During the referendum campaign one of the key issues that was discussed by both sides was that of the currency of an independent Scotland. This is where I believe the independence vote was lost as by asserting that Scotland would keep Pound Sterling, the Yes campaign enabled opponents of independence to cast doubt over this plan. Because of the united front put up by David Cameron, Nick Clegg, and Ed Miliband on the issue of a currency union, the No campaign could bombard the Scottish people with scaremongering stories about economic uncertainty and potentially joining the Euro. In order to establish a truly independent nation, Scotland should establish its own currency and build up its credit worthiness before seceding from the UK. In some ways it already has its own currency, in the form of the Scottish Pound, but it needs to be reformed so that transitioning away from Sterling becomes easier. In order to conceive of these reforms, I feel it necessary to start from a clean slate.
When establishing a currency the financial system of Scotland must also be amended to make it distinct from the Britain’s or at least have it compete with financial institutions and mechanisms present in London. There also needs to be a discussion about the fundamentals of the financial system so hopefully this article will address those fundamentals whilst also proposing ways the Scottish government could go about establishing a national currency. For the sake argument I shall name the new Scottish currency the ‘New Scottish Pound’ (NSP).
The most fundamental question about a new currency is what type of currency it should be. Given that we live in the post-Nixon Shock world it would make most sense to establish a Scottish currency in the form of fiat money. This would enable the currency to be functional within Scotland without the Scottish government needing to immediately purchase foreign currencies or gold as reserves. If Scotland were to become independent, the Sterling used by the Scottish people to buy NSP banknotes would act as temporary reserves to purchase other currencies and commodities. Although fiat money does not require the backing of commodities like gold or silver, the acquisition of such assets would improve NSP’s credit worthiness in the eyes of lenders and investors.
After deciding what type of currency to use the Scottish government will have to establish an authority to actually issue the currency to the public. This would take the form of a Scottish Central Bank that would act as a lender of last resort, control the amount of money supply, manage foreign exchange and gold reserves, and set national interest rates. Such an authority could also regulate the financial industry but the Scottish Parliament could also play a role in this area.
Following the creation of the Scottish Central Bank in Edinburgh, the Scottish government should establish a network of Central Bank-backed credit unions that would issue NSP all over the country and then enable people to pay for government services in this currency. This would create the situation whereby NSP would be in circulation alongside the British Pound and whereby there would be an instant market for the currency. As well as being in circulation alongside Sterling, the currency would be pegged to the pound which would make it very similar to the current Scottish Pound. Although guaranteeing its credit worthiness, the pegging of NSP to Sterling poses a problem in the event of independence: financial institutions would be able to discriminate against the currency post-independence as it would no longer be de facto backed by the Bank of England.
Given the current legal and fiscal framework that the Scottish government finds itself in, I do not believe that this eventuality could be avoided as the only way to legally establish a national currency within the confines of UK law would be to establish it as a local currency pegged to Pound Sterling. It would therefore be inevitable that in the immediate aftermath of independence, the Scottish government would have have to pay higher interest rates. Once again this would seem that the new currency would in many ways look like the current Scottish Pound, apart from perhaps in name and appearance.
A report released in 2013 details the Bank of England’s policy on local currencies. The Bank’s policy on local currencies is that they should not be treated as banknotes but rather as local vouchers. The Bank warned that if these currencies were treated as banknotes, consumers that were victims of counterfeiting would question the scheme’s legitimacy, thus causing a crisis of confidence in the local currency. Indeed the Bank argues that because the notes are vouchers they do not have the same level of consumer protection as a banknote from authorised commercial banks. These problems could be overcome by having the Scottish Parliament pass legislation to have all authorised issuance of banknotes invested in a Scottish Central Bank. By doing so the notes would not be classed as vouchers but as banknotes with the same protections for consumers as Sterling. The Bank of England has also stated that local currencies that are pegged to Sterling do not pose a risk to the financial or monetary system’s stability as the money in circulation would not have increased or declined.
According to the Banking Act 2009 the commercial banks that issue the Scottish Pound at the moment require their currencies to be fully backed by risk-free banking assets, which can be in the form of Bank of England banknotes, UK coins, or ring-fenced funds in Bank of England accounts. If a Scottish Central Bank held accounts at the Bank of England containing assets deemed risk-free, it would seem that this authority would still be in compliance with UK law. The Bank of England’s main concern with local currencies is that if such a scheme were to fail, consumers would falsely expect recompense from the Bank.
The solution to this would be for the Scottish government to guarantee that should the scheme fail, consumers would be able to get financial recompense from the Scottish Central Bank, thus transferring the liability of the currency away from the Bank of England. These changes to the Scottish fiscal situation do not change much on the surface, as those using the currency won’t treat it any differently from the current Scottish Pound, but it would make the idea of independence more feasible to potential future creditors.
The next dimension of introducing NSP would be creating a market for it and ‘selling it’ to the Scottish people as a credible alternative to Sterling. If the Scottish government were to establish this Sterling replacement as a local currency that could only be issued by institutions supported by a central bank in Edinburgh, the Scottish government could legislate to pay all government workers and contractors in this currency. Because NSP was pegged to the British Pound these employees would not see a decline in their wages, and, if done with enough public warning, businesses would deem it necessary to accept this new currency. Indeed, there are a number of practical reasons that businesses would allow for customers to pay for goods and services in this new currency.
Firstly, accepting the new currency would enable big businesses to effectively use the currency as a marketing tool to promote their brand as a Scottish company. In addition, small businesses would be able to use NSP as a way of keeping capital in local communities rather than that using money that could go to other parts of the UK. The long-term risks of not accepting the currency would be too great as well. Even if a business ignored the fact that the currency would be backed by a Scottish Central Bank and that these notes would be redeemable from that monetary authority, businesses risk being alienated from a section of the population.
For example, imagine that there is a town in which there are five coffee shops. Of these five shops two are independently run and the other three are chain shops. If the two independent coffee shops decided to accept the local currency, all those government employees that were paid in NSP would go to these shops. In order to maintain their competitiveness with these two independently-run outlets, the chains will eventually need to accept the new currency as well. By accepting NSP at the same time, these chains would prevent the independently-operated shops from cornering a portion of the market, and if they delayed accepting the currency the consumers that used NSP would become a new loyal customer base for their competitors. The Scottish government could easily cultivate this interest among independent businesses, for example through offering tax relief, and then market forces would force larger outlets to follow suit.
By enacting these currency reforms the Scottish government would be able to, in effect, create a national currency without exposing the Bank of England to any additional risk. Simplifying the Scottish financial system would prepare the country for independence, as it would make negotiations with London after a second referendum much easier with liabilities from the Bank of England easily transferable to the established Scottish Central Bank. Indeed in the short-term the creation of NSP as a local currency would boost economic growth in Scotland and make the country more financially self-sufficient.
In the event of a second referendum, the existence of a strong Scottish currency will not remove all talk from unionists of potential instability after the Bank of England is removed as the lender of last resort, but it would silence any claims of Scotland looking to join the Euro. In order to settle this issue, Scotland needs to rationalise its financial system by severing as many ties to the Bank of England before the next independence referendum as this will strengthen the financial case for secession.
With the Scottish Central Bank ensuring adequate regulations of the financial sector and controlling inflation without interference from London, the market will have fewer qualms about secession. By establishing a currency which is as separate from Sterling as possible, Scotland could make a more financially credible pitch to both potential creditors and the electorate, and this will be essential in convincing the Scottish people to make the dream of independence a reality.