Securing the pound in your pocket

Transcription

1 Securing the pound in your pocket February 2014

2 Securing the pound in your pocket The argument about whether Scotland could keep the pound if we left the UK has been all over the media. Impartial experts have concluded that it is highly unlikely an agreement could be reached on a Eurozone-style currency union and the Governor of the Bank of England recently explained the difficulties in such an arrangement. This consensus among the experts follows the clear view of the UK decision makers who uniformly agree that such a deal would not be in the UK s or Scotland s interest. This short report explains what it all means. No economic decision is more important for Scotland than the currency we use. Today, as an integral part of the UK, Scotland uses the pound. We ve done so for hundreds of years, and people value the strength and stability it offers. But what if Scotland became a separate, independent state? Could we keep using the pound then as the SNP claim or would we need to have a different currency of our own? What would that mean for jobs, trade, interest rates and our financial security? 2

3 Contents Part 1: The strength of the UK pound 4 Part 2: The end of our shared currency 9 Part 3: Can t we just use the pound anyway? 12 Part 4: Could Scotland join the euro instead? 13 Part 5: Could we have a new Scottish currency? 15 Part 6: Is there a plan B? 17 Annex: Fact checking the SNP s currency claims 18 3

4 Part 1: The strength of the UK pound Today, as part of the UK, we use the UK pound as our currency. We have used the pound for hundreds of years. One of the things the Scots successfully negotiated with the rest of the UK in the 18th century was that we would have a single common currency. It s important to understand what that means. First of all, it makes trade much easier. No one has to worry about exchange rates, and whether they might go up or down. This matters for ordinary people, getting our wages and salaries, buying the things we need for our families and daily lives. We take for granted that we can use the pound, which is a stable, respected and trusted means of exchange. We would all suffer if we lost it. And it matters a great deal for Scottish companies too, as most of Scotland s trade is with the rest of the UK. Losing the pound would disrupt that, and be bad for jobs and prosperity. Scotland s trade Scottish exports by main destination, nominal terms ( ) Rest of World European Union Rest of UK The value of the pound Dr Angus Armstrong and Dr Monique Ebell, National Institute of Economic and Social Research Governments since Charles II have not defaulted on debt or eroded its real value through excessive and unexpected inflation. This track record over such a long time period is unique. Sterling is perceived as being a sound store of value, which lowers the cost of borrowing. Yet this property is inalienable to the UK Government; it is part of its history. The currency is more than just a way of buying and selling. It allows us to save and invest, to plan for the future, with certainty and stability. We can make plans with confidence for everything from our pensions to our grandchildren s future. Companies can borrow and invest to create jobs and wealth. But only if we have a currency everyone can trust. Today, Scots are able to save and borrow from banks all across the UK and Scottish banks and financial companies have 90% of their customers elsewhere in the UK creating jobs for people here in Scotland. About 200,000 Scottish jobs depend on that. Billions Scotland s financial services Scottish financial services firms customer base Percentage of products provided by Scottish firms to non-scottish postcodes Percentage of products provided by Scottish firms to Scottish postcodes Source: Scotland s Global Connections Survey As part of the UK, we share a common currency, the UK pound. We also have shared banking and monetary systems. It s not just that we all use the same notes and coins, and measure our savings and borrowings in the same pounds. It means we have a single banking system. The Bank of England oversees all of the banks, and plans monetary policy setting interest rates to suit the whole UK, including Scotland ISAs Pensions Mortgages Source: UK Government, Scotland Analysis: Financial services and banking, May

5 Scotland s financial services Participation in the Scottish financial services market Percentage of the products sold to the Scottish based customers by non-scottish firms Percentage of the products sold to Scottish based customers by Scottish firms 0 ISAs Pensions Mortgages Sources: UK Government, Scotland Analysis: Financial services and banking, May 2013 That s why we need a stable and well-regulated banking system. That means a trusted central bank to oversee it. Its job is to keep the currency itself secure and stable, manage interest rates and the supply of money, so the economy can grow in a sustainable way. The Bank of England does that job for the whole UK today, including for Scotland. As we have seen in recent years, financial stability matters to all of us. To ensure it, the Bank has to work very closely with not just the government, but bodies like the Financial Services Compensation Scheme which gives us all security for our savings. As the Governor of the Bank of England recently explained in Scotland, a stable financial system needs effective supervision of the banks; it needs a central bank that will ensure that solvent banks always have the cash to meet people s immediate needs; and it needs a credible deposit guarantee system. The UK does all this for Scotland today. Of course the banking system has been through many uncertain times recently. Everyone has felt the effect of that. But these problems have also shown the strength and resilience of the UK monetary system. When the two Scottish banks got into great financial difficulties, it was the Bank of England and the UK Government, backed up by the taxpayers of the whole UK, who were able to rescue them and put them back on a sound footing. And it was through being part of the UK we had the financial strength to borrow the very large sums needed to avoid a deep recession becoming a terrible depression. Saving the banks Alistair Darling, former Chancellor and Leader of the Better Together campaign I will never forget the telephone call I received when I was the UK s Chancellor of the Exchequer. It was the head of the Royal Bank of Scotland telling me that the bank was running out of money fast. We faced the real prospect of banks collapsing, people losing their homes and jobs. We have seen on the news what has happened in other small countries when their banks got into trouble over the last few years. People literally went to cash machines and found they were closed. Because Scotland was part of the UK, with 60 million people standing together, I was able to take immediate action to bail out the bank. The debts of RBS were far bigger than Scotland s wealth. For me that experience really brought home the benefits to Scotland of being part of something bigger. When times are tough we are there for each other. We are stronger and better together. Scotland is able to be part of this currency and monetary union because it s part of a wider union. First of all, we are an integral part of the whole UK economy. We trade very freely with all the rest of the UK. Indeed we specialise in providing services like banking to customers all across the country, not just in Scotland. People can move back and forth across the UK to take up jobs as the opportunities arise, and many Scots do nearly a million Scots have done just that. Indeed our economy is actually very typical of the UK as a whole. As Mark Carney, the Governor of the Bank of England put it: If one part of the union imports a large share of what it consumes from other parts, changes in demand will be quickly transmitted. This helps to align economic cycles and makes a common monetary policy more appropriate. 5

6 Keeping Scotland s financial system stable 6

7 Scotland s employment and productivity Labour productivity (2011) Output per job 0 UK Scotland Source: ONS, Regional Labour Productivity (June 2013) Labour market outcomes UK Scotland Employment Rate Unemployment Rate Inactivity Rate Source: ONS, Labour Market Statistics (July 2013), Labour Force Survey All this is necessary for our shared currency with the rest of the UK to work. And it does. But there is more to it than that. Because we are a political union with the rest of the UK, we pool and share our taxes and our public spending. So our public services in Scotland don t depend just on how the Scottish economy is doing, but are supported by taxes from across the whole UK. In good times, we pay into the common pot, and support public services in the poorer parts of the country. In hard times, we can draw on the UK s resources. As part of the UK, different parts of the country can call on shared resources to cushion the effects of economic shocks. That might mean to pay for unemployment benefits if we are hit by a downturn. Or it might mean sharing surpluses in good times. Take oil, for example: most Scots agree it s right that it should be shared with the whole UK, and in practice we ve been able to do that and benefit from higher and stable public spending over many decades. Attitudes towards pooling risks and sharing resources Scotland only % UK as a whole % North Sea Oil Revenues Unemployment benefit Old Age Pension Source: Scottish Social Attitudes Survey 2013 This sharing of resources - fiscal union - is needed to make a shared currency work. The Governor of the Bank of England explained this very clearly recently. As he put it a currency union requires a common fiscal backstop for its central bank and confidence in deposit guarantee schemes relies on a national backstop. In other words, the institutions that make our shared currency work need the full resources of a single government to stand behind them. Anything else is likely to be unstable. All this is possible for Scotland today because the UK is not just a currency and monetary union but a political union too. People in Scotland elect members to the UK Parliament to take these decisions. Decisions about sharing resources, but also decisions about how the UK can help in times of difficulty, such as the collapse of our banks. And because we are part of the same country, there was no question at all about it - UK taxpayers stood behind the Scottish institutions to rescue them. 7

8 How much money went into the Scottish banks In 2008, the UK Government spent 45 billion recapitalising the Royal Bank of Scotland in order to protect the deposits and savings of households and small business. In addition, the bank received 275 billion of guarantees through the UK Government s Asset Protection Scheme. To put this into context, this combined support from the UK Government to RBS is equivalent to: 211% of Scottish GDP (including a geographical share of North Sea oil) in times Scotland s geographic share of North Sea revenues in times Scotland s health spending in As a range of independent commentators have noted, Scotland would not have been able to afford such interventions alone. Other countries such as Ireland, Iceland and more recently Cyprus were unable to absorb the implications of the financial crisis on their own. By contrast, total UK interventions across the whole banking sector were almost 1.2 trillion or 76% of whole UK GDP. Source: UK Government All this works for Scotland today, as part of the United Kingdom. But what would happen if we became independent, and a separate country? 8

9 Part 2: The end of our shared currency If Scotland leaves the UK, it is highly likely that we would lose the UK pound. That is because independence would break the critical links that make our shared currency secure a single banking system, a fiscal union, and a political union that oversees them and makes them legitimate. But the SNP are still saying that it would continue. They assert we could keep the shared currency even though we no longer shared our taxes and public spending, and were not part of a political union. The most senior UK figures, from all political parties, make the position clear, but the SNP pretend these are empty threats. Of course it s obvious why they say this. They know people in Scotland don t want to lose the pound, so they simply claim that we would keep it even if we became independent whatever the evidence says, whatever the experts say. After all, we know that the SNP are willing to say and do anything to try to get us to back their plans to break up the UK. But why wouldn t currency union work, and why wouldn t the rest of the UK want to stay in a currency union with Scotland? The SNP say it would be in the continuing UK s interest not to have to change currency at the border, and worry about exchange rates going up or down? economy is very like the UK s. We have a single banking and finance system and one central bank to manage it, overseen by our shared UK Parliament. We share our taxes and spending so that the government can offset any imbalances that arise from economic differences. Most important of all, we have a political union which ensures that both fiscal and monetary policy works for the whole country, especially important in times of crisis. If Scotland became a separate country, its economy would diverge from the UK s. Certainly the SNP claim it would, as they say we would all become much better off. This is simply wishful thinking. A number of experts have concluded that we could well become much worse off. But all the evidence is that borders do have an effect on economies, by reducing trade across them: that s why, all across the world, countries try to reduce that effect by having free trade areas. But even then a border is still a big influence. If we left the UK, our economy would, over time, diverge from the rest of the country as different policies were pursued. That would put strain on the currency union. Because we d chosen to become a separate state and not the fiscal union we are today there would be no way for governments to transfer resources to offset that imbalance. Well, when we understand what currency union means we see it s more complicated than that. Our GDP Share 100 GDP % Germany Italy France Netherlands Austria Finland Ireland Luxembourg Cyprus Malta Spain Belgium Greece Portugal Slovakia Slovenia Estonia Euro Area Continuing UK Scotland Sterling Area Source: 2011 GDP at current market prices, from Eurostat, ONS and Scottish National Account Project 9

10 Believe the experts or believe the nationalists Mark Carney, Governor of the Bank of England John Swinney, SNP Finance Minister It is no coincidence that effective currency unions tend to have centralised fiscal authorities whose spending is a sizeable share of GDP averaging over a quarter of GDP for advanced countries outside the euro area. Another imbalance would be the effect of oil. Although oil has passed its peak, it s still very important to the Scottish economy, and so Scotland s currency would be much affected by oil prices. Today, that s not a problem. This is absorbed in the wider UK economy, as oil revenues are shared, and passed back to Scotland in a stable flow of public spending. But if Scotland becomes a separate country, that couldn t happen. The exchange rate would be subject to pressures, up or down, that would make maintaining a currency union very difficult. What the experts say Professor Ronald MacDonald, Adam Smith Chair of Political Economy, University of Glasgow Resource shocks are likely to be extremely important for the behaviour of the exchange rate of an independent Scotland. Scotland would be a net exporter of hydrocarbons. Oil would be a significant part of the budget of an independent Scotland and so-called oil shocks could move the exchange-rate around a lot with important consequences for the non-oil sector. As we have seen, our shared currency works today because the UK is a fiscal union. In his recent lecture, the Governor of the Bank of England explained that a successful currency union needs a central government that has control over about 25% of GDP and can redistribute it as needed. Very roughly, that s about 50% of our taxes and public spending. But the Scottish Government insists that independence means Scotland would have 100% control over tax and spending. That s simply not consistent with a successful currency union. An independent Scotland will control 100 per cent of our own revenues. Perhaps the biggest difficulty of all, however, would be in managing the financial and banking system. At the moment it is wholly integrated, and the whole UK stands behind each institution. We ve seen that in practice. It simply wouldn t happen after independence. UK taxpayers would be under no obligation to support the banks of a foreign country. The consequences for Scotland, which is even more dependent on the financial services sector than other small countries like Iceland or Ireland, could be very serious indeed. All the experts agree that the SNP s plan to stay in the UK s financial stability system while leaving the UK simply won t work. What the experts say Professor Brian Quinn, Former Executive Director of the Bank of England The concept of a shared system of supervision and crisis management is seriously perhaps fundamentally flawed and that its weaknesses would increase during the indeterminate period of transition following independence. All this might sound very theoretical, but we can see exactly these problems today. The Eurozone is a lesson for us all. It s a monetary union but doesn t have an effective political union to oversee it. It doesn t have an integrated banking union, and is not able to transfer taxpayer resources to countries which are in trouble like Greece in recent years. That s why all of the senior UK figures and virtually all of the expert commentary is clear that if Scotland were to vote for independence, it wouldn t be in either Scotland s or the UK s interest to import 10

11 the problems of the Eurozone into a new monetary union. Compare and contrast As part of the UK What the experts say Mark Carney, Governor of the Bank of England CURRENCY UNION POLITICAL UNION The euro area has shown the dangers of not having... a single prudential supervisor maintaining consistent standards of resilience, a single deposit guarantee scheme backed by the central government, and a common central bank, able to act as Lender of Last Resort across the union, and also backed by the central government as well as the difficulties of the necessary pooling of sovereignty to build them. BANKING UNION SNP s proposed monetary union CURRENCY UNION FISCAL UNION So it s quite clear: leaving the UK means leaving the UK pound. We cannot expect that after independence Scots will be part of a monetary and currency union with the UK, because we will have rejected the very thing that would make it stable a fiscal and political union. So, what are the alternatives? Does Alex Salmond have a plan B? POLITICAL UNION BANKING UNION FISCAL UNION 11

12 Part 3: Can t we just use the pound anyway? You often hear the SNP say this. Scotland could just use the pound anyway, and the rest of the UK couldn t stop us. Would this work? Well one country can t stop another from using its currency to buy and sell things. A number of developing countries do that with the dollar. Closer to home, Montenegro uses the euro, even though it s not part of the single currency. The Eurozone countries don t prevent that. But Scotland is not a developing country, and the example of Montenegro is not encouraging. Montenegro and the euro Montenegro, born from the collapse of Yugoslavia, had a history of extreme instability. It had two separate periods of hyperinflation, including one of the most extreme phases of hyperinflation in economic history in In 1999, it unilaterally adopted the Deutsche Mark but annual inflation was over 42 per cent. The adoption of the euro was done outside of the official framework for euro entry and there was no formal discussion with the EU or the ECB prior to the decision to adopt the euro. This gave Montenegro a credible monetary policy during post-war reconstruction. Inflation was below three per cent in But then Montenegro had very limited policy tools available to restrict the rapid increase in credit growth in 2008 and prevent the economy from overheating. The IMF has recommended to Montenegro that it should keep significant reserves of cash in order to provide a backstop for the financial sector. But this isn t a currency union. What it means is that Scotland would actually have no currency of its own, and no central bank. The rest of the UK would use the pound, and the Bank of England would work for it, supervising its banks and financial institutions, and making sure its interest rates and supply of money were stable. The Bank wouldn t do anything for Scotland. have difficulty in borrowing money, and would have no control over interest rates or other aspects of monetary policy. This is not how a modern economy works, and it would be very damaging. Even the Scottish Government s own advisers ruled it out as not being a credible long-term option for Scotland. The SNP s own advisers ruled it out Scottish Government Fiscal Commission report: International evidence suggests that informal monetary unions tend to be adopted by transition economies or small territories with a special relationship with a larger trading partner. Advanced economies of a significant scale tend not to operate in such a monetary framework. Though an option in the short-term, it is not likely to be a long-term solution. It would be damaging most of all to Scotland s banking and financial services industry, on which around 200,000 jobs depend. It is simply not possible to have a sophisticated banking and financial services industry without an effective monetary policy and central banking system. Additionally, a country which does not have a central bank and a monetary policy of its own will find it very difficult to borrow on international markets to support a deficit. As a result, there will be pressure to decrease public spending and increase taxation. It s inconceivable that this policy, which is followed by countries whose economies or financial systems have collapsed, is appropriate for a modern successful country like Scotland. When the SNP suggest this, they are treating the people of Scotland like fools. Because Scotland would have no central bank and no currency of its own, it wouldn t have all the tools of economic policy that a modern country needs. It would be able to decide how much to tax and how much public spending to have, but would 12

13 Part 4: Could Scotland join the Euro instead? If a separate Scotland is not able to use the pound, could it use the euro instead? Well, until quite recently this was the SNP s plan. SNP euro U-turn The SNP s first term independence white paper favoured joining the euro: Scotland would continue to operate within the sterling system until a decision to join the euro by the people of Scotland in a referendum when the economic conditions were right. It would be difficult to devolve monetary policy effectively while Scotland remained part of the United Kingdom as a common currency is a feature of a unified state. For example, if majority opinion in Scotland favoured joining the euro, that would not be possible within the United Kingdom. First Minister Alex Salmond, speaking in January 2009: As you know, we re in sterling and sterling is sinking like a stone. It s now about parity with the euro. I think there is a strong argument for the euro, and I think as sterling declines even further that argument is being made very strongly. The UK has a permanent opt-out from the euro, as it would not be suitable for the UK economy. Equally it s not suitable for Scotland s economy. But it s quite possible that an independent Scotland, as part of its negotiations to join the European Union, would have to give some sort of commitment to joining the euro. That could put us in a difficult position. Joining the EU means joining the euro Since 1993 all new EU Member States have been required to commit to join the euro. As part of the United Kingdom, we benefit from an opt-out from the euro. The UK s favourable terms of membership, reflects our unique position and interests, which we have negotiated over a long period of time. The Scottish Government s claims that it would retain the pound are at odds with the EU s rules for new members. Currency used since countries joining the European Union since 1993 Year joined EU Country Required to join the euro? Current status 1995 Austria Yes Has used euro since 1999 Finland Yes Has used euro since 1999 Sweden Yes Required to adopt once necessary conditions met 2004 Cyprus Yes Has used euro since 2008 Czech Yes Preparing to adopt Republic Estonia Yes Has used euro since 2011 Latvia Yes Has used euro since 2014 Lithuania Yes Aims to adopt euro in 2015 Hungary Yes Preparing to adopt Malta Yes Has used euro since 2008 Poland Yes Aims to adopt as soon as possible Slovenia Yes Has used euro since 2007 Slovakia Yes Has used euro since Bulgaria Yes Committed to adopt Romania Yes Committed to adopt 2013 Croatia Yes Committed to adopt Source: European Commission Professor Andrew Hughes-Hallett, SNP s Fiscal Commission Working Group member: All new members of the EU are required to join the Euro eventually and it is not clear that there are grounds to argue that Scotland has the right to inherit the UK s current Euro opt out. 13

14 Some people in the Yes campaign want us to use the euro. Yes chief wants us to use euro Dennis Canavan, Chairman of Yes Scotland campaign: I think that there is a considerable body of opinion that would favour Scotland having its own currency and keeping open the option that if and when the Eurozone recovers economically then possibly put it to the people of Scotland by means of a referendum whether we should join the Eurozone. Asked if he would like an independent Scotland to join the Eurozone, Mr Canavan said eventually, if the economy within the Eurozone recovers, yes, I think that would be something to aim at. BBC News, 30 April 2013 It seems unlikely that the euro would be a good currency for Scotland. We could be in the position of one of the smaller Eurozone countries. They find that they have imposed on them an economic policy, and interest rates, that may be suitable for the larger members, like Germany, but which put their economies under great pressure. Greece is perhaps the most extreme example. All the evidence is that Scotland s economy is much more like the UK economy than the Eurozone s. Our levels of productivity are very similar, and our economy responds to external events and pressures in the same way as the UK s, not the Eurozone s. So it is unlikely that the interest rates and monetary policies are right for those countries would be right for us. greater fiscal union. So Scotland would have to share sovereignty with the other Eurozone members, just as it would have to if it wanted to be part of a sterling currency union. Other countries would have a say in how much we could tax and spend. And it gets more complex. Membership of the euro is not an immediate possibility because countries which are committed to join the euro are obliged to keep their own currency stable against the euro for a period of a couple of years. This is to ensure that they enter the new currency at an exchange rate which is sustainable in the long run. Entering a currency union at the wrong rate could be economically fatal. So before joining the euro an independent Scotland would have to manage its own currency for at least a period of a couple of years. So we would have to change our currency not once but twice. Once from the pound to a new Scottish currency and then again from that into the euro. The transition costs would be huge. Maybe we would be better just to have our own currency? Additionally, as the vast majority of our trade is with the rest of the UK, which will continue to use the pound, using the euro would mean transaction costs for businesses and individuals and uncertainty about the exchange rate. There is therefore a very serious risk that membership of the Eurozone would not be in Scotland s long-term best interests. Scotland would also have to keep the rules of euro membership, the so-called Maastricht criteria. That would set limits on how much the country could borrow, and on inflation. On top of that, in order to increase its own stability as a currency union, the Eurozone is becoming more integrated including 14

15 Part 5: Could we have a new Scottish currency? There is no reason in principle why it would be impossible for a separate Scottish state to have a separate Scottish currency. Many small countries do, but it s by no means an easy option, and managing the transition could be very difficult. A new currency isn t created very often. All the evidence suggests that it would have to be introduced very quickly indeed. There would probably be a system of capital controls first, to stop people taking their money out of Scotland because they wanted to keep their savings in pounds. Scotland would have to create its own central bank. There would be a difficult job in deciding how contracts, savings, pensions and salaries would be converted at the start into values in the new currency. The worst time to adopt a new currency would be during a crisis. If the SNP remain in denial about the fact that their currency union is not going to work then they might create such a crisis. Assuming these hurdles could be surmounted, the big question about a Scottish currency would be how to manage its exchange rate. Should it be allowed to float on the markets, go up and down perhaps driven by the price of oil or should the Scottish Government try to keep its value stable, perhaps against the pound or the euro? Letting the new currency float on the markets might allow it to find its own level. The government wouldn t need to spend a lot of public money to stabilise it. But Scotland is a small open economy, and greatly affected by the oil price. So the exchange rate could be volatile. You could not be sure from day to day or week to week how much the new currency was worth. The effect on individuals and businesses of exchange rate uncertainty could then be very great. Trade, and so jobs, would suffer, because these costs would hit businesses. Buying goods and services from elsewhere in the UK which we all take for granted today could become much more difficult. Alternatively, the government could try to fix the new currency at a stable exchange rate, perhaps compared to the pound. Many small countries try to do this, but it greatly reduces their economic freedom for manoeuvre. They then have to hold substantial reserves of foreign currency to be able to intervene on the markets to keep the currency stable. This very much reduces their ability to borrow to invest in public services or manage the country s economy. Yes campaign currency chaos Patrick Harvie, Yes Scotland board member To be clear, my preference would be that the scenarios would still include at least the possibility over the long term that a separate currency could be put in place I would personally prefer to see any period of continued use of sterling as a transition period leading to something separate. Colin Fox, Yes Scotland board member After weighing up all the issues involved and recognising that many other small Independent countries such as Norway, Switzerland and Iceland prefer to use their own currency - this option seems to make most sense. Pat Kane, Yes Scotland board member Sterling zone might be solid first step for independence but it is in no way final. The strictest version of this is what s called a currency board. That means new Scottish currency would be tied, pound for pound, to the UK pound. The Scottish Treasury would have to keep one pound sterling in its reserves to match every Scottish pound it issued. Some countries manage this, and small jurisdictions like Gibraltar or the Channel Isles. But just like using the pound without formal agreement, it gives the government no real economic powers of its own, and in particular no real freedom over interest rates or the supply of money in the Scottish economy. Most challenging of all, a new currency will have to win the confidence not only of people in Scotland, but of the international money markets, so that Scotland could borrow money to finance its public sector deficit. Nationalists never admit this, but even after oil revenues today, Scotland has a substantial fiscal deficit. All the predictions are that as oil revenues decline our deficit will increase markedly. Scotland can sustain higher levels of public spending today because resources are shared across the whole country. A separate Scotland would have to borrow from the international markets to finance its deficit, but could find it very difficult to do this and at the same time 15

16 maintain the currency link. That is why countries that maintain currency boards typically run big fiscal surpluses to avoid any risk to their currency. So Scotland might have to move from a position of deficit to one of surplus, implying billions of pounds of cuts in public spending or increases in taxation far over and above what would be required anyway. The UK, which has a strong record of repaying debts for hundreds of years, can borrow money at very attractive rates. We already know from estimates by economists that, because it would be a new country with no track record of borrowing, Scotland would inevitably be charged higher interest rates than the UK does today for any new borrowing it was able to do, or to refinance its existing debts. This additional cost will have to be borne by Scottish taxpayers. If, in addition, the markets were unsure about a new Scottish currency, and whether it might fall in value, a further premium on interest rates would be highly likely. That means paying more for things like loans and mortgages payments. Higher borrowing costs If Scotland leaves the UK, the continuing UK s borrowing costs would not be expected to change. The independent National Institute of Economic and Social Research have estimated that Scotland s borrowing costs would rise following independence, between 0.7 and 1.65 percentage points above UK borrowing costs. Even a small increase in costs could lead to a significant impact. To illustrate, if independence resulted in there being a 1% rise in mortgage rates it would cost the average Scottish households: with a 75 per cent mortgage, around 1,300 in increased payments in the first year; and those with a 90 per cent mortgage, around 1,590 in increased payments in the first year. In total, this would be around 1 billion a year in increased interest payments for all Scottish households. Higher borrowing costs lead to higher living costs. Scotland would be launching a new currency with no credit rating. This would mean higher credit card and store card bills and more costly car loans. It would also mean higher taxes as the Scottish Government would have to pay more to borrow money. Source: NIESR & UK Government 16

17 Part 6: Is there a plan B? People in Scotland understandably want to keep the pound, but leaving the UK means leaving the UK pound. Countless economic experts and senior UK figures from the Chancellor to the Governor of the Bank of England and the Shadow Chancellor are making it clear that a Eurozone-style currency union wouldn t be in the UK s or Scotland s interest. So what are the alternatives? What is Alex Salmond s plan B? Of course he won t tell us, but in truth there are only these three. Each of them is worse for Scotland than keeping the pound inside the UK. 1. Just using the pound anyway, with no formal currency union, would put Scotland in an impossible position. We would have no monetary or interestrate policy of our own. We couldn t run the modern banking and financial services firms on which much of our economy depends. We would struggle to borrow money to finance public services, and the effect on jobs and incomes could be catastrophic. If Scotland chooses to remain a strong and proud part of the UK, we can be sure of keeping the UK pound. We would be choosing to remain in a successful economic partnership, as part of an integrated economy, in which the UK s resources stand behind our public services, our banks and financial institutions, and the Scottish economy as a whole. That s the choice that Scotland will face this September. Plan B unpopular 12% believe Scotland should just use the pound without a formal agreement 11% believe Scotland should set up a new currency 4% believe Scotland should join the Euro Source: Panelbase poll of 1,012 Scottish adults, January 29 - February In principle a separate Scotland might use the euro, but it would be agreeing to a monetary and interest rate policy designed for the majority of the Eurozone and not suitable for Scotland s economy. No one would want Scotland to be put into the position of Greece in the Eurozone, but the effects could nevertheless be very serious. And there s no easy way to get there, without repeated disruption. 3. The last option is a separate Scottish currency. This would be very difficult to do but perhaps not impossible. But then Scotland would be faced with a choice between two uncomfortable alternatives. We might have a Scottish currency that was volatile, driven by the oil price and market sentiment. It is then difficult for individuals and businesses to predict from day to day what costs they would face, or price they could get for their goods and services. Alternatively the Scottish Government might try to fix the exchange rate. This is potentially very costly, and would require Scotland to run a very strict fiscal policy, with serious effects on taxation and public spending. Either way the interest rates we all face would go up. All of these are second best to what people in Scotland want to keep the currency they know and trust, the UK pound. 17

18 Annex: Fact checking the SNP s currency claims With so many claims and counterclaims flying around it can be hard to keep track of what is fact and fiction, so here are the facts on the SNP s currency claims. 1. THEY SAY: The pound is Scotland s currency just as much as it is the rest of the UK s. A vote to leave the UK is a vote to leave the UK pound. That s part of the choice people in Scotland are being asked to make. The UK pound isn t an asset to be divided up between the two countries like a record collection after a break-up. The value of the UK pound is not the notes and coins in circulation, but that it is backed by the Bank of England, which in turn is backed by the strength of the taxes paid by the 60 million people living across the whole of the UK. To use the UK pound after independence would need an agreement to set up a Eurozone-style arrangement something which experts have said is unlikely to be agreed. An independent Scotland cannot insist that taxpayers in a country that it would have just voted to leave would continue to back its currency or stand behind its banks as a lender of last resort in the event of another collapse. 2. THEY SAY: A currency union is in the overwhelming economic interests of both Scotland and the rest of the UK. Not true. And in any event it would be for the continuing United Kingdom to decide what was and was not in its interests. A Eurozone-style currency union would not be in Scotland OR the UK s interests because: As the Governor of the Bank of England and leading experts have made clear: currency unions don t work without close political and fiscal integration. Independence is about disintegration, not integration. The lesson of the Eurozone crisis is clear currency unions are very difficult without fiscal and political union, and can expose all their members to significant risks. Eurozone countries are moving towards closer political and fiscal integration to address these challenges. But the SNP want the exact opposite currency union without fiscal or political union. The economies of an independent Scotland and the UK would diverge as different policy decisions are taken. Scotland in particular would be far more dependent on North Sea oil which is volatile and will run out. Sudden changes in oil prices would affect Scotland far more and therefore the same interest rate would not suit both countries. A Eurozone-style currency union would not be in an independent Scotland s interests because: Even if it could be agreed, a formal Eurozonestyle currency union would severely limit an independent Scotland s economic freedom. As the Governor of the Bank of England has said: tight fiscal rules would be required, adding that It is no coincidence that effective currency unions tend to have centralised fiscal authorities whose spending is a sizeable share of GDP averaging over a quarter of GDP. To ensure the risks to the rest of the UK were managed properly an independent Scotland would not be able to set its own interest rates and would have to accept the rest of the UK having oversight of its tax and spending plans as is the case in the euro area. As the Governor of the Bank of England has said: a durable, successful currency union requires some ceding of national sovereignty. If financial markets sensed that the Bank of England s monetary policy did not suit Scottish circumstances they might doubt Scotland s commitment to the currency union. Financial market speculation could lead to capital flight and higher interest rates. Ultimately, if markets weren t calmed, Scotland might have to adopt its own separate currency in a time of crisis. A Eurozone-style currency union would not be in the rest of the UK s interests because: The Governor of the Bank of England has said: a durable, successful currency union requires some ceding of national sovereignty. Joining a currency union with another state would therefore involve the UK giving up some of its control over in monetary and fiscal policy. Why would it agree to this? The continuing UK would comprise around 90% of total GDP in a sterling currency union, 18

19 with Scotland as 10%. The continuing UK would therefore bear much more risk of having to bail out an independent Scotland if it got into fiscal difficulties. As Martin Wolf, chief economics commentator for the Financial Times, has said: it is doubtful whether a union would be in the interests of the rest of the UK. The gains from the shared currency would certainly be far smaller for the rest of UK than for Scotland, since the latter represents a 10th of the shared market. Why take the risk? Negotiating a Eurozone-style currency union would be far more important for an independent Scotland than for the continuing UK. The rest of the UK accounts for 70% of Scotland s total trade, whereas Scotland accounts for 10% of the UK s trade. As Carwyn Jones, the First Minister of Wales, has asked, what gain is there to the rest of the UK from having an independent country share its currency, other than uncertainty leading to higher interest rates and higher borrowing costs for Scotland and all parts of the union, making everyone worse off? Mr Jones has made clear he is not convinced that a shared currency would work. 3. THEY SAY: Scotland is the UK s second biggest trading partner. It is in the interests of business in the rest of the UK not to put up unnecessary barriers. Lets be clear: it is the nationalists that are in the business of putting up barriers. If we make the decision to leave the UK, we don t get a say in what the UK does anymore and that includes over whether we get to share the pound. The rest of the UK accounts for around 70% of Scotland s total trade, whereas Scotland accounts for 10% of the UK s trade. Common sense therefore tells you that negotiating a Eurozonestyle currency union would be far more important for an independent Scotland than for the continuing UK. The UK s biggest trading partner now is the United States no one would suggest we switch to using the dollar to suit them. Our next biggest trading partners are France and Germany no one suggests that we would automatically join the euro. Scottish trade is important to the UK economy, but is it important enough to run the risk of recreating the problems we have seen in the euro area in the British Isles? 4. THEY SAY: Neither the Governor of the Bank of England or UK politicians have ruled out a currency union. As the Governor of the Bank of England has made clear, it s not his role to decide on this it is for elected politicians. Dozens of experts have said the SNP s proposals for a Eurozone-style would create significant risks for an independent Scotland. The Chancellor, Shadow Chancellor, former Chancellors and the First Minister of Wales have all said that a currency union is unlikely to be in the UK s or Scotland s interests and highly unlikely to be agreed. 5. THEY SAY: The UK Government would be obliged by the Edinburgh Agreement to agree to a currency union. This is simply not true. There is nothing anywhere in the Edinburgh Agreement that could require the continuing UK to agree to a Eurozone-style currency union with an independent Scotland. Whatever the Scottish Government say, they cannot compel the rest of the UK or future UK Governments to set up a currency union that recreates the problems of the Eurozone. The Chancellor, Shadow Chancellor, former Chancellors and the First Minister of Wales have all said that a currency union is unlikely to be in the UK s or Scotland s interests and highly unlikely to be agreed. The only way to guarantee Scotland keeps the UK pound is to vote to keep our United Kingdom together. 19

20 6. THEY SAY: Scotland and the rest of the UK would remain an optimal currency area after a Yes vote. The plans in the White Paper are all about divergence. Ending political and fiscal union, different immigration policy, different business taxes to change productivity. The problems in the euro area clearly illustrate the risks and challenges of creating and maintaining a formal currency union across different states with differing economies. We need look no further than the Eurozone to see that currency unions are difficult to make work. As the Governor of the Bank of England and dozens of experts have now said: they can only really be made to work if you have fiscal, economic and political integration. Independence is about the very opposite of that; it s about disintegration of political union and economic and fiscal divergence. The euro area is moving towards closer political and fiscal integration to help overcome these challenges. If Scotland left the UK it would inevitably mean economic decision-making in Scotland and the continuing UK would move further apart this is hardly a credible basis for a currency union. The lessons learned from the Eurozone have been clear: while these kind of arrangements can appear successful in a period of stability and growth they can lead to brutal readjustments in times of economic stress and uncertainty. The Governor s speech highlights the clear risks of moving away from what we have now. In these economic times the last thing we need is more uncertainty. 7. THEY SAY: The Bank of England has been operationally independent and has set interest rates over the past 10 years and more. Since 1997 the Bank of England has had a degree of operational independence with responsibility for the setting of interest rates. However, as the Governor has made clear: the Bank of England is a financial technocratic institution which exists to implement whatever monetary arrangements [are] decided once decisions are made, we implement this; we re not the ones who are elected to make decisions, very clearly. If Scotland left the United Kingdom the Bank of England would be governed by England, Wales and Northern Ireland, not Scotland. A foreign central bank and foreign government would decide not only the interest rates on which our mortgage and business borrowing depend, but also the money supply, crisis interventions and even employment targets so vital to our young people. A crucial consideration here is in whose interests would decision be taken. As Professor Jo Armstrong has said: To be honest with you if you have one half of the currency union 90% in value and the other side 10% it does make it look like the UK or the rest of the UK would have the upper hand. 8. THEY SAY: Scottish exports, particularly North Sea oil and gas, make a substantial contribution to the UK s balance of payments. This is just not true. Independent experts, including Professor Brian Ashcroft of the Fraser Allander Institute, have said that the impact of independence on the UK s balance of payments would be likely to be neutral. The reason is because the Scottish Government has chosen to ignore a number of important factors, including: The fact that the majority of profits from largely foreign owned oil and gas companies are sent abroad, so they don t help our balance of payments now. Scotland has a deficit on its trade in goods and services. This would provide a major boost to the continuing UK s balance of payments in the event of independence because currently trade within the UK falls outside the measure. Around one fifth of Scottish GVA is produced by companies headquartered or registered in the continuing UK so profits are sent elsewhere in the UK would therefore enter the continuing UK s balance of payment positively in the event of Scottish independence. Common sense tells you that the UK economy, which is ten times the size of Scotland s economy, 20