The London based Institute for Government has opined on Scotland's currency options in the event of independence. The result is, unfortunately, very London-centric.
To give credit where it is due, they have noted that:
[T]hree currency options – a formal currency union with the rest of the UK, joining the euro, and ‘pegging' a new Scottish currency to the value of another – are not initially viable.
In other words, the only possible option for Scotland is independent is its own, free floating, currency, which is exactly as modern monetary theory would suggest appropriate. Debate on any other option is, to be candid, meaningless.
It's also unnecessary. Given that exchange rates are largely set by relative productivity rates after hot money flows are taken out of account then Scotland should have little difficulty in establishing a stable currency settling just a little lower than the pound (which will assist Scottish exports) after independence. This is a rate differential simply reflecting the absence of the hot money that the City of London generates.
Thereafter the report goes downhill. Its assumption are fourfold, although it is not explicit on them all:
a) Scotland will run a deficit of 8%;
b) Scotland will be dependent on international money markets;
c) Scotland will not be able to use QE;
d) Scotland will not be able to fund its own deficit from Scottish sources.
These assumptions are wrong. First, that deficit is based on data within the Union and is rigged to suggest that Scotland has higher deficits than it actually has. Do we need to keep revisiting this debate when even GERS makes it clear it is no indicator on this issue?
Second, it would seem that the Institute for Government has not noticed that the Covid pandemic has proved that countries do not need to borrow to fund deficits. It's simply staggering that they have not.
That, of course, is linked to their overlooking QE, which Scotland could do if it had its own currency and central bank, which is the only option the Institute for Government suggest possible. It is a very basic error on their part to ignore this.
And last, there is the rather odd assumption that the Scottish people would not be willing to lend their own government money after independence. As in the rest of the UK there are substantial savings owned by Scottish people. My research has shown that maybe 80% of UK savings are tax driven as to their location. This is likely to be true in Scotland, therefore. If the Scottish government decided that it wished to change tax incentives in ISAs, pensions and its own range of savings accounts to encourage people to save with it then that would very likely be successful in raising significant funds for it. The dependence on foreign money markets could be eliminated.
Better still, my solution puts Scottish savings to work, when at present few of those savings will actually fulfil any useful function within the economy. Much will be lying dormant in bank accounts earning almost nothing. And by Saving for Scotland what people will also do is provide the capital for the solid foundation of their new state - and in the process help build it for the generations to come. As a move towards national solidarity little could work better.
The Institute for Government looked for a problem and found it.
I looked for a solution and also found it.
Which of us is right? Might I suggest it's the one who thought a little harder and worked out how to answer the question?
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Hi Richard, would there even be a requirement to borrow from the people like that? From my (very basic) understanding borrowing money is a means of controlling the interest rate and/or taking money out of the system to prevent it being spent and therefore causing inflation. By normalising government debt and borrowing are we just feeding into the neoliberal myth that they are necessary?
The Scottish government will run a deficit. It need not borrow of course, at all. It can just run a deficit on its central bank account, and no one could stop it doing so. But it could also entirely avoid foreign debt is the point I am making. But neoliberalism does not come into this. This is government funding without the dogma attached. The IfG do not even appear aware that is possible.
I understand and totally agree on foreign debt. I do not like what I hear from SNP on taking their share of the debt as if it is some noble gesture to appease the markets, especially with plan to continue using the pound.
Incentives can change savings behaviours in an independent Scotland
Incentives can change where savings are located as well.
It follows that:
Tax changes can change behaviours in an independent Scotland
Tax changes can change where retired people and working-aged people locate themselves.
Glad we’ve got that sorted.
I guess you know what you are trying to say
Saving in this way would certainly appeal to me, as someone currently in the process of relocating from England to Scotland.
I am not sure that the SG would need to entice Scots too much to invest in their own country. Yes, there will always be the me me me attitude of some, but there will also be those willing to lose a little to aid the majority.
I have savings. Like most I try and get the best return that I can on them. After all despite your (sometimes persuasive) arguments I don’t like to see sixty years of scrimping gradually being eroded to less than when I started. Having said that my wife and I have put the maximum amount allowed into the local Credit Union. Not for the return, which we could find better elsewhere, but to benefit those in our community whose need may be more than ours. Saving with the Scottish Government of an independent nation would simply be looked at as a national Credit Union without an upper limit.
So bring it on, I’m all in!
I think this could really work….
This is a flaccid effort from the IOG. It begins by noting that the Scottish Government has little borrowing power, then frames the next sentence as follows: “The UK government borrows from international debt markets on behalf of the whole of the UK and repaying the debt is the UK government’s responsibility.”
This strangely worded statement may easily imply to the casual reader that the UK requires to borrow all its money internationally, and that means ‘overseas’. Framed in this way it would clearly provide a particular challenge for a newly independent Scotland. There is a challenge for Scotland, but not as so insidiously framed by the IOG.
In fact, according to HM Treasury Debt Management Report (TDMR) 2019-20; for the UK, 10% of borrowing is NS&I, 3% TBs, and by far the largest amount is in Gilts of various kinds, made up broadly as follows: “At end-September 2018, the 3 largest investor groups of gilt holdings continued to be insurance companies and pension funds (32%), overseas investors (28%), and the Bank of England’s Asset Purchase Facility (24%)” (TDMR, p.21, Para A.8, and in chart form, A9). Thus broadly 28% of Debt was identifiably overseas in 2019. The Asset Purchase Facility is effectively QE, ‘debt’ owned by the Government itself, and this ‘debt’ is now much larger following Covid-19, for 2020-21.
According to the House of Commons Library, The Budget Deficit: a short guide: “At the end of 2020/21 [UK] public sector net debt was £2,138 billion (i.e. £2.1 trillion)”. This is not £2.1 trillion of overseas lending, for as we have seen a very significant proportion is now owned by the UK Government, and by large numbers of UK citizens who hold their funds with the UK State because they are ‘safe assets’, in their own currency.
It should be noted that the UK structure of its debt is based on decisions of UK Governments, given its particular history and positioning in the world, and specifically as a major international financial centre (City of London). That history and environment, and the structuring of debt that follos from the history and circumstances is not only particular to the UK, but in some casess peculiar to the UK (and will continue with rUK as ‘continuator’ state). It therefore cannot simply be superimposed on an independent Scotland.
Thanks
Agreed
This international debt idea is ludicrous
The IFG website doesn’t ask for comment on their reports.
Maybe you could do a short review or comment in a relevant publication – focussing on their assumptions a) to d)?
FT? LGC? Guardian? Scotsman?
The National, most likely
Surely even the most basic economist must know that FX rates are primarily driven by interest rates in different currencies, not productivity?
They’re not
That’s why no one knows that
Every economist knows that exchange rates can drive productivity, but productivity rarely drives exchange rates.
The available data and research shows that changes in productivity have limited impact on FX rates, and can affect the exchange rates in either direction.
Where on Earth are you getting you economics from? It sounds like you are just making things up to suit whatever you are saying at any given time.
Actually, every economist knows the exact opposite.
Try explaining UK / Germany changes without reference to productivity and referencing only interest rates
Can you provide any (credible) economic source to support your claim? There are multiple sources that suggests that Nigel is correct.
Mark Glover
Cite them
And in the world of near zero interest rates explain how that now works?
Real world evidence please
And note Krugman on this and what he says influences long term rates… https://www.nber.org/system/files/chapters/c6948/c6948.pdf
Richard,
As in Krugman’s paper, many factors affect real and nominal exchange rates – interest rates being one of them.
One factor he specifically does NOT mention in this paper you link to is productivity. As is well known, productivity has little or no effect on exchange rates.
It might be worth you reading papers before you link to them in future, as this one does not help your case. Real world examples have also shown, repeatedly that productivity is simply not a factor for driving exchange rates. It is very much the other way around, if anything, with exchange rates driving productivity.
You also ask for real world evidence, yet seem utterly unable to provide any yourself.
Have you read the paper?
I suggest you do so and see what he discusses when looking at long term equilibrium exchange rates
Interest rate changes are short term factors and – you might like to muse in this – really do not happen any more
You are, politely, ignoring the evidence
And I note but a single citation again
No more comments like yours will appear
I don’t know why Scotgov is still pushing either a currency union or Sterlingisation. Both would be a disaster for a new nation trying to build new ministries and institutions, fund more patrol boats and planes for eg.
They are wilfully ignoring the excellent work Commonweal and the Currency Research Group have done to demonstrate that a Scot£ would work, be cheap and easy to set up (every new country has done it). Also the fiscal levers it would allow would be unobtainable any other way.
And of course we cannot join the Euro without first having an independent currency be stable in ERM II for at least 2 years. Those are the strictures. Sterling will not count of course. So even if we want to join the Euro (No from me for some time post Indy) it will take years before we can even consider it.
Those who posit that we adopt the Euro are either ignorant or being deliberately obstructive.
Never go near the euro…
Peter, we’d be mad to adopt the Euro: firstly we’d have to create our own sovereign currency to be eligible to join the EU and also agree to adopt the Euro at some undefined future date, so we’d have much greater fiscal flexibility in the interim period. Why give that up, lose that flexibility and be subject thereafter to the ECB’s regulations and policies? Admission to the EU requires agreement to adopt the Euro, but no date is specified and subsequent adoption has never been enforced. There are currently eight EU member states which have not adopted the Euro (Czechia, Denmark, Hungary, Poland, Sweden, Bulgaria, Croatia and Romania) and of these Sweden has been in the EU since 1995 and has still to ratify the Euro Treaty. Denmark has been in the EU since 1973 but has an opt-out from using the Euro, albeit the krone is effectively pegged to the euro (within a margin of ±2.25%).
While the SNP has stated a desire to join the EU once independence is achieved, there are alternatives to full membership which may be more appropriate bearing in mind that we have to reach a negotiated separation from rUK before EU membership can be achieved. That settlement with rUK may involve trading and border agreements which might make full EU membership impossible. However that shouldn’t preclude closer alignment with Europe: membership of EEA, EFTA and ECU are alternative possibilities. The point is clear: nothing definitive can happen until we’ve got a clear secession agreement with rUK, then the appropriate application(s) can be made.
So the intention is to sign up to the Euro with no intention of fulfilling the agreement. And you’re going to make this public upfront!
This is priceless stuff! And yet you criticise Johnson for ‘not acting in good faith’ for trying to re-negotiate a deal that has been agreed, but which is clearly not working for either party.
There is no duplicity at all. There is a desire to join the EU but not the euro. That’s completely honest. The problem is all yours. And I note you are a practiced troll so please do not call gin.
Your ‘Krugman’ paper is nothing to do with short-term exchange rates , which are driven by interest rate differentials and supply and demand factors (‘the basis’).
Have you read the paper?
It’s very clear you have not, because it rejects your claims.
Now politely, don’t waste my time again with your nonsense
I have read the paper. Looks very much like you didn’t though.
At no point does it mention productivity at all. Not once.
So why are you trying to use it as an example of economists saying that productivity drives exchange rates?
Weird
Just word search it
It’s really not hard
And this debate is over
There is absolutely no point in Scotland borrowing from international markets. ScotGov will need S£ for its spending and in the early years international markets will have zero S£ to lend whether they want to or not. What would happen if ScotGov borrowed e.g. US dollars? Well it can’t spend dollars in Scotland so they would have to be exchanged into S£. That would mean ScotGov would sell its dollars to the Scottish Reserve Bank which would create new S£ and credit them to the Finance Ministry account. So the SRB has now added the dollars to the FX reserves, ScotGov has in effect got new S£ from the central bank so has lent itself the money, and meanwhile we are now all paying fees and interest to the international market for the privilege of lending ourselves S£ and parking the US dollars in the SRB correspondent central bank account at the US Fed in New York. That would be total madness. Cut out the international markets and just have the SRB grant an overdraft, or sell a bond to DOMESTIC investors in S£.
Agreed
Could you elaborate a bit on this point – “dependence on foreign money markets could be eliminated”?
What is the dependence on foreign money markets? How much is it likely to amount to?
In any case, I’m interested in the mechanism by which borrowing from the public sector avoids this, and would be grateful for an explanation.
See my National column tomorrow
I’ve seen that online already this evening.
Very clear, although I wish the National had waited till tomorrow and put a bit more effort into checking for typos.
They are not the best sub-editors, and I do make typos – as everyone knows
Everyone also knows it is very hard to see them in your own work
I don’t understand economics very well but its so refreshing to read your work on it and rebuff the lying Westminster mob , they will say any thing to try and stop Scots from being independent , I know that nearly all my friends and family will work their socks off to make Scotland a better place for our people , thank you Richard
With apologies for coming very late to this piece, and also my apologies that I have not read through every comment above. A couple of thoughts: provided that banks incorporated in Scotland remained so, the Central Bank would have an immediate market for its paper for reserve purposes. And as a now ancient ex-forex dealer, recalling what can happen when traders decide to wade in and short their positions, there is a residual concern about the harm caused by volatility for no other reason than that dealers do that.
Thanks