going to happen.)

      1. Martin Pratt

        The future of this country is not going to be decided by what Scotland decides to do. We can hold our own thank you very much, as much as you can.

  2. Doug Daniel

    Actually, there’s a far more straightforward way to rule out the Euro option, and it continues to amaze me how many people – particularly folk I would have thought would have at least some knowledge of the process – don’t seem to understand this point:

    Scotland cannot just join the Euro when we feel like it.

    The convergence criteria specifically prevents it. The same measures that stop us being FORCED to adopt it also stop us being able to adopt it straight away. A member state cannot join the Euro until it has met the convergence criteria, one of which is having your currency in ERM II for at least two years. Scotland’s currency the day before Independence Day will be Sterling, which is not in ERM II because the UK was forced out of ERM on Black Wednesday in 1992, and has never rejoined. So Scotland fails that part of the convergence criteria, meaning our currency on Independence Day will have to be Sterling or a Scottish currency.

    Unless Sterling is suddenly signed up to ERM II between now and May 2014, then the only way Scotland is joining the Euro is by having our own currency first. Therefore, “join the Euro” is a false option, since it is predicated on first choosing to have a separate currency.

    If learned academics don’t understand this, perhaps I’m being a bit harsh when I get irate at journalists failing to pick people up on it when they suggest Scotland might have to join the Euro…

    If anyone is not convinced, just have a gander at the European Commission’s official website:

    (Unless we do what Montenegro did of course, and just use the Euro unofficially… Although Montenegro still require their own central bank as a result.)

  3. Russell Bruce

    It is a giant step forward to have rational debate and reasoned argument on the currency question from these authors. George Osborne’s day excursion was about casting doubt over the viability of Scotland’s choices because the Treasury prefers to have control of Scotland’s economic assets and that ceases to be the case after independence. It’s a bit like your next door neighbour saying I can look after your income for you and that saves you having to worry about doing it yourself.

    As Scotland is the most prosperous part of the UK after London and the South East of England and accounts for around 10% of the UK economy, the lack of a Sterling currency union after independence would cost jobs in England. It is in both our interests to maximise the potential of the UK single market within the EU single market. A currency union is an advantageous facility in maintaining and building on existing trading relations. Osborne needs to ask businessmen in England if they really want him to make doing business in Scotland more difficult than it need be after Independence.

    A variety of arrangements already exist for the Falklands pound, the Isle of Man pound, the Gibraltar pound and others.
    It is Scotland that has the choices following independence and that is what is worrying Osborne, but you would not expect him to admit that of course.

    1. Martin Pratt

      It wouldn’t cost jobs south of the border at all. We didn’t want a currency union with our largest trading partner, the EU, why woulod we want one with a near but rather periferal neighbour. We don’t have one with Ireland or France, it beggars beleif we would want one with Scotland. Why are you guys any different to Ireland and France? Gibraltar etc. are crown colonies who use sterling. Th e comparison is not valid. We will hold Scotland as the rest of humanity, in peace friends, in war enemies. We want our own currency – you can use it by all means, just don’t expect a role in its management.

  4. Davie Ballantine

    At Some Point A Independent Currency Would Need To Be Floated

    The rate to the pound was maintained in 1949 when the pound devalued relative to the U.S. dollar, leading to a rate of 7.142 kroner = 1 U.S. dollar. In December 1992 the Norges Bank (Central Bank of Norway) abandoned the fixed exchange rate in favor of a floating exchange rate (managed float) due to the heavy speculation against the Norwegian currency in the early 1990s which lost the Norwegian central bank around two billion kroner in defensive purchases of the NOK through usage of foreign currency reserves for a relatively short period of time.

  5. Dario Casitiglia

    May you people could think about the idea of free banking. That existet so far in Scotland, England and Sweden. I raccomand to read the book from F.A. Hayek – the denationalisation of money. Best regards.

  6. Martin Pratt

    Whether or not we south if the border want to be in a currency union with a foreign country is irrelevant eh? We haven’t wanted to be in a currency union with out souther neighbour, France, and I see no reason why we would want to be with our northern neighbour, Scotland. The balance of payments argument is hugely overstated.

    1. ben leiper


      I think the balance of payments argument is understated.
      Scotland is an exporting country, the UK is an importing country
      facing an energy shortfall in terms of electricity and fossil fuels.
      There have even been in the past proposals from both sides of the border
      to export fresh water south.

      How would sterling be effected if these things had to be paid for in a different currency?

      Scottish government have proposed a currency union which seems to me to
      be at odds with a significant chunk of pro independence folk. Perhaps they have no wish to
      harm the economy of the big country next door by going with our own
      currency from day one.

      1. Martin Pratt

        We import far more from the Eurozone than Scotland and I don’t see us rushing to be in a currency union with them. We get more electricity from the EU than we do from Scotland. You argument is, frankly, silly. There is no desire anywhere in Scotland to “help” England – quite the opposite – there is more of an avatistic desire to harm. The desire for a currency union comes from the fact that 70% of your exports come here more than any risible suggestion to “help” the Auld Enemy.

        1. ben leiper

          OK Martin you think my argument is “frankly, silly”, maybe you are more informed than me.

          Seems Proff Catherine Schenk and Duncan Ross dont think the balance of payments argument is silly. I doubt George Osborne thinks its silly either.

      2. Martin Pratt

        …and I don’t think you wil find any serious proposals to import water from North of the border, even if we needed it (which we don’t) as importing it from France and Wales would be far easier. I think the proposals came from Scotland.

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