Should an independent Scotland use the UK pound in a formal or informal currency union? Or use the euro? Or just go ahead and set up its own currency?And does it even matter?
It does matter, and more than you know. To demonstrate that, in this article I start with four facts to demonstrate the folly of making the wrong currency choice. Letting the cat out of the bag early, I can tell you the wrong choice is anything other than a Scotland currency adopted as quickly as possible after independence.
Currency – four facts
- Fact 1: A Scotland using the UK pound, even without a formal monetary union, would be a currency user not a currency issuer.
- Fact 2: As a currency user Scotland would have to borrow in a foreign currency to fund its policies. Borrowing in a foreign currency means taking on debt denominated in a foreign currency, which entails a risk of default.
- Fact 3: As a currency user Scotland would have no control over monetary policy.
- Fact 4: Without a central bank, financial regulator and supervisor and our own currency, Scotland would not be able to join the EU.
Those are the facts; everything else I write here are my views on the implications of those facts.
FACT 1: A Scotland using the UK pound would be a currency user not a currency issuer
If you are unfamiliar with the terms currency user and currency issuer, see my beginners guide to monetary sovereignty in the Bylines Scotland article:
The Scottish Government – a currency user, versus the UK Government – a currency issuer in which I wrote, “…a monetary sovereign country is one that can supply or remove money from the economy. Monetary sovereign countries include, among others, the UK, the US, Japan, New Zealand, and Australia. These countries have control over monetary policy and are currency issuers.
“In the UK, the sole currency issuer is the UK Government. Only the UK Government can spend pounds into the economy. Every pound in your wallet or your bank account initially came from the UK Government. And every year, you pay some of that money back to the government when you pay your taxes.”
Once you understand the difference between a currency issuer and a currency user you are already 99% along the road to understanding the importance of Scotland having its own currency.
FACT 2: As a currency user Scotland would have to borrow in a foreign currency
Borrowing in a foreign currency means taking on foreign currency debt which entails a risk of default. The UK pound would be foreign currencies to an independent Scotland. The borrowing rate would be determined by the foreign currency holder, in this case the Bank of England/UK Government. Even the limited amount of borrowing Scotland undertakes now means some of Scotland’s income goes towards funding debt repayments.
The Scottish Government fiscal framework outturn report, 2021, states “…in 2021 Scotland borrowed £150 million at an interest rate of 1.14% and another £50m at a 1.25% – both over 25 years. £150 million will be repaid over a 25-year period, at an interest rate of 1.14% percent, and £50 million will be repaid over a 25 year period at a rate of 1.25%”.
Borrow a tenner at 10% and you only have a pound to pay back, but borrow at £50 Billion at 10% (Our green energy programme alone will cost at least £30 Billion – though some estimates put it as high as £180 billion) and you are looking for an extra billion a year. Multiply that by a few decades and an independent Scotland is heading for financial trouble.
I’m being extreme by quoting unrealistic borrowing costs, but I’m making a point – a point that has been the reality for many countries.
A recent example is Sri Lanka, which had to borrow in dollars to fund the Covid crisis. However, Covid also meant a collapse in its tourist trade. It was unable to bring in dollars to fund the debt and the country went bankrupt.
Scotland can run a deficit even without its own currency
If Scotland is using the UK pound, in theory there are no limits to its ability to run a deficit to meet its policy goals. Scotland can borrow to make up the difference between what it spends and what it takes in in taxes. Countries run deficits as a matter of course; the UK has consistently run a deficit since the 18th century, apart from a few decades when it had income from its colonies. For the UK, as a currency issuer, running a deficit is not a problem as it effectively borrows from itself. For Scotland on the other hand, as a currency user, building up foreign currency debt is real debt – just like the debt people now have with mortgages they can no longer afford.
Additionally, there is a downside beyond the simple idea of paying interest on a debt. Any country that borrows in a foreign country puts itself in danger of serious negative consequences. These include debt default; reduced ability to tackle financial crises and potential loss of control over policy decisions, as policy goals focus on activities that have to bring in foreign currency to pay debts.
If we are busy selling our energy, our food, and our water to the rest of the world – to bring in foreign currency – our own energy, food and water security are compromised – and the needs of Scottish citizens are not met.
The more debt we build up the more leverage we give to the countries we borrow from, and eventually the politicians within the governments we borrow from are the people who determine our policies.
These are not fanciful or unlikely scenarios. Tunisia, while trying to pay its foreign debts, finds itself in a position where agricultural policy focuses on growing strawberries to export while failing to grow wheat for its own population. So a build-up of debt puts Scotland in a difficult situation – potentially in the pockets of those we are indebted to.
Economic shocks are the real danger
If Scotland is not a currency issuer economic shocks can cripple our economy. During Covid the US government effectively magicked up $5 trillion of financial support to keep the country going during lockdown. Scotland, as a currency user, can’t magic up a single pound to help Scottish citizens survive such a shock. Like Sri Lanka, Scotland would have to borrow, and borrowing builds up real debts that must be paid back. So external shocks are the biggest danger to any country without monetary sovereignty.
FACT 3: As a currency user Scotland would have no control over monetary policy
If Scotland used the UK pound, even in an informal union, monetary policy would be set by the Bank of England Those policies would be set to meet the needs of the rest of the UK, not be tailored to the very different needs of an independent Scotland.
Interest rates would be set by the Bank of England. Economic shocks such as Brexit, Covid, the 2008 financial crash, the recent fall in the value of the pound and the fall in the price of government bonds that nearly bankrupted pension funds, would all affect an independent Scotland.
Bank of England monetary policy decision would put constraints on Scotland’s ability to run its own affairs as it would determine interest rates, the cost of our borrowing and our exchange rates. Right now, the weak pound, exacerbated by decisions made at Westminster, means higher import costs for Scotland – and the rest of the UK – pushing up inflation.
Scotland’s ability to make policy is constrained
Scotland may, in theory, be able to borrow to fund its economic program but in reality if monetary policy is determined by the rest of the UK – our ability to do what we want will be constrained by UK policy priorities – which from current and historic evidence show are likely to be the polar opposite of Scotland’s.
FACT 4: Without a central bank, financial regulator and our own currency, Scotland can’t join the EU
To join the EU, Scotland will need to have its own currency. Scotland can of course apply to join the EU before having its own currency; i.e., while using the UK pound without a currency union. However, this could prove problematic without agreement with the UK. As Kirsty Hughes, the former director of the Scottish Centre on European Relations notes, “good relations with neighbours are a crucial part of accession talks”.
I agree that Scotland should join the EU. However, it should not join the Euro for the reasons I have outlined above. If Scotland joins the Euro, just as with the UK pound, it gives up its ability to issue its own currency and implement the policies tailored to the needs of Scotland’s citizens.
The following quote is from the EU, European Commission, website:
“Adopting the euro… In particular, it requires economic and legal convergence…Its exchange rate is irrevocably fixed and monetary policy is transferred to the hands of the European Central Bank, which conducts it independently for the entire euro area.”
This is precisely why Greece found itself in such a mess. Greece gave up its monetary sovereignty and paid a heavy price. The EU forced austerity upon it while refusing the borrowing it needed to keep its citizens in work and keep its economy working. People’s lives were sacrificed to the EU’s neoliberal economic orthodoxy; economic myths combined with arbitrary ‘deficit rules’ were used to ruin the lives of millions.
Scotland needs full currency sovereignty
In short, an independent Scotland needs full currency sovereignty as quickly as possible after independence. Scotland needs the ability to both issue money into the economy and take money out via taxation.
An independent Scotland has start-up costs and ambitious goals: a more equal country, a wellbeing economy and a just transition to green energy. These goals need to be funded and are much harder to achieve while using a foreign currency.
Just as with any monetary sovereign country, i.e., any country that is a currency issuer, running a deficit is money that the government spends into the private sector, not a debt as you or I understand it. You can’t say a country has a debt when the money paid out from the government is the same money now circulating in that country’s economy. And who is the country, if it is not the people? The people are using that money to pay their bills, create new businesses, do research, make art, manufacture goods and so on.
When a monetary sovereign country borrows in its own currency it is essentially borrowing from itself, as it is the sole issuer of that currency. A monetary sovereign country does not have a limit to the currency it can create. Scotland along with all other modern countries will use a fiat currency, not a currency tied to the amount of gold, or any other physical resource stored in a bank vault. That system stopped in 1971, but unfortunately orthodox neoliberal economists have yet to catch up with that fact.
Just as the UK Government and the US Government were able to fund the Covid recovery, Scotland must fund the policies that we need to build a successful country that meets the needs of every one of its citizens. To do that it needs its own currency.
Additional resources are available. However, below are a few I recommend.
- Who can join and when by the European Commission.
- IndyLive Podcasts 778 Scotland’s pathways to Europe – with Dr Kirsty Hughes, writer, political commentator and former Director of the Scottish Centre for European Relations.
- The 7 Deadly Innocent Frauds of Economic Policy by Warren Mosler.
- Embrace the self-financing state— it is already here by UCL Institute for Innovation and Public Purpose.