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A yes campaign volunteer displays a campaign leaflet in the runup to the vote on 18 September
A yes campaign volunteer displays a campaign leaflet in the runup to the vote on 18 September. Photograph: Jeff J Mitchell/Getty Images
A yes campaign volunteer displays a campaign leaflet in the runup to the vote on 18 September. Photograph: Jeff J Mitchell/Getty Images

Can Scotland be independent and keep sterling?

This article is more than 9 years old
If the yes vote wins on 18 September, what currency will an independent Scotland use?

The future of the pound in an independent Scotland has been a central part of the debate in the lead-up to the 18 September referendum. Scotland’s first minister, Alex Salmond, insists the country will continue to use the pound if it votes for independence. But all three main political parties at Westminster have said an independent Scotland would not be allowed to continue to use sterling.

Up until this week, financial markets had seemed pretty convinced that Scotland would vote against independence and the upcoming referendum made little impact on either share prices or the pound. All that changed on Tuesday, when a poll suggesting a surge in support for the yes campaign acted as a wake-up call that the vote could be much closer than investors had been pricing in. There was a rush to insure against potential swings in the currency as its future role was called into question by the YouGov poll showing the yes campaign needed only a three-point swing to win the independence referendum.

The pound fell to a five-month low against the US dollar and also weakened against the euro. Traders said it was likely to fall further as the referendum approaches and uncertainty intensifies around Scotland’s future currency and the pound’s place should the yes camp win.

In the event of a vote for independence, the pressure would rise much further still on UK assets, ranging across shares, government bonds and currency markets, say experts. Jack Allen at the thinktank Capital Economics comments: “If Scotland left the UK, there would be a potentially lengthy period of negotiation between the Scottish and UK governments in order to resolve issues such as the division of public debt, the regulation of Scotland’s banks and the currency regime. We suspect that this uncertainty would weigh heavily on demand for gilts, UK equities and sterling.”

Here we consider the main currency options that might be on the table for a Scotland that votes yes to breaking away from the rest of the UK. Each comes with risks and at this point, with the debate muddied by posturing, economists say it is hard to judge which is most likely.

Get in touch below the line, email your views to katie.allen@theguardian.com or tweet @KatieAllenGdn

What are the main currency options for an independent Scotland?

Scottish and English banknotes ahead of the Scottish independence referendum on 18 September. Photograph: Danny Lawson/PA

Before we consider Scotland keeping or leaving the pound it is worth looking back over the long history of sterling in Scotland. The sharing of the pound sterling between England and Scotland is a monetary union that has “proved more enduring than any other between nations”, according to Angus Armstrong at the National Institute of Economic and Social Research.

In a paper on Scottish independence, he laid out the background: “Political union between England and Scotland began with the Union of the Crowns in 1603 which marked the start of a monetary union with the pound Scots pegged to sterling at a rate of twelve to one. The Acts of Union in 1707 brought into effect the Treaty of the Union, where the two parliaments merged into the parliament of Great Britain, and full monetary harmonisation with sterling replacing the pound Scots to become the legal currency of Great Britain.”

Will that long currency union endure should Scotland become independent? Such a nation has four main currency options. Let’s consider each one:

1. Keep sterling as part of a formal currency union

Alex Salmond’s chief economic adviser has insisted Scotland has viable options for its currency if there is a yes vote. Photograph: Jeff J Mitchell/Getty Images

This is the SNP’s preferred option: a currency union which would allow Scotland to use sterling and retain the Bank of England as its lender of last resort.

The obvious problem here is that the Conservatives, Labour and the Liberal Democrats have all ruled out such a currency union.

The Bank of England governor, Mark Carney, has also raised doubts about Scotland’s plan to use the pound. He said in January that an independent Scotland would need to give up significant areas of its sovereignty and reach a watertight deal with the UK on banking, taxation and spending if a new sterling zone were to avoid the risks and instability which had plagued the euro.

But he also said there were some logical economic and business arguments for a currency pact involving countries with similar economies. Many economists have pointed out that Scotland and the rest of the UK meet the main criteria used to assess the viability of an “optimal currency area”, particularly a high degree of cross-border trade as well as capital and labour market mobility.

Similarly, Prof Joseph Stiglitz, the Nobel prize-winning economist, says a currency union would be accepted after a yes vote because the Scottish and UK economies were so closely intertwined. Stiglitz, one of Salmond’s key economic policy advisers, says the UK government is bluffing over its opposition to a currency union.

Salmond, meanwhile, has threatened to renounce Scotland’s share of the UK debt if Westminster vetoes a deal to share sterling. As such, John Swinney, Scotland’s finance secretary, argues that rejecting a sterling union would greatly increase business costs for UK companies operating in Scotland, and leave the Treasury paying off Scotland’s share of UK debt. Ultimately, he says, the parties in Westminster “will agree to a currency union after independence”.

“They cannot turn round to the electorate in the rest of the UK and say we are going to let the Scots go away debt-free from the United Kingdom,” he said in August.

2. “Sterlingisation”: use the pound, but not in a formal currency union

Scottish banknotes. Photograph: Jeff J Mitchell/Getty Images

Currency market experts liken this to going down the Kosovo route. Kosovo is not a member of the eurozone but uses the euro. It is legal tender but the country is not even a member of the EU and has no formal currency agreements with the European Central Bank (ECB) and other European institutions. Such a path would be one way to keep the pound without having to wrangle with Westminster. But under this option Scotland would not benefit from the Bank of England as lender of last resort. With bank runs and bailouts still fresh in people’s memories, Scotland’s sizable financial sector and many other businesses are unlikely to accept such a position.

But the Adam Smith Institute argues that an independent Scotland could flourish by using the pound without permission from the rest of the UK.

The free-market thinktank cites the example of Panama and other Latin American countries that use the dollar as proof that the informal use of another country’s currency “can foster a healthy financial system and economy”.

“Under sterlingisation, Scotland would lack the ability to print money and establish a central bank to act as a lender of last resort. Evidence from dollarised Latin American countries suggests that far from being problematic, this constraint reduces moral hazard within the financial system and forces banks to be prudent, significantly improving the overall quality of the country’s financial institutions. Panama, for example, has the seventh soundest banks in the world,” the institute said in a report last month.

But Olli Rehn, the former EU commissioner for monetary union, has said any plan to use the pound without formal permission would “simply not be possible”. Now an MEP, Rehn said it would be impossible for an independent Scotland to join the EU if it used the pound without a formal currency deal or its own central bank.

3. Join the euro

Euro coins placed on a Scottish bank note. Photograph: Amer Ghazzal/ Amer Ghazzal/Demotix/Corbis

Several years have passed since the debate about Scotland possibly joining the euro really kicked off – Salmond had originally suggested keeping the pound to start with and maybe joining the euro several, or more likely many, years later.

It was understandably a fairly unpopular prospect in the immediate aftermath of the global financial crisis and still is now. Given the discussions of recent years over who might leave the currency bloc, the idea of joining during a storm is not a vote-winning one.

The SNP has moved away from arguments for joining the euro but shadow chancellor Ed Balls argues Scotland will have to join the euro as the “least bad” option for its economy if it votes for independence.

That is an unattractive prospect. The eurozone faces worryingly low inflation – and even outright deflation in some member states – and with growth flagging the ECB is contemplating yet more unprecedented measures to turn things around.

On top of that, the nature of Scotland’s likely trading pattern does not lend itself to euro membership as much as retaining sterling. Alex White, economist at JP Morgan in London, says: “This would not be the obvious choice for Scotland given its high trade share with the UK, but is an option if negotiations with the UK break down.”

Regardless of what an independent Scotland might want to do, or feel pressed to do, joining the euro is not a mere formality. There are already questions about whether an independent Scotland would even remain an EU member. Outgoing European commission president José Manuel Barroso has said it would be “difficult, if not impossible” for an independent Scotland to join the EU given that member states seeking to prevent their own semi-autonomous regions from seceding would almost certainly block Scotland’s membership. Senior SNP figures reject his assertions, however, countering that they are based on false comparisons.

Finally, swapping sterling for the euro does not mean Scotland would be shaking itself free of outside controls. It would be swapping monetary policy set by the Bank of England for monetary policy set by the Frankfurt-based ECB – policy that tries to fit a myriad of different economies spread over a wide area.

4. Get a new currency

Coins shaken out of a purse. Photograph: Jeff J Mitchell/Getty Images

This is widely seen as the riskiest option.

JP Morgan’s White notes that with its own free-floating currency Scotland would have greater control over its monetary policy and would be able to offer a more credible lender of last resort facility. But the move would be costly.

He says: “The downsides here would be higher transactions costs with Scotland’s largest trading partner and the large transitional costs associated with setting up a new currency …

“In the event Scotland issues its own currency, we would expect the government to begin by fixing its value to sterling using a currency board – leaving open the option of shifting to a free-floating currency in the future if need be.”

Conclusion

Scottish independence referendum campaign materials. Photograph: Jeff J Mitchell/Getty Images

With a range of options and so many opposing statements of what will and will not be possible, it is hard to know which option is most likely. While politicians on both sides seek to make bold assertions now before the vote is in, economists reckon the reality of a yes vote would prompt compromises and above all a will to calm markets and the public with some pretty swift decisions.

Rob Wood, chief UK economist at the private bank Berenberg and a former Bank of England economist, sums this up: “We expect that London and Edinburgh would reach a deal on the outlines of a velvet divorce quickly in the event of a yes vote. A long, noisy negotiation would drag out uncertainty and the short-term pain, which would suit no one.”

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