The chancellor will not be stalking the borders with a shotgun to prevent parity with the pound. Westminster wants the simplest deal with Scotland
‘Osborne to kill Scottish banknotes,’ said the headline. The idea of the chancellor chasing paper currency over the heather, shotgun in hand, is one of the more bizarre images of the independence referendum. Scotland has issued its own banknotes since the 1690s and the Bank of England was set up by a Scot, William Paterson, in 1694. But George Osborne is not one for historical irony.
‘No ifs, no buts, there will be no sterling zone,’ he said in his second declaration of monetary exclusion. Back in February he announced that ‘if Scotland walks away from the UK it walks away from the pound’. That didn’t go down too well. In fact, support for independence actually rose in the succeeding two months and a majority of Scots said they didn’t believe him.
So, he decided to spell it out again. Not only would there be no currency union, but the Treasury would also seek to prevent an independent Scotland issuing its own currency at one-to-one parity with sterling, as Latin American countries do with the dollar or countries such as Denmark with the euro
A number of commentators have pointed out this would undermine trade. Professor John Kay, the economist, dismissed the chancellor’s threat as bluster, arguing that any country can use sterling if they want to. Ireland issued its own pounds based on parity with sterling for 50 years after independence.
It was not an ideal arrangement. It meant Irish interest rates were set by the bank of a foreign country, the Bank of England, and these rarely suited Ireland’s essentially agrarian economy. The Bank was forever hiking interest rates in the 70s and 80s when the Irish economy needed the reverse. It got monetary liberation eventually by joining the European Monetary System. Indeed, Ireland’s explosive growth dates from its liberation from sterling.
Would the same hold true for an independent Scottish currency? Well, as the governor of the Bank of England, Mark Carney, observed in January, Scotland and England make an optimal currency zone because the two economies are closely matched in terms of productivity, exports, business cycle, language and financial services. Scotland is not in the place Ireland was in the 1930s – with low productivity, little industry and poor exports.
However, the governor insisted that there would have to be common currency and fiscal arrangements to insure against the risk of banking failures. In other words, the Bank of England would not be prepared to act as the lender of last resort to Scottish banks unless there was oversight of Scottish finances. This would entail a ‘ceding of sovereignty’.
Surprisingly, the Scottish Government did not demur, and effectively agreed that its borrowing and even overall spending would be within limits set by the UK. Well, they said, is that any different to what happens in Europe? There the European Central Bank sets interest rates and there is oversight of national accounts through the ‘stability pact’ – though it hasn’t been working too well in recent years of eurozone turmoil.
However, this is all rather academic. If Scotland does become independent, it is most unlikely that England would declare monetary war against its largest trading partner. It is an open secret in Westminster that the UK would seek to have the simplest arrangement, almost certainly a currency union in the short term, to prevent the loss of £40bn in trade and to ensure that Scotland accepted its share of the UK debt pile.
It would be in no one’s interest to erect a financial Hadrian’s Wall to stop pounds leaking north. That is the problem with the unionist case. Like the killing of the Scottish banknotes, it all sounds just a little, well, un-British.
Iain Macwhirter is political commentator on the Sunday Herald
This opinion piece first appeared in the June edition of Public Finance magazine
