THE SNP CURRENCY CONUNDRUM

Sturgeon's 'Plan A', formal monetary union, fell apart. Now 'Plan B', Sterlingisation, is disintegrating. The truth is, the currency union we have right now is optimal.

Given the Scottish Government will publish its paper on the economics of independence next week, it is worth exploring the currency conundrum at the heart of the SNP leadership’s current difficulties. Put simply, the optimal currency arrangement for Scotland is what we have right now and the First Minister knows this.

The failed ‘Plan A’: monetary union

During the 2014 Independence referendum Nicola Sturgeon’s first preference was for a formally agreed monetary union between an independent Scotland (iScotland) and the remains of the United Kingdom (rUK). Labelled ‘Plan A’, this was viewed as the closest possible set of arrangements to the status quo ante upon independence.

Envisaged as a way to achieve independence without having to leave the Sterling zone, the SNP had argued a formal monetary union would be a long lasting arrangement. The only problem was, that thinking was a pile of hokum. Closer inspection by the experts revealed the nationalist ‘Plan A’ for currency as trite and unrealistic.

For one thing, a formal monetary union between iScotland and rUK could never be viable long term. It could only ever be a transitional arrangement. As a net exporter of hydrocarbons (oil & gas), an iScotland would be a petro-currency. A petro-currency country is one where the currencies of oil-producing nations tend to rise in value against other currencies when the price of oil rises (and fall when it falls).

That reality means Nicola Sturgeon’s ‘Plan A’ would never have worked. An independent Scotland simply could not expect to successfully maintain a formal monetary union with rUK.

According to Professor Ronald MacDonald of the Adam Smith Business School University of Glasgow, the downsides of a formal monetary union between iScotland and rUK were substantial. In September of 2014 he published a paper which set out why the nationalist ‘Plan A’ was not a sustainable option:

“Our calculations show that because of the petro-currency effect the competitiveness of Scotland’s non-oil export sector will worsen by approximately 7% per annum.

This loss of competitiveness can only be addressed by a dramatic rise in productivity of around 7% or internal adjustment of wage cuts and a rise in unemployment much as what happened in Greece and Spain recently.

The competitiveness of firms trading in Scotland will be volatile and uncertain containing the same risks and costs as a separate currency with none of the benefits”¹

Put simply, the ‘Plan A’ on currency presented by the SNP in 2014 fell apart after it became obvious it was offering up all the uncertainties of having a separate currency but none of the advantages of actually having one. Plus, it was clearly a transitional prospectus not the viable long lasting set of arrangements Alex Salmond and Nicola Sturgeon had promised it to be.

‘Plan B’: “the worst possible” option

After the disintegration of ‘Plan A’, as the referendum was lost and Salmond resigned, Nicola Sturgeon realised she needed to find a new position on currency. She believes she discovered it with the 2018 Growth Commission.

The Growth Commission crafted the SNP’s runner-up plan, known as ‘Sterlingisation’. But as ideas go, this one is stillborn. Professor Ronald MacDonald has said of Ms Sturgeon’s new position:

“Adopting the pound informally – Sterlingisation is without doubt the worst possible currency option for an independent Scotland”²

So we have went from a ‘Plan A’ - which offered Scots all the disadvantages of having a separate currency without any of the advantages of having one - to ‘Plan B’ which is “the worst possible currency option”.

But why would the SNP’s ‘Plan B’ be “the worst possible currency option”? Well, I have written previously about some of the inherent weaknesses with Sterlingisation before. You can read that for more detail and depth, so I will be relatively brief here.

Informally using the pound for an indeterminate period of time after independence (Sterlingisation) would involve the following:

1. No ability to print money

2. Zero sovereign control over monetary policy

3. Absence of any lender of last resort

4. Unable to devalue to boost competitiveness

5. A necessity for disgusting levels of austerity

Points 1-4 are addressed in my other article, so this time I will focus exclusively on my fifth point. The SNP ‘Plan B’ of Sterlingisation would necessitate substantial austerity immediately upon independence.

Sterlingisation would necessitate abusive austerity

Why? Let’s keep things simple. Sterlingisation means no ability to print money (we would literally have no control over our own money supply in the sense that we would have no central bank and be using someone else’s currency without any formal agreements to do so). This means changes to the Current Account of the Balance of Payments would directly affect the supply of money in iScotland’s economy. This, quite obviously, is an incredibly unstable proposition. Let me explain:

The Balance of Payments (BoP) records all economic transactions in goods, services, and assets of the country with the rest of the world for a specified time period, usually a year. The BoP is made up of two accounts, the current account and the capital account. The current account records exports and imports in goods, trade in services and transfer payments.

Sterlingisation means that a surplus on the current balance would increase the amount of sterling in an iScotland’s economy (with the inflationary implications of this). Conversely, a current account deficit would function as a deflator, sucking money out of the economy*

* (remember, Sterlingisation means we can’t print pounds, so if we are importing more with rUK than we export, we’re literally running out of money as its leaving our system and entering rUKs. Less money in the economy deflates whereas more money is inflationary)

To counteract these dangers, iScotland under the Sterlingisation plan would need to build up substantial foreign exchange reserves. This is because we would need to smooth out the effects of the sorts of flows I’ve described. So iScotland under Sterlingisation would need to construct reserves. Professor MacDonald as estimated that we would require foreign exchange reserves anywhere between £40bn-£160bn

“the evidence from other similar sized economies to Scotland – for example the Nordic countries - is you need foreign exchange reserves of upwards of £40bn. But if the Monetary Authority was prepared to offer deposit insurance to the some £120bn of retail deposit accounts (see Armstrong and McCarthy (2014) on this point) it would need to accumulate reserves of around £160bn?”³

So let me ask you: where would we get that money from?

The answer is blindly obvious, the most egregious levels of austerity. Huge cuts to public spending, massive tax hikes and spending reductions across all budgetary dimensions. The social, economic and cultural consequences would be staggering and completely unacceptable to any healthy mind.

The SNP currency conundrum

The First Minister’s policy retreat from calling for a formal monetary union (‘Plan A’) to instead adopting the pound informally (Sterlingisation ‘Plan B’) reveals her currency conundrum.

In a nutshell, she knows the optimal set of arrangements is what we have right now. Currently, we have a monetary and fiscal union and the wider strengths and size of the overall UK economy insulates Scotland from the petro-currency downsides. We don’t need to face any of the risks which come from Sterlingisation and have no need to impose brutalist austerity to make currency substitution work.

But if you want independence, you can’t really accept this reality can you? If your entire political career is built on selling independence to Scots, you can’t just admit that the best set of arrangements on currency is the status quo.

So what do you do? You instead, you end up with ‘Plan A’ until it falls apart under scrutiny then retreat to Sterlingisation (which, likewise, is falling apart under expert examination). The continued reliance on flogging alternative currency options on the pretence it means no meaningful changes to the currency status quo ante of before independence is the stuff of the huckster. The SNP are going door to door trying to trick people into believing that you can have independence without facing up to any of the pain. The ludicrousness inherent in their ever-changing currency policy prospectus demonstrates the SNP’s underlying dishonesty.

The economic case for leaving our currency union is incredibly weak, this is why the SNP have been tying themselves in knots trying to pretend we don’t need to.

But for all the nationalist ad nauseum gyrating on currency questions the truth is exceptionally clear: our currency union that we have right now is the optimal set of arrangements. Even senior nationalists such as Nicola Sturgeon and John Swinney admit this. Just listen to them - in their own words - saying repeatedly that currency union is the best set of arrangements for Scotland:

So, if a currency union is the best thing for Scotland…and the SNP’s ‘Plan A’ and runner-up ‘Plan B’ both mean abandoning it…why go for independence?

This is the hard truth snoring in the bowels of the nationalist prospectus for independence. The central currency conundrum is, the optimal currency arrangement for Scotland is what we have now. So why bother with independence?

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If you want to read more about the currency union that we have right now, and why it is the best option for us, check out Blair McDougall’s ‘Notes on Nationalism’ Substack article ‘The Case for a Currency Union’.

1. MacDonald, Ronald (2014, 14 September), ‘An Independent Scotland’s Currency Options Redux: Assessing the Costs and Benefits of Currency Choice’, Centre for Economic Studies & IFO institute (CESifo), CESIFO WORKING PAPER NO. 4952 CATEGORY 7: MONETARY POLICY AND INTERNATIONAL FINANCE SEPTEMBER 2014, pdf page 3, file:///C:/Users/User/Desktop/cesifo1_wp4952.pdf

2. ibid, pdf page 4

3. ibid, pdf page 10