Note: this piece was written for and first published by Common Weal. It was written well before the trailing of SNP proposals about Scotland’s currency position. I am now in a state of despair. The SNP does not seem to have a grasp of the difference between ‘fiscal’, ‘monetary’ and ‘economic’, or perhaps it just doesn’t care. It is not producing policy for independence, it is doubling down on a terrible decision to save face. By this time next week this nonsensical policy position will be set in stone and the independence movement will not escape it. I’m running out of ideas of how the cause of independence can be saved from this idiotic, failing regime. But, here you go anyway – something like a coherent plan for a post-independence fiscal and monetary policy.
As the UK economy melts down I though it might be useful to do a quick primer about how an independent could deal with the fallout, how it can go about solving the problems the UK is creating for us. I hope this is of use and not too boring…
If Scotland is going to be successfully independent we need to make sure a few of the fundamentals go right in the early days of independence. We need to ensure that we have a workable currency which has the right value for the Scottish economy. We need to develop a credible fiscal strategy for the early years. And both of these require a solid monetary and tax policy.
Starting with currency, when I say a workable currency I mean either our own Scottish currency or a currency union – any option which gives us access to and the support of a proper central bank. That means either a Sterling Union (which has been ruled out) or joining the EU and adopting the Euro (which is a bad idea right now and in any case not possible for quite a few years).
So we need our own currency. Keeping it at the right value for the Scottish economy means that during a transitionary period there should be no big shocks of devaluation. If a Scottish currency fell substantially below the value of Sterling it could push prices in the shops up which wouldn’t be helpful. In the longer term it also means that we wouldn’t want it to rise too fast or far as that would reduce prices in the shops but handicap exporters.
The solution is to peg the currency and then transition to a free-floating currency. That means a peg which keeps it at the value of Sterling within steadily increasing ‘bounds’. Bounds just mean ‘how far above or below we will allow it to go’. If your bound is five per cent, a the value of a Scottish currency can rise or fall by up to five per cent before action is taken.
If action is required you use a number of strategies, particularly the use of a foreign currency reserve. That is a large national savings account held in other countries’ currencies. If you use it to buy up your own currency it pushes its value higher; if you sell your own currency your reserves get bigger and the currency value drops.
The risk with a peg is a ‘speculative attack’. Very loosely, this is where someone thinks your currency value is too high, buys lots of it using IOUs, either then waits or sells Scottish currency to drop the value, pays off the IOU in a different currency and banks the difference. What you have to do is either ‘play chicken’ and keep pushing the prices up faster than they can bring it down, or don’t bother and float your currency.
This is why the majority of speculative attacks fail – and Scotland has another advantage in the early years. To begin with money traders won’t actually hold a lot of Scottish currency which makes a speculative attack much harder. Scotland really doesn’t need to worry about speculative attacks in the first few years.
And we shouldn’t want to peg the currency for long. When currencies rise and fall in value it is actually the market pushing the currency towards a more appropriate level for their economy – Scotland shouldn’t want a currency valued much higher or much lower than desirable. So economic and monetary indicators should be watched closely and the peg widened and dropped as quickly as possible.
From the beginning and especially from the moment of floating you need to underpin your currency for your economy and for borrowing. Most people think that is something to do with ‘credit ratings’, but that’s a small part of it. The key is strong economic fundamentals – which means investing into Scotland (which is what lending to a government is) must give you solid returns.
Scotland’s economy has been so under-developed inside the UK that there is lots of scope for absorbing investment as we transition to a national economy – giving investors confidence
This is why the UK is in crisis – it has been very heavily reliant on the economy of London and this is now ‘over-developed’. London has profited from constant asset inflation (not least because of Quantitative Easing) and those are now ‘too hot’. There is not enough productive investment that the economy can absorb, so Sterling is falling.
Scotland is not in that position; our energy alone gives us enormous capacity to successfully absorb investment. In fact our economy has been so under-developed inside the UK that there is lots of scope for absorbing investment as we transition to a national economy. That gives investors confidence.
Then we want to escape permanently the UK’s ‘cheap money’ policy which was used to inflate asset values and encourage households to borrow and spend to cover up for the fact that wages weren’t rising. Scotland doesn’t want short term speculative investment and a debt economy but a productive economy where long-term investment rewards the investor.
So we want to maintain higher interest rates (which is now being done in the UK, not strategically but out of desperation over inflation). The problem with this is household debt – so we need a major debt reduction strategy for Scottish households after independence (not space here to detail that).
Good investment opportunities and a solid interest rate and inflation policy underpins the value of the currency. In fact preventing the currency becoming too strong might be a key issue for monetary policy (though that is mostly good for households). And that underpins borrowing capacity.
Scotland wouldn’t have much credit history so would have a lower credit rating than the UK, but credit ratings tell you less about your borrowing costs than people think – there is massive variation of borrowing costs inside a single credit rating level and it is absolutely routine that countries with a lower credit rating can still borrow less expensively than those with higher credit ratings.
Scotland may still pay a small premium for borrowing early on, but it is not anything to worry about. There are ways to avoid it anyway – over 80 per cent of the assets in the economy are held in the domestic currency (especially pensions and mortgages). A broad policy plan to encourage that money to invest in Scottish Government bonds can give access to a lot of borrowing.
This is in your own currency so is low risk and low cost. All of this means that Scotland can borrow just fine based on a clear strategy. To make all of this work we should publish an open and transparent ‘business plan’ for the first ten years of independence. Set out clearly and honestly what your strategy is and lenders will have confidence. We can also publish full national accounts and a transparent nation balance sheet.
(The UK doesn’t do this because too many of its assets look less impressive if you write them down and share that in public – so UK national accounting is opaque.)
Running deficits is crucial; government must put more into the economy than we take out over the first decade – we can’t do that forever but it is essential early on
So now we can spend – and we absolutely have to spend. Scotland has been treated like a regional economy for 300 years and we must make a rapid transition to having the profile of a normal national economy. To do that we must invest heavily in a major industrial policy.
Running deficits is crucial – we must put more into the economy than we take out over the first decade. We can’t do that forever but it is essential early on. So we need a fiscal strategy.
That should be based on full employment and in particular a strategy for greater economic equality. This creates enormous tax efficiency and raises tax revenue without raising taxes. That should be explicit policy. Then we can crack down on tax evasion and avoidance with a competent tax code (the UK tax code is twelve times as long as the King James Bible…).
We also have massive ‘failure demand’ in Scotland, the cost to public services of picking up the pieces of UK inequality and austerity. You have social problems so you pay for remedial action, leaving no money to prevent the problems, round and round in a circle. So we need a period of targeted investment to break the UK’s failure cycle in Scotland. That must be effective and strictly time-limited.
Do all of this and by the end of ten years you should be able to set annual budgets which are close to balanced. And then you can get on with being a normal country.
The independence movement needs a strategy like this. All of the above is a fast preview of what Common Weal is going to put forward as a strategy in the big piece of work we are finalising just now. I hope that it proves useful in trying to create some strategic direction for the independence movement.
For just now, I hope the above race-through of the issues gives you enough to understand what is happening in the contemporary British economy and how we can make the argument that Scottish independence is the right solution to the crisis in which we find ourselves.