RSS
Scottish independence is another financial crisis waiting to happen
Alex Salmond's plan for Scottish independence could usher in an economic disaster
 
Keeping the pound would be unwise for an independent Scotland.
Keeping the pound would be unwise for an independent Scotland. (Jeff J Mitchell/Getty Images)

Scottish independence officially ended in 1707 when the cash-strapped country accepted a full union with England after a disastrous scheme tried to colonize the Gulf of Darién in central America. Scotland had long been sliding towards incorporation with its larger neighbor to the south, having fought fierce independence wars with England in the Middle Ages, but this was the final nail.

Today, lots of Scots wants out. And just as Scotland ended up in union with England for economic reasons, economic incentives are important factors for why many Scots will vote "yes" to independence in a referendum on September 18. The "yes" campaign wants Scotland to keep all the (dwindling) oil wealth of the North Sea. And it wants to maintain full state control and funding of its public services, especially its National Health Service, the funds for which are being cut by the Conservative-led coalition government in London.

Some proponents of Scottish independence even fantasize that an independent Scotland — fueled by oil wealth and the potential to become a global financial hub — could become one of the richest countries in the world, like a British version of Qatar or Dubai.

Now, I am not fundamentally opposed to the concept of Scottish independence. Any region that truly wishes to become independent has the right to democratic self-determination. But the Scottish independence plan on the table today has some seriously massive holes.

Alex Salmond, the leader of the Scottish National Party and the "yes" campaign for independence, wants to continue using the British pound as Scotland's currency. On the surface, keeping the pound might seem like a good idea for Scottish businesses. The rest of the U.K. is by far Scotland's largest trading partner. If Scotland was independent, 67 percent of its exports would go south of the border. So, as The Economist notes: "Keeping the pound means Scottish firms would not need to worry about exchange rate fluctuations of the transaction costs of doing business in a foreign currency."

And additionally, Scottish pensions and investments are denominated in British pounds. Switching to another currency risks fluctuations or devaluation in their value.

But there are serious problems with Salmond's plan to keep the pound. Most obviously, the British coalition government — and all the major British political parties — have rejected the idea outright. Salmond argues that the British government is bluffing, trying to scare Scots out of voting for independence. Once Scotland has voted for independence, he says, the British government will relent and let Scotland use the pound. And if not, Salmond thinks Scotland can just continue using it anyway without Britain's consent. The pound is, after all, an internationally tradable currency and Scotland's economy, banking system, and government are already using it.

Tony Yates, an economist at Bristol University, doesn't think the British government is bluffing at all. He described to me why:

Britain doesn't want to recreate the problems we see in the eurozone right now, which many see resulting from having a currency union without a proper fiscal or banking union. What Britain would worry about is that Scottish fiscal policy is not run sufficiently conservatively to leave enough headroom in terms of borrowing capacity to cope with a situation where the UK as a whole has to bail out its banking system, and Scotland pays its fair share of that.

In other words, as Bank of England chief Mark Carney put it earlier this year, Britain is worried that it could end up footing the bill for bailing out the Scottish banking system.

So, the irony is, the only way to establish a currency union between Britain and a newly independent Scotland would be for the latter to give up its independence on government spending. Scotland might also have to accept other concessions such as letting Britain continue keeping military bases on Scottish soil and perhaps even sharing North Sea oil revenues. In other words, Scotland would remain as it is now, not really independent of London. A currency union with the rest of Britain requires political union with the rest of Britain. That is not the independence that Salmond or supporters of the "yes" campaign want to achieve.

On the other hand, if Scotland went to plan B and tried to use the pound without the British government's consent, deeper risks could emerge.

Right now, the Bank of England has to take the economy of Scotland into account when setting monetary policy. If Scotland broke away, it wouldn't. So Scotland would be completely at the mercy of the economy south of the border, and the decisions of a foreign central bank over which it has no control or sway. If the Scottish economy booms and the British economy slumps, the Bank of England would ease, and Scotland would risk overheating further. And if the British economy booms, and the Scottish economy slumps, the Bank of England would tighten, and Scotland's recession would worsen.

The ongoing crisis in the eurozone illustrates that these problems with currency unions are very real indeed. But an even better example is what happened to Argentina when it pegged its currency to the U.S. dollar during the 1990s. By 1999, the U.S. economy was overheating, and the Argentine economy was in a slump. The Federal Reserve — which sets monetary policy solely for the U.S., not for ancilliary economies that have attached themselves to the dollar — tightened, worsening Argentina's slump and eventually resulting in the South American country defaulting on its government debt and entering an economic depression. The aftershocks of that are still being felt.

Furthermore, without a currency union deal with Britain, the Scottish economy would have no lender of last resort. That means its banking system would be uninsured, and because Scotland would no longer control its own currency, its government would run the risk of running out money if it tried to stimulate the economy or bail out the banks. As Tony Yates described to me: "Not having a lender of last resort would expose the country to a massive recession that would make the last financial crisis look like chickenfeed." And having ignored London's warnings against sharing the pound, Britain would be under no obligation to help.

If Salmond and the "yes" campaign were really serious about independence they would have addressed these issues. If Scotland is going to be truly independent, it needs its own currency backed by its own central bank. Scotland could float a Scottish pound initially valued at 1:1 against the British pound. Yes, that would risk devaluation of pensions and investments and major currency fluctuations due to oil export fluctuations. But the truth is that that is what it would take for Scotland to become truly independent.

Salmond might be known as a firebrand for Scottish independence. But keeping the pound is not really independence at all. Currency union necessarily means political union, as the eurozone is discovering. And blundering on with so-called "independence" as Salmond is doing risks a big, nasty mess.

 
John Aziz
John Aziz is the former economics and business editor at TheWeek.com. He is also an associate editor at Pieria.co.uk. Previously his work has appeared on Business Insider, Zero Hedge, and Noahpinion.

THE WEEK'S AUDIOPHILE PODCASTS: LISTEN SMARTER

Subscribe to the Week