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| Currency conundrum: Scottish nationalists want monetary union with the rest of Britain but fiscal and political separation Photo: Alamy |
11 Oct 2012
'In or out” – that is the question. Scots, we now know, are to be presented with a simple choice when the referendum on whether to remain part of the United Kingdom is held in 2014, with the devo-max option traded in for a lower voting age. Only in practice, nothing is ever that uncomplicated.
What Scotland will in fact be voting on is whether to give its devolved government a mandate to negotiate independence. Precisely what form that separation takes is at this stage anyone’s guess, and is highly likely to remain so right up to the time Scots make their fateful decision. In that sense, they will be voting blind. Critical issues such as the share of the national debt Scotland takes on, whether it is made liable for the tens of billions spent bailing out Scottish banks, what share of tax revenues from North Sea oil belongs to Scotland, and therefore what sort of a fiscal position it will be in after separation, are likely to remain unanswered.
Now obviously, Alex Salmond, Scotland’s First Minister, has his wish list. It goes something like this. You keep all the national debt, we keep all the oil and, since it was London that messed up so spectacularly in regulating the Scottish banks, you can keep those liabilities too. Salmond is demanding a whopper of a divorce settlement, even though he is, as it were, the guilty party. That Westminster would just roll over and let its tummy be tickled seems unlikely. But it is the monetary arrangements that are the most problematic, and which are the real Achilles’ heel in the economic case for separation.
Scottish nationalists were once minded to think the solution lay in joining the euro. If your monetary policy has previously been delegated to London, what’s so bad about delegating it to Frankfurt instead? The euro crisis has made Salmond think again, and now the favoured approach is to remain part of the sterling area, at least for the time being. To put it mildly, to vote for fiscal and political separation, but for the continuation of monetary union with England, Wales and Northern Ireland, is a contradiction in terms. If there is one thing we have learnt from Europe’s experiment in monetary union, it is that it won’t work unless accompanied by fiscal union and political federalism.
In Europe, the strategy has been to start with monetary union, and then, however implausibly, make everyone march in lockstep towards fiscal and political union, even if the voters are blissfully unaware that this is what they have signed up for. If all goes according to plan, eventually nation states end up much as Scotland is within the United Kingdom, with the status and fiscal flexibility of little more than a local authority. Scotland would be doing the whole process in reverse. It starts with fiscal union, and then… well, who really knows? I’m damned if I can figure it out.
As a stopgap, however, Scotland would have the pound – but under what terms? For choice, Scotland would presumably opt for the same arrangements as exist within the euro area – that is, with the central bank, in this case the Bank of England, acting as lender of last resort to the Scottish banking system, and in extremis the Scottish government.
But to do this in a way that doesn’t land everyone in the same soup as the eurozone, you first need a banking union, and, er, something very close to a fiscal union. It follows that you also need common political governance.
Without such safeguards, the monetary authority cannot legitimately act as lender of last resort, for by doing so it exposes the host country to potentially catastrophic liabilities and losses. In circumstances where Scotland was heading for a yes to independence vote, you’d likely see some flight of capital out of Scotland into England. Normally, the Bank of England would address the consequent shortfall in the Scottish banking system by providing it with liquidity. But would the Bank of England be prepared to do this in circumstances where Scotland was leaving the United Kingdom? Not likely.
The logic of European Monetary Union is that it eventually leads to harmonisation of virtually everything, from budget deficits and taxes down to pension rights, unemployment benefits and healthcare entitlements. Yet Scottish nationalists seem to think they can have both monetary union and continued fiscal divergence.
Alternatively, Scotland could choose to be a passive participant in the sterling area, rather in the way that Montenegro, Bulgaria and the Baltic states are with the euro. Montenegro uses the euro as its currency, despite the fact that it is not yet a member of the European Union, let alone the euro. Likewise, Bulgaria and the Baltic states link their currencies to the euro through currency boards, but have no influence over eurozone monetary policy and no access to European Central Bank liquidity.
These arrangements can work, particularly in the case of small developing countries with a history of high inflation, yet it’s a hard road that subjugates not just monetary policy but much fiscal decision-making to the demands of the host currency. There is also a tendency to extreme boom and bust cycles, as has occurred, with devastating consequences, in the Baltic states.
The point is that monetary union doesn’t work unless those involved are in pretty much perfect economic, fiscal, monetary and political alignment. We are therefore left with one over-riding question about Scottish separation: beyond bravado and grandstanding by a small cadre of senior politicians, what precisely is the point of it?
*Source: UK Telegraph
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