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Friday, February 21, 2014

Monetary consequences of Scottish independence

Sand cat licking his paw by Tambako the Jaguar from flickr (CC-ND)

Scottish independence referendum is coming soon, and so far it looks that the No option will win, rendering everything I mentioned here moot. But on an off chance residents of Scotland change their mind and vote for independence, the next big question is what currency they're going to use.

The 3 choices are:
  • some kind of Scottish Dogecoin, or whatever else they'll name their currency, with floating exchange rates
  • British Pound, or some Scottish Pound at fixed exchange rates with British Pound
  • Euro, or some Scottish Euro at fixed exchange rates with Euro
And my point is that Scotland will be totally screwed no matter which one of this options it chooses.

British Pound

This is the most obvious choice, since that's the currency Scotland currently uses.

Usually, it's a really horrible bad idea to use currency of another country and give up control over own monetary policy, as eurozone periphery learned in 2008, Argentina in 1998 and the entire world during Great Depression, to just note the most prominent cases.

Currently whenever economy of Scotland goes through a better or worse times than the rest of UK, fiscal transfers do a huge amount of work to level things out. After independence, it will no longer be possible - just compare fate of Greece or Spain with fate of Florida or California - even when their housing markets failed fiscal union among American states provided enough cushion to prevent the kind of Great Recession level of screwup eurozone periphery had to suffer through.

This will be somewhat alleviated by much higher trade levels between Scotland and its monetary partner rest-of-UK, and by Bank of England's far greater competence and democratic accountability than ECB.

On the other hand Scottish economy will be very small, and its exports will be dominated by North Sea oil and gas - so value of exports from year to year will change drastically depending on highly volatile commodity prices, and on production level from just one big source.

Overall, not the greatest idea.

Scottish Dogecoin

The second obvious idea is to pick up its own currency. By the orthodox economics this is the right thing to do - except for the tiny issue of debt denominated in British Pounds.

Scotland, on separation from UK, will inevitably inherit some portion of British debt. British public debt levels are pretty close to 100% of its annual GDP, some of the highest in the world - so assuming Scotland inherits debt about proportional to size of its, it will also be around 100% of its annual GDP.

This will be a huge problem for Scotland regardless of its monetary policy, but let's be serious here - there's no way in hell any country can survive with that amount of debt denominated in now foreign currency. Any chance if exchange rate between British Pound and Scottish Dogecoin can easily skyrocket Scottish debt levels to even higher levels, and unlike large and monetarily independent British economy which can get away with low interest rate, small Scotland with foreign debt would represent a huge default risk, and it would be priced accordingly.

This is even worse than keeping the British Pound.

Euro

As if Scottish Dogecoin wasn't bad enough idea, you can do even worse than that. Upon secession Scotland will not have any kind of automatic EU membership, and one of accession criteria is adopting the euro - the only exempt countries are UK and Denmark. So far EU has been extremely lax with this rule, so a lot of EU countries have a schedule of switching to euro in about 2000-never, but they might very well decide that it's a good idea to push harder here.

Scotland would then be in a completely ridiculous state - monetary policy controlled by the most incompetent central bank in the world with zero democratic accountability, and crippling debt denominated in even different foreign currency. If any of that looks likely, run the hell out of Scotland before it's too late, since Greeks will have it easy by comparison.

Any ways out?

Core of the problem here is that for Scotland to be independent it must negotiate terms with both UK and EU, from very weak position in both cases - UK can simply refuse to grant it independence if it wishes to, or enforce just about any terms it chooses, referendum be damned; and EU blocking accession or some kind of Norway-style association would instantly cripple Scottish economy.

Neither UK nor EU have any reason to feel particularly generous towards independent Scotland, and in EU's case any such deal would require unanimity and some of its members (especially Spain) would absolutely hate to establish an easy precedence, since that would pretty much lose them Catalonia next year.

There are some options like going for Scottish Dogecoin, then basically defaulting on all debt by forced conversion of it into Dogecoins, but good luck with all the international litigation in such case - vulture funds are pretty well established part of modern economy, and they are pretty good at screwing weak countries over.

Or if UK felt amazingly generous it could take over Scottish portion of debt - most likely in exchange for a very large portion of North Sea oil and gas revenues. And then if EU felt amazingly generous it could just let Scotland it on Dogecoin without any complications (and then Catalonia next year).

If neither of these looks very appealing, staying on British Pound and hoping for the best might still be the least bad way.

By the way I doubt very much economic arguments are going to convince either supporters or opponents of Scottish independence - if nothing could convince Greece, Spain, Ireland and the rest of periphery to quit euro, and Latvian politicians forced it upon its people even while seeing in plain sight how crippling it would be, there's little chance Scots in their current safety will care about potential risk of future recessions.

1 comment:

Neil Wilson said...

The view of the 'debt' is mistaken. There isn't really any 'debt' in the context of a sovereign nation. It's a myth.

As I show here