LAST week The Times' senior political columnist Kenny Farquharson attempted to critique the SNP’s policy on currency post-independence, but in doing so he filled his article with misinformation. One of his claims was the common myth that an independent Scotland would be forced to pay a premium when issuing government bonds to financial markets. This claim was made whilst misleading readers on the Scottish National Party’s (SNP) currency policy. Let us set the record straight.
The SNP’s policy is to implement a new currency within the first parliamentary term post-independence. The institutions for a new currency would be built during the transition period towards independence. This leaves a window to implement a new currency on day one to the last day of that term. During the SNP’s 87th national conference, delegates passed a motion noting the preference for a currency sooner, whilst supporting the drafting of a bill for the establishment of a Scottish Reserve Bank. Any suggestion that SNP policy is to maintain Sterling for the medium or long-term is simply wrong.
Kenny also mentions the SNP’s six currency tests, pointing out their design is essentially a barrier to building the institutions for a new currency. I agree with this point, however, it’s worth noting SNP members also amended the six tests so a Scottish Reserve Bank would no longer be required to follow their guidance. Only SNP MSPs are expected to follow these tests, which is entirely voluntary. Overall, it is clear the SNP has drastically shifted away from the vision of Andrew Wilson’s (above) Sustainable Growth Commission for the more progressive vision of the Social Justice Commission.
Let us turn to the issue of borrowing post-independence. What we describe as “borrowing” for countries with their own currency and central bank (monetarily sovereign) is misleading. A better description for these monetary operations is "asset swapping". When a monetarily sovereign government issues bonds, it is simply turning normal currency into interest-bearing currency. This interest-bearing currency will sit in a savings account at the central bank and does not finance any government spending programmes.
There are two markets for selling bonds - the primary market and the secondary market. The primary market is for institutions with large amounts of capital (multinational banks) whilst the second market focuses on pension funds, hedge funds, local government pensions and foreign investors.
READ MORE: Why an independent Scotland must reject the Euro and use its own currency
There are a few points worth considering. First, a monetarily sovereign Scottish government would be the boss when setting conditions for issuing bonds. The primary bond market is established by the Scottish government, which sets the overnight-rate of interest on the bonds they issue. Because bond bidders want access to "Triple A" savings accounts at the Scottish Reserve Bank, they will offer rates close to the government target. Those who offer unreasonable rates will lose out on these accounts.
Monetarily sovereign governments may take it a step further to set long-term interest rates by simply selling bonds directly to their central banks. This is what the Japanese government did back in 2019, by selling ¥6.9 trillion of government bonds directly to the Bank of Japan. Japan achieved this by simply using their monetary levers - this is something that all monetarily sovereign countries can do.
Any suggestion that free markets can force a premium on Scottish bonds, as Kenny Farquharson does, should be dismissed. Most of the world’s bond markets are not offering low rates out of the kindness of their hearts – but because central banks are saying so. Further, for bond bidders to place their currency in a savings account at the Scottish Reserve Bank they would first need to receive it. Therefore, countries that spend in their own currency are effectively self-financing.
READ MORE: How long would independent Scotland take to set up a new currency?
Opponents of independence will further argue that bond vigilantes will sell off their Scottish assets in order to drive up the rate of interest on bonds. Not only are there very few cases of this through history, let alone for a developed and stable economy like Scotland’s, but it makes little sense to do from the bondholder's perspective. They would be making the loss and harming their own portfolios.
Other opponents of independence will point out Scotland is a net importer – which in real terms of trade is a positive – meaning there is a “leakage” of Scottish currency going to the UK. Therefore, if the UK is holding Scottish financial assets, then we would be forced to borrow from them with a weaker exchange rate and increased levels of inflation.
We now know this is not true. The Scottish Reserve Bank will simply subtract numbers from the UK’s current accounts and add those numbers to its savings accounts. This is a simple accounting adjustment using a keyboard and spreadsheet. The only thing we would owe the UK would be a bank statement. If the UK did not want to place Scottish assets into savings accounts, they would be free to reinvest back into the economy or keep the currency within their foreign exchange reserves.
A Scottish currency that floats would see no measurable effect on domestic inflation. Canada, a small open and developed economy with a floating currency, has seen wild exchange rate fluctuations of 20% for the last twenty years whilst the domestic economy experienced stable inflation, growth, and a gradual decline in unemployment. Another case study is Australia, which has run a trade deficit of 20% of GDP (twice the size of Scotland’s) for nearly thirty years yet has experienced declining and stable inflation.
A new Scottish currency will not take markets by storm, nor will it crash and burn. Instead, it will simply operate like most floating currencies – underwhelming normal.
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