How Osborne’s Currency Roulette Backfired

How Osborne's Currency Roulette Backfired roulette-300x263
Pic: Rod Fleming

Well, what a fascinating weekend we just had in the Scottish Independence campaign. After weeks slowly getting redder and uglier, the boil of the ‘No’ camp – often known as ‘Project Fear’ – burst and showered its surroundings in a thick layer of pus.

 What happened was that an allegedly senior but unnamed Tory Minister admitted the truth: George Osborne’s assertion that there would never be a Currency Union between England, Wales and Northern Ireland (EWNI) and an Independent Scotland, was a lie. It was just another filibustering bluff, the latest in a long series of such from the bottom-feeders who slither along the corridors of Whitehall.

 This admission, that the second most senior member of the ‘British’ Gummint, had been barefacedly telling porkies, was made to The Guardian newspaper, which ran big with it, and yesterday’s Sunday papers, well, the Scottish editions, followed suit. The Mondays are full of it.

 Project Fear had seen its Belgrano torpedoed. Even the doughty Scottish First Minister said Project Fear had been ‘holed beneath the waterline’ and sinking ships analogies are flying thicker than Exocets around the Falklands.

 But, just like that unfortunate Argentinean dreadnaught, the threat was always a fake. It was meant to give the impression of strength, from a position of catastrophic weakness. In the days after the Osborne announcement, many commentators, including me, pointed out that if EWNI didn’t want formal currency union with Scotland, well tough, we could still just use the pound – and by the way, refuse to bale out the massive national debt run up by incompetent plonkers that Scotland did not elect.

 However, this penny seems to have got caught in an anti-gravity field, because apparently it never dropped. In part this is due to the antics of Scotland’s journalists, who clearly have been hitting the MacEwan’s too hard. Or maybe there’s another shilling they’ve taken.

 The Pound Sterling is floated openly on the world’s currency markets. Anyone can buy and use pounds, and people do all the time. They’re called currency traders. Furthermore, the people in Scotland don’t have to buy pounds, we have them already; EWNI has no powers to ask for them back.

 So Osborne’s threat was always just so much wind and piss, and most people laughed it off – except for the professional journalists who are actually paid to get things like this right. Oh my.

 Some of this confusion may be – and I am being so charitable it hurts here – because some people do not understand the difference between a formal currency union and just buying and selling pounds. Anyone can do the latter, and there’s not a damn thing the EWNI Gummint, or for that matter, the Old Lady of Threadneedle Street, could do about it. Didn’t these people ever hear of George Soros? Central banks all over the world got their fingers badly burned when they tangled with him, an independent currency trader, who bought and sold their currencies without a word of by-your-leave.

 Have we forgotten how the UK was forced out of the European Exchange Rate Mechanism in 1992? After the Bank of England had blown billions to shore up the pound (from its own holdings of other people’s currencies) it collapsed, and that was that. The UK was squirted out of the ERM like a melon pit squeezed between finger and thumb. And why did it collapse? Because currency traders were flogging it shorter than Tunnocks. Other nations’ central banks, along with corporations and individuals like Soros, were buying and selling currency in huge volumes, and they still do exactly the same. Currency speculation is a big earner.

 (You may question how it comes about that one can make money by buying and selling money and never a penny actually changes hands; but it’s all imaginary, you know. You just have to suspend your disbelief.)

 So how on earth did it ever get into anyone’s head that the Bank of England could prevent an independent Scotland from doing exactly what everyone else does? Oh yes: it suited the Project Fear party line.

 Buying and selling money is not a currency union. As far as I know, George Soros has no treaties with the Bank of England. He just uses its money. Just as  Scotland would.

 A Currency Union, on the other hand, is what the states in the Euro-zone have. These are independent, but they share a common central bank. There are other ramifications to currency unions, which are set out in the binding treaties that the countries which use the Euro are expected to honour (but don’t always.) However, the main point is the shared, common central bank, in this case the European Central Bank, or ECB, which is in Bonn. This bank sets the interest rate across the Euro-zone, and controls the money supply. It is obliged by its charter to act in the interest of the common weal, to favour no one country.

 In a formal Currency Union between Scotland and EWNI, the Bank of England would play this role and the treaties which would have to be agreed and signed between the two parties would ensure that it too, was an honest broker that acted in the common interest of both, and did not overly favour one or the other. This is a far more binding and complex solution than just using the pound.

 Why would an independent Scotland want to use the pound anyway? Well, the first reason is that a great deal of business is done between Scotland and EWNI, and using the same currency reduces the costs of transactions, or rather, does not introduce any. That’s straightforward enough. The second is also simple: we already own a large amount of pounds, so going on using them further avoids costs.

 The third is more complex, and also seems to have escaped the pundits, but in this case we are inclined to think this is because they don’t like the idea: an independent, uniquely Scottish currency risks being too strong. I’ll repeat that, since it clearly isn’t being heard. Scotland’s economy is so strong that its own currency might rise dramatically and this would make our manufactured exports much more expensive to our customers.

 Since Scotland is an exporting nation, this is would be very bad news. We don’t have the luxury we once would have had of simply slashing our base rate of interest, because globally these are already so low.

 At the same time, we write with a grin of schadenfreude on our phizog, without Scotland’s wealth there is a real risk that the pound sterling would nosedive. It’s not really in Scotland’s interest for our biggest trading partner’s economy to dissolve, even if it might provoke a justified horse-laugh.

 So what Scotland has to do is get round this. Using the pound, with or without a currency union, is an excellent solution. The currency markets look at the overall performance of each currency, so the relatively poor economy of much of England drags the pound down, balancing the economic strength of Scotland
and London.

That is what is happening right now – and it is what would continue to happen after independence, if Scotland uses the pound with or without currency union. The markets are blind to things like nationhood; they’re only interested in the overall performance of the currency.

 However, if EWNI didn’t feel like letting us help them out, Scotland could use the Euro, either with or without ‘joining’ the Euro, i.e. entering formal currency union with the other member states, and we could do this whether or not the member states or the ECB like it or not! Just like the Bank of England, they have no power to prevent us, because the Euro is also a freely traded currency. We  could even use the US dollar, and again, there is nothing could stop us.

 An independent Scotland holds all the aces here; it is the country whose currency we might decide to use that has an interest in currency union, in order to sign us up to binding treaties that would regulate our fiscal behaviour, which might, after all, impact on its currency.

 It has frequently been said that the Bank of England (assuming we use the pound) might want us to underwrite the cost of it being ‘lender of last resort’ to Scottish banks. But here again, misinformation has crept in; at the end of the day, it is national treasuries which underwrite the activities of all the banks operating on their territory. They may act through a central bank – indeed they have to – however it is not the bank’s money that is used, but the taxpayer’s.

 In a currency union with EWNI, all these banks and their liabilities across the joint territory (exactly the same as the UK is now) would be pooled, and responsibility – i.e. the cost of baling them out when they mess up again – would be apportioned by a formula that took account of where they did business, not where their head offices happened to be; and in this case, because the EWNI market is so much larger than Scotland, this would be predominantly the responsibility of the EWNI treasury, with around a tenth due from Scotland. So, no change.

 Without currency union, a Scottish treasury would be responsible for baling out failing banks directly, but only for their activities in Scotland, whether those banks were Scottish or not; in other words, the same difference.

 Using any of the three currencies above – the Euro, the pound or the dollar – are genuine options for us; the first two could be adopted with or without formal currency union, while in the last case, this would not be available anyway. All have advantages; trading costs are much reduced if both partners use the same currency, which is one important consideration. However there are others: the dollar in particular is a global currency, and oil, for example, is priced in dollars, so using it is attractive. Then again, we might wish to politically woo the Euro-zone nations, and using their currency might help there.

 Personally I favour using the pound and refusing currency union with EWNI until such time as an independent Scotland is established and stabilised, and then coming to a final decision, supported by referendum. However, while I by no means agree with everything he says, Alex Salmond is a very capable economist and he favours formal currency union with EWNI. I am sure he must have good reasons, and I am inclined to give him the benefit of the doubt.

 Still, I think he must be very grateful that Osborne has been proved to be a liar, since Salmond’s position had allowed Osborne to play a joker and pretend it was an ace. Having that card safely trumped and the aforementioned thick layer of pus spread all over his opponents must have caused the inner Alex to smile a little.

 But then, Salmond is no stranger to such crises; he’s known to like a bit of a flutter, a common habit amongst economists, so he’s good at spotting bluff. If there were a poker match between he and Osborne, or for that matter, any of the deadbeats populating the UK Gummint, I know which one my money would be on.

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