Monday, 15 September 2014

The Scottish Referendum: The Pound and Why All the Fuss?

Friday morning and we shall all know.  Until then, footwear will be worn out, voices cracked, keyboard tapped and nerves frayed.  Televisions and radios will be sworn at.  Friday will see desolation for some, manic celebration for others.  The weekend will pass in a similar vein. 
Come Monday, that is when the hard work really begins.

Whatever is the outcome of the vote on Thursday, we all know that the referendum campaign has changed Scotland and the United Kingdom for ever.  If Scotland votes No and stays with the Union, at least that is one variable out of the equation: we get to keep the pound Sterling.  If it is a Yes vote, Friday will still see me spending my pounds at the local ASDA.  The question for all of us is what will we be buying our groceries with in a couple-three years time?

There are several options, the first of which is to keep Sterling: the preference of the SNP.  They want to enter into a monetary and banking union with the UK government, thus retaining some influence with the Bank of England, whom the last Labour government made independent.  Of course, it would take the most leaden of intellects not to see the irony of the position: “we like your currency and financial system, just not you.”  There has been currency union since 1707, when the pound Scots was exchanged at a rate of twelve to one for pound Sterling.  The claim continues though that it would be to mutual benefit to both nations.  Let us have a closer look at this.

Staying in monetary and banking union with the UK would certainly be a good deal for an otherwise independent Scotland.  Up to now, Britain has managed to retain a triple A rating with the financial markets, meaning that government bonds are of the highest safety, thus being able to pay out the lowest of interest rates.  In other words, the UK can borrow money cheaply.  Introduce more risk and borrowers to the state would wish to see a higher return to offset the chance of the country defaulting upon repayment.  Scotland’s credit rating will be higher than if standing alone financially because if a bank should undergo a crisis, the Bank of England remains the borrower of last resort.  Great for the Scots.  Trade would also be stable as there would be no additional currency fluctuations or bank charges.  Business as usual:  Scotland would remain plugged into one of the world’s largest and most successful financial systems.

The question has to be asked though is “what’s in it for the rest of the UK?”  After all, the claim is for mutual benefit.  True, north-south trade remains but this is of far greater value to Scotland than to England: the main market.  The only real benefit I can see for England is maintaining the value of Sterling.  Scotland does have most of the oil (if one counts Shetland: that is another story) and thus would be the main beneficiary of the tax revenues.  Oil revenues are a major pillar of currency value but in a currency union, that will not matter so much because the revenues are still going to uphold the value of Sterling.  Sterling stays relatively strong.

What happens though if the UK keeps true to its word?  There will be no currency union: this has been stated by all the major Westminster parties.  Sterling falls in value, because current oil revenues are no longer counted towards its strength.  This makes imports more expensive: ironically enough even the price of fuel at the forecourt will rise because Sterling falls against the US dollar: the price of crude rises relatively, owing to the fact that oil and gas are traded in dollars.  The price of imports go up, everything from coffee to televisions to the price of foreign vacations.  There is good news too: suddenly it is cheaper to visit Britain, so one would expect numbers of tourists to rise.  It is also good for export business, as goods and services sold in Sterling also become relatively cheaper.  The effect on business will take some time to filter through; in the meantime the rest of us see the price of many goods rise.
It is not all bad news: government revenues from oil rise as a result of the strong dollar-pound rate.    The Scottish government though is under an imperative to build cash reserves because the Bank of England is no longer the lender of last resort for Scottish banks.  In order to avoid a run on Scottish banks, there has to be a credible lender of last resort.  That in tern will mean a new Bank of Scotland, an alternative to the Bank of England..  Since that title is already taken, let us call it the Scottish Central Bank.

The Scottish Central Bank has to be set up, initially to secure the future of Scottish banking.  That still leaves Scotland without control of its own interest rates or money supply and thus with absolutely no control over its own economy.  This is denounced for the craziness that it obviously is, and the Scottish Government decides to launch our own currency.  The pound Scots (abbreviation £Scots) is reborn.

Celebrations all around.  It maybe the case that now backed with oil (assuming both the Scottish government have honoured their share of taking responsibility for UK debt and have also being willing to issue bonds at inflated rates demanded by the money markets) the £Scots gains in value.  It is even conceivable that, as the Irish Pund did in the 1990s, it on occasion even excesses Sterling in value.  The Nationalists burst with happiness.

Here is the bad news.  The rest of the UK is still Scotland’s largest market, regardless of currency, just as the UK is still Ireland’s largest trading partner.  Geography is an inconvenient truth that ignores sentiment and politics.  Now trade both ways faces exchange rate charges and the added volatility of oil price fluctuations.  Proportionally, the stress is far more upon Scottish firms than UK business, purely on proportion of overall business done.  Just as Ireland has to turn their best minds to getting the advantage in trade with the UK, the same will happen in Scotland.

Throughout this essay, I have referred to oil and it is worth taking a moment to consider its long term future.  Now the Yes campaign will tell you, with truth, that there is still years of production ahead and there are new fields to the west of Shetland.  

What they will not tell you is this: 

The graph above are based upon figures from the UK government website linked here.  I have not updated it for 2013 but as you can see by following the link, the production trend is still downwards.  From the peak in the late 1990s, both oil and gas production has fallen by 70% and both proven and probable reserves have also fallen.  It is true though that oil and gas production are still important: when the Buzzard field went offline in September 2012, it nearly threw the UK economy into a triple-dip recession (report here).  
If one field shutting down for a month has such an effect upon the UK economy as a whole, imagine the effect upon the far smaller Scottish economy.  It is important because business needs stability, they need to be able to plan ahead with a degree of confidence.  An independent Scotland may offer dizzying heights but equally abyssal lows.  Especially over short time frames, both are equally damaging.  This is what economists call volatility. 

We are not yet finished with the currency though, so please forgive the digression.  To return to the narrative, Scotland now has a central bank and we also have the £Scot.  The next big question is whether we rejoin the EU.  Like the rest of the United Kingdom, there is divided views on this.  One of the reasons I am voting No on Thursday is that I will not cast a vote to leave the European Union.  Let’s give the SNP the benefit of another doubt though and think through the end game for the brief life of the £Scot.  Its life as a currency would be brief owing to the fact that new applicants would be expected to join the Euro Zone as condition of entry.  The process is never swift: negotiations take years, sometimes decades.
The alternative would be to join EFTA, the European Free Trade Association, and go the way of Norway and Iceland.  This maybe economically appealing but in order to really work, I believe it takes a Scandinavian mindset - a willingness to be truly fair to each other in society and be united.  This unity is both in the view of the outside world and within society.  As an academic from the University of Edinburgh recently observed on the Today Programme, Scots believe themselves to be more progressive and tolerant that the neighbours to the south.  When views and beliefs are actually measured though, we are all pretty much the same in outlook across the entire United Kingdom.  We all think British, because we are British.  No matter in what high regard we may hold our neighbours, we are not Scandinavian.  The division with Scotland caused by the referendum is enough to prove that case.

There is two alternatives ahead on us on Thursday.  To vote, regardless of consequences, Yes for an independent Scotland.  The SNP are keen to emphasise the benefits of independence while at the heart of their campaign is a single dishonest word: scaremongering.  Exploring the avenues, looking ahead and assessing the possibilities, that is not scaremongering.  That is making an informed choice: a choice that by using terms like scaremongering and Project Fear, the SNP have been keen to shut down.

I am making an informed choice on Thursday by voting No. 

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