I have had several enquiries this morning (mainly be email) about the article I have in The National in Scotland this morning. Ths is typical:
Is there any risks from attacks on a Scottish currency in international money markets if, say, Scotland was running a big deficit? If the supply of money is independent of that process then presumably there isn't a direct threat, but the currency could still be devalued sufficiently on international foreign currency markets to destabilise the currency couldn't it?
My answer to this is that there is none, but the reasoning needs to be worked through.
Remember currency attacks only work if a government is determined to hold an aspect of its currency management fixed and speculators want to exploit that determination by forcing a change in that aspect of the currency onto the government in a way that will inevitably involve a price change to their advantage. They're not doing this for any other reason, after all.
Let me unpack that a bit. The two things that a government may want to hold fixed with regard to its currency are its value, reflected in the exchange rate, and it is interest rate. The third dependent variable is the amount of debt in circulation, which used to be considered a matter largely beyond its control. I'll return to this third point in a moment and stick with the first two for now.
A government might want to fix an exchange rate for three reasons. First is the old fashioned one of national pride. This departed the scene with floating exchange rates in the 70s. The second is because it has agreed to do so. This was why the UK was vulnerable to attack 1992: it had agreed semi-fixed exchange rates with Europe that speculators knew were economically unsustainable on the basis of trade fundamentals. It laid itself wide open to attack as a result. The third reason is to control inflation. This is pretty much a forlorn hope in exchange rate management: if trade indicates that the currency needs to fall in value come what may it will. A government needs to let that happen and address the domestic issues that necessitated the move in value (lack of investment, poor products, poor productivity) instead of wasting money supporting the currency. It would also better tackle inflation with changes in domestic tax rates than intervene in international markets. The important point is that if it agrees on all these three things it cannot be held to ransom on the exchange rate. The risk disappears.
On interest rates the threat is from the bond markets that might refuse to buy new bonds issues unless the rate rises. This threat was possible when it was thought a government had to sell its bonds come what may - effectively the third, uncontrolled, variable noted above. But this risk no longer exists because QE now eliminates it. If there was now a market based attack on interest rates it would require the sale of bonds already in existence to force their price down. And the answer to that now is that a government would just buy those bonds back and so neuter the attack using QE. The weapon the attackers used - that there was no other buyer for debt and so governments were beholden to markets - has gone because the government can itself be a buyer. The interest rate weapon is history.
To put it another way, Scotland will not be beholden to markets if it chooses not to be so. But it has to have its own central bank and currency to achieve that. Nothing less will do.
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Richard, this message about national governments’ power to decide on their own funding policies independently of “international finance” appears in many of your blog posts. The problem is that the mainstream politicians, media and economists still think otherwise.
A few weeks back no less prestigious a publication than The Economist magazine said, in an article on Jeremy Corbyn and the Labour Manifesto, that “…increased public spending would damage international confidence and risk capital flight”.
Why do they not see QE as a valid tool to control the bond markets in the same way that you do?
I have no idea
“I have no idea”
I do (and I will enjoy sharing it). A. Pessimist should know that Conservatives and Neo-liberals are intellectualy stuck in a delusional time-warp where they implicitly assume that “capital” is desperately scarce and “flight-risk” a frightening threat.
In an industrialised world characterised by weak consumer demand, income inequality, ultra-low interest rates and debt-fuelled bubble markets, “capital” is anything but scarce. The world is awash with funds looking for places to invest. Those that are risk averse are recieving very low returns on account of historically low interest rates.
Those that are not so risk averse are caught up in speculative (ponzi) financial markets whose fortunes are unsustainable and bear no discernible relationship with the real economy. The reality is that is that if one source of capital flees there will be another to take its place.
Folks like those at The Economist should know better by now. These assumptions about capital and flight risk are clearly at odds with some of their other commentaries. It is as if they’d just gotten so use to same old script over the past 30 years that no one had bothered to check for consistency or change it.
Such things sadly predictable and patently redundant.
Sad reflection on both the Economist and any society which holds it in high regard that a publication apparently so dedicated to the spread of misinformation should be regarded as ‘prestigious’. I’m reminded though that, once upon a time, serious, well-meaning and highly respected people, perhaps even those regarded as prestigious, were convinced the Earth they stood astride was flat. Times change. Let’s hope we’ll be seeing change in our time, and soon.
This always has the heads of the neoliberals spinning round on their shoulders. Seems to make them very angry.
If its not insolvency it will be the predictable wiemar and Zimbabwe arguments being rolled out by the mainstream in the coming months in connection with independence.
“If there was now a market based attack on interest rates it would require the sale of bonds already in existence to force their price up. ” Shouldn’t this be “force their price down” ? Selling pressure reduces prices, buying pressure raises them, right?
You’re right – too much haste
It would certainly be a novel approach to counter pressure for an interest rate rise (which are invariablt associated with conditions causing a weakening in the currency) by flooding the market with more of that currency.
The neoliberals wouldn’t see that one coming.
A knew someone would turn up from Worstall
First I made the point that if there was pressure for a fall in the currency it should happen. Did you read what I said?
Second, and somewhat differently, I made the point that QE can deal with bond pressure. Sure it creates new currency. But demand it be placed on reserve and pay no interest on it (as is perfectly legal) and the risk is neutered
Next?
I’m not from ‘Worstall’ whatever that means.
I haven’t argued against the fact that a currency should fall if need be. What I was trying to point out would be that creating new liquidity would exacerbate that problem beyond the initial reasons for the currencies fall.
Could you please explain what you mean by ‘It must be held on reserve and pay no interest’ as that wasn’t mentioned in your initial comment ? Maybe this would provide an insight into why your solution would work. Would this be accompanies by a similar demand that all existing liquidity be treated in a similar manner ?
I am told QE is reversible
I can see no reason why liquidity used for this reason could not be reversed very quickly indeed
The reserve issue was not mentioned because I am writing blogs not text books
The reserves are central bank reserves required of banks. They can be used to take money out of effective circulation
Can your super-duper new blog format advise readers of comments even if they have no wish to comment themselves? Should one simply submit a blank comment, perhaps?
If you submitted a comment saying ‘Comment subscription’ I would add it
Perhaps you should bring that to broader attention and, if necessary, get someone to automate the process.
I’ll ask…
Without wishing to sound too sceptical on this can you explain why Argentina borrows in US$. It has its own currency and meets most of the requirements you cite. Could Scotland be forced to borrow in Euros? Sterling? Us$?
Because it believes it has to
And that’s because it did default because it did do so
Richard
Thanks for link to this. It does not though answer the question I see being asked : how does Scotland pay for international trade ? Do we trade in-country in £Sc and use £/€/$/¥ for international trade ? If so that surely relies on an exchange rate mechanism.
Having visited Iceland earlier this year it was very interesting to see their use of currency internally to push societal equality. One side effect being that those who visit find the country amazingly expensive whilst citizens are comfortable.
Very interested in your perspective.
You trade in whatever people in Scotland decide using a floating exchange rate
I am not sure what the issue is
The issue is acceptance of a new Scottish currency by the market and into a floating exchange rate mechanism plus being able to ensure, as you have stated, there is a degree of stability in said exchange rate.
The South East Asia currency crisis is I think a prime example of what can be done to manipulate a country’s currency.
You probably have a better understanding of the mechanisms but from the angle of having working in global companies I do have a concern here about international payments whihc it wiuld be good to allay.
You trade in whatever people in Scotland decide using a floating exchange rate
“People in Scotland”? I don’t think so.
The seller quotes and subsequently invoices in a given currency and the buyer agrees to pay in that currency. So the counterparty abroad will agree to pay or will invoice, as the direction of trade determines, without reference to the “People in Scotland”.
This is basic international trade stuff and whether the buyer or seller, as appropriate, lays off the foreign exchange risk or whether the trade is accompanied by a confirmed l/c has no bearing on the nature of or participants in the transaction itself.
The state has a role potentially in limiting or forbidding the convertibility of its domestic currency through a ban or by exchange controls like the UK Exchange Control Act 1947 (as subsequently amended in later years). Alternatively, the state can allow the markets to determine the relationship between the domestic currency and foreign currencies which policy is the most favourable for foreign trade in both directions as well as being the one which you plump for, rejecting the alternatives. The “People of Scotland” may not agree with you on that.
I have traded internationally
And I have negotiated currency
My point was correct
Richard
As a progressive I find the idea that a fiat currency could pay for universal healthcare, job guarantees, education for life, etc without consequence very attractive.
My question is why do you think it isn’t already happening? Why do any countries (with their own central banks) have currency crisis? Surely, it just needs one to turn on the ‘printing presses’ and others would follow?
The idea is promoted by a handful of economists
It seems that politicians and economists are revolted alike by something that has been known to be true for decades
I cannot yet explain why
Somehow that feels unsatisfactory. It would be just as attractive to a Putin or Erdogan as a way of rewarding/bribing their populations and yet no one dares do it?
They have other means at their disposal
I have traded internationally
And I have negotiated currency
My point was correct
The clue is in the word negotiated used by you here in its generally accepted sense rather than more technically as with letters of credit or other negotiable instruments and yet you appear to insist that one party can unilaterally decide the currency of a trade transaction.
I never pretended anything other than negotiated
I never pretended anything other than negotiated
In that case we’re of one mind – the currency in which settlement occurs is a matter for the buyer and the seller to negotiate as indeed is the price in that currency for the goods or services being traded.
The “People of Scotland” have no locus in the matter and if the state were to introduce regulations that controlled the flows of foreign exchange, and bullion too for that matter, this would be a constraint that would undermine international business for Scottish business.
I’m obliged to you for allowing me to clarify what it was you were driving at.
Did I mention capital controls anywhere?
I think this is why the Scottish/US economist, Mark Blythe, thinks it would take a good 5 years to set up a Scottish currency. It takes time for confidence.
There is certainly a potential problem in that so much of international Scottish trade is now conducted in Sterling and with an English (head) office importers or exporters may feel more secure by choosing not to change. Although I also don’t think Scotland should ever be happy to make itself as an independent country lower than Coca Cola in turnover.
Still, we mustn’t forget that the Bank of England was started by two Scotsmen…
I don’t buy the turnover comparison
And Scotland would be a mid-sized state in the world rankings
As I recall Krugman rightly calls this the “confidence fairy”.
Denmark and New Zealand are of comparable size and do just fine with their own independent, sovereign currencies. Scotland is easily large enough to qualify as an Optimal Currency Area according to the original Mundell concept.
I agree
But surely the EU proves you need to be a big beast to get Google or Amazon under some sort of control. Little Scotland or little England or even Little UK couldn’t manage it!
I agree. The EU gas many merits.
The euro is not one of them.
“Little UK” wasn’t really trying.
Did I mention capital controls anywhere?
Yes: A government might want to fix an exchange rate for three reasons…
This implies capital controls where a currency is over-valued and the establishment of the Sterling Area was designed, as you know, to establish a sound overseas deposit base at the Bank of England and preserve the value of sterling against the US Dollar. A fixed exchange rate and capital controls can go hand in hand, as you will agree.
You appear, quite rightly in my view, to favour floating rates determined by the market which obviates the need for capital controls. We also know from contemporary observation that capital controls curtail economic activity and historically from places that your correspondent Scott Egner refers to as the predictable wiemar that fixed exchange rates and expanded money supply in the wake of the Versailles Treaty prejudice economic well-being.
I then went on to sa Scotland should not do that
Simple follow up from non-economist : Denmark, NZ, Iceland are often quoted. What mechanisms do they utilise to be able to carry out international trade and protect their currency ?
Also have to say I agree wholeheartedly with a Scottish currency but think we need to be able to explain to the man in the street who would be lost already in this thread.
They have no special arrangements
They trade
They float their exchange rates
They offer sensible interest rates
Iceland,nowhere in crisis, used exchange controls
They do what you would expect
So too would Scotland
It does not need more than apply a modern understanding of economics
Stop looking for a problem that is not there and a Holy Grail that is not needed
🙂
Richard you and I both know if we do not ask the awkward questions the opposition will and unless we have solid fact and example based answers again the currency question will let us down.
It really is that simple.
But I have answered the question