The possibility of Scottish independence is back on the political agenda once again. And one question – which currency would an independent Scotland use? – that was crucial in the 2014 referendum has still not been resolved.
The informal use of the pound is a very risky option.
To see why, the Scottish National Party (SNP) might look at the problems which Facebook is having in getting its proposed digital currency libra off the ground. Already, companies like PayPal, Visa, Mastercard and Ebay have withdrawn as potential sponsors.
While Facebook is a company and Scotland is a country, the issue is how the currencies are backed.
Facebook proposes to back the libra by its accumulated profits held in a portfolio of “low volatility assets”. But as Barry Eichengreen of the University of California points out, “anyone who lived through the 2008 global financial crisis will know that low volatility is more a state of mind than an intrinsic attribute of an asset”.
In the face of an unexpected adverse shock to the values of these assets, Eichengreen notes that these will be subject to the equivalent of a bank run. But there is no lender of last resort able to simply print money.
By simply using sterling, as many Latin American countries do with the US dollar, the Scots would have no means of printing money if their banks were attacked in a financial crisis. Taxes would have to rise massively to support the banks.
The Scots could instead apply to join the euro. An immediate problem with this would be the rule in the Stability and Growth pact that countries in the Eurozone should keep their budget deficits below three per cent of GDP.
The UK spends only 1.1 per cent of GDP more than it raises in taxes. Ironically, this would make us a shoo-in for euro membership, if Britain as a whole wanted to join.
In contrast, the latest figures produced for Government Expenditure and Revenue for Scotland show the nation running a public sector deficit of seven per cent of GDP.
This is obviously much higher than would be allowed in terms of membership of the euro. It is, in fact, the highest in the whole of Europe, the next highest being Cyprus at 4.8 per cent. So to join the euro, the Scots would have to make large cuts in public spending.
If instead they decided to set up their own currency, the markets would almost certainly force similar public spending reductions on them. After all, small countries running large public deficits tend not to be viewed kindly.
This problem has been magnified dramatically by the statement by Derek Mackay, the Scottish government finance secretary, that an SNP government in an independent Scotland would refuse to repay its share of outstanding UK debt.
A massive public sector deficit and defaulting on government debt is hardly a very sound basis on which to launch any new currency.
The desire for independence is often driven by emotion rather than rational calculation. But unless the currency question is addressed and solved, an independent Scotland would live to rue the day.