The SNP's Currency Conundrum

Money is a bit of a mystery to most of us. Not just how to get enough to pay the bills, but what is it exactly, how does it get made, and why should we trust it? Most especially, why should we trust one currency rather than another? And in today's frenetic Scottish debates, what currency could an independent Scotland use?


It seems to be a bit of a mystery to the SNP too. In recent years, they've had at least three plans. Back in 2014, Scotland was going to be in a currency union with the rest of Britain. You can see why they wanted to say this - most people in Scotland don't want to lose the pound sterling. The problem is you can't force the rest of the UK into a currency union with Scotland, and actually it wouldn't have worked. If you share a currency, you’ve got to share some tax revenue and public spending too. That's been a terrible problem for European countries like Greece who joined the Euro, but don't get much support from the richer countries for their public spending.


Then there's a new Scottish currency. Sounds great in theory, but how exactly would you get it off the ground? And who would trust it – wouldn't they prefer the pound they already know? If it somehow got going, what would it be worth? Given the big external deficits that the Scottish economy runs (collectively we spend more than we earn) it would devalue quickly. That pound Scots in your pocket would suddenly be worth a lot less in practice. While that kind of devaluation might make good economic sense in the circumstances of independence, admitting it is not a vote winner.


So that's why the SNP have now come up with a plan which is the worst of all possible worlds. We'll just keep using the pound, even though we’re not part of a currency union, everything will be just fine. To see why this is the economics of fairyland, think a little harder about money.


First of all, it's certainly true nobody can stop you using someone else's currency. Some countries do, often trying to escape deep economic trouble. Zimbabwe is one example, where it has not helped, but so is Montenegro, whose financial system collapsed, but is doing better. So why not?


There's a big difference between being a business, or household, and being a country. A country can decide how much of its currency there is, through its central bank. So it's able to ensure that there is enough money around to keep the wheels of the economy turning. It doesn't run out of cash as more can be created, though get that wrong and that cash might turn out not to be worth very much.


But everybody knows you can't do that at home. Households and businesses can't create money, they can only earn it. And a country which doesn't have a currency of its own is in exactly that place. It's got to make sure that there is at least as much cash coming into the economy as going out of it. Otherwise it will simply run out of money to finance day-to-day transactions.


So countries which use somebody else's currency have a real problem. They can't create money, or alter its exchange rate with the rest of the world. Because they can’t create it, they have to earn it, or maybe borrow, if anyone will lend. But if like Scotland they’ve got a big deficit on the balance of trade and public spending, the demand for borrowing – in somebody else's currency – gets bigger and bigger. The only solution is austerity to balance the books, and not just in public services. There are no other options available because you have thrown away those critical tools of economic management – money supply, exchange rate.


This isn't just economic theory. History tells us it’s what happens if you tie yourself to someone else's currency when your economy is different from theirs. It's the story of the Republic of Ireland from the 1920s onward, until they stopped using sterling, after decades of unrelenting economic squeeze.


This is what happens if you let political wishful thinking decide your economic policy. None of the options for a Scottish currency is anything like easy. Getting out of a currency union is very hard, and launching a currency that people will trust exceptionally difficult. But condemning your population to years of austerity in the public and the private sectors because you haven't the courage to tell them what the challenges really are is a gross dereliction of duty. It's extraordinary that Nicola Sturgeon is prepared to contemplate it.


By Jim Gallagher



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