The big deceit at the heart of Alex Salmond’s Yes campaign

It is extraordinary that Scots could think monetary union with Westminster perfectly compatible with full scale independence

Scottish First Minister Alex Salmond covers his eyes with branded cakes reading 'AYE' during his visit at Browning Bakers in Kilmarnock, Scotland, Britain
A Yes vote in nine days' time is going to create myriad problems for everyone, but nowhere more so than Scotland itself Credit: Photo: EPA

Like Boris Johnson, my sense is that Scotland will eventually vote no. But what a kerfuffle we are seeing in the meantime. A once mighty economic and political power stands on the brink of dissolution. Only now is the world, and the markets, waking up to the potentially seismic geopolitical and economic implications.

But rather than witter on about the threat to Britain’s place in the world, I want to focus instead on what kind of economy awaits if Scotland does decide to take the plunge.

The first thing to make clear is that Scots have absolutely no idea what they are getting into. I mean this in a literal, rather than a patronising, sense, for virtually all the terms of separation have yet to be negotiated. However, one thing is clear. Whatever the outcome of subsequent negotiations on the terms, it won’t result in the feather-bedded welfare nirvana promised to them by nationalist campaigners. The currency issue alone is what’s going to make this impossible. Scotland is being taken independent on the basis of a false prospectus. What to do about the currency has always been the major flaw in the case for independence, and it remains very much the big deceit at the heart of the Yes campaign. One of the reasons why the polls have been narrowing in favour of a Yes vote is that Alex Salmond, Scotland’s first minister, has been highly effective in convincing voters that Westminster is bluffing over the pound.

And up to a point, he’s right. One of the major mistakes made by the unionist establishment is that of lecturing the Scots about what’s good for them. Scare tactics about the pound have only succeeded in further fanning the flames of independence. It was the wrong approach. They should simply have said, you can have the pound if you want, but just be aware of the price. There’s nothing in principle to stand in the way of monetary union with the rest of the UK, even if the leaders of all three main political parties have said they won’t allow it, nor could Westminster stop Scotland unilaterally adopting the pound – so called sterlingisation.

But both approaches would deny discretionary monetary policy, would severely limit fiscal and financial independence and would certainly be incompatible with the Scottish National Party’s vision for an independent Scotland, big on welfare and apparently impervious to fiscal constraint.

In view of all that’s happened in Europe, it is extraordinary that Scots could think monetary union with Westminster perfectly compatible with full scale independence. This is none the less the platform sold to them by the Yes campaign. All the evidence suggests that a shared currency without shared government doesn’t work. Monetary union requires a high degree of both fiscal and banking integration. That Mr Salmond proposes the very reverse is economic gobbledegook.

The reasons for this have been exhaustively explained elsewhere already, but bear brief repetition.

Countries with their own currency shouldn’t logically ever run into fiscal difficulty. In a downturn, when spending rises and tax revenue falls, they can always print money to cover the shortfall. The printing press also gives them the wherewithal to bail out insolvent banks, and thereby prevent wider economic collapse. With a shared currency, these privileges are denied, if only because more solvent nations tend to refuse liability for insolvent ones.

Any monetary union with the rest of the UK is therefore certain to involve a high degree of continued fiscal and financial oversight by Westminster. Without such controls, monetary union would be unacceptable to the rest of the UK. But with such controls, it would be equally unacceptable to Mr Salmond. Independence would count for little if Westminster continued to dominate Scottish affairs. The Scots can have monetary union if they like, but they cannot also have Mr Salmond’s promise of welfare-max, otherwise known as socialism.

Three other alternatives exist – the hard peg of sterlingisation, the slightly softer peg of a currency board, or a completely free floating independent currency. The last of these possibilities has been all but ruled out – and for fairly obvious reasons. Scotland has a lot of debt, both public and private. As home to the UK’s two largest banks, total debt is off the scale relative to GDP once financial liabilities are also taken into account. It would be impossible for the new currency to stand behind such mountainous foreign currency obligations. And if sterling debt was redenominated in the local currency, it would be tantamount to default, creating a massive financial and economic crisis.

Debt is what renders parallels with the “velvet separation” achieved by the Czech Republic and Slovakia back in the early Nineties largely invalid. The two new countries started out with a common currency – the Czech koruna – but concern about the potential liability to the Czech Republic caused the currency union to be dissolved a few years later. This was achieved with little mishap because the debts involved were still relatively insignificant.

With Scotland, it would be a different ball game, which is why we can expect both Royal Bank of Scotland and Lloyds Banking Group to announce they are re-domiciling south of the border within hours of a Yes vote. Even if they thought it worth the risk of staying, the Bank of England would not. To forestall a run on the two banks, they would have to remain safely under the Bank of England’s wing.

This leaves sterlingisation or currency board arrangements similar to those operated by Hong Kong. The latter option, which demands foreign exchange reserves of at least the same size of the monetary base to work convincingly, would appear a non starter, at least in the short term. Where is Scotland going to get reserves of this order of magnitude from?

So sterlingisation it is – a perfectly acceptable solution, and as Professor Steve Hanke, who having advised on a number of currency boards is one of the few international economists to take the time to analyse how pegged currencies work in practice, points out, actually a very good one if you believe in low taxes, a small state, and a much smaller, low risk banking system. In time, Scotland could evolve back to its free market roots as a country which had a number of competing currencies in circulation, he says. Yet this, unfortunately, is not how independence is being sold. Denied the flexibility to borrow and print at will, Scotland would have to fund its spending through higher taxes, which would in time render the country uncompetitive and therefore unable to sustain its welfare promise. A Yes vote is going to create myriad problems for everyone, but nowhere more so than Scotland itself. To declare yourself independent is one thing, but to do so on the basis of a lie is quite another.