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Black Wednesday’ Salmond currency plan threatens a Scottish ‘Black Wednesday’ Alex Salmond has five plans for the currency of an independent Scotland according to his list in the STV debate on 25th August (and then there is the latent plan F). They were presented as a range of equally attractive options. This makes light of the issue. One of the options – using “a currency like the Danish krone” - means entering the ERM (the Exchange Rate Mechanism) that the UK was so disastrously a part of and which the UK wasted a meaningful portion of its foreign exchange reserves (£48 billion in today’s money) trying to stay within just on 16th September 1992. That was Black Wednesday, when the Bank of England base rate went up to 15%. Notably Alex Salmond omitted to mention the Norwegian krone: Scotland, with high public spending, too little oil&gas left in the North Sea, and an all-in national debt of £131 billion equivalent on a GDP of £146 billion, will need its oil&gas tax revenues to either defend its currency or manage its debt, and will not have enough left over for a Sovereign Wealth Fund. Scotland has the attributes of a lax fiscal policy now: a current deficit of taxes versus spending (called a primary fiscal deficit) of 5% of GDP, with extra spending promised by the SNP that could expand an already high debt as a proportion of GDP. The debt is likely to start out at above 70% in cash, plus another 20% in contingent liabilities like PFI, backing for Bank of Scotland and RBS, and Scotland’s share of the Euro bailout of Ireland and Portugal. In other words an all-in debt-to-GDP ratio of 90%. Disinvestment by the Financial Services industry for regulatory reasons is inevitable, as is a reallocation of UK government work back to England/Wales/Northern Ireland after independence: both would reduce Scotland’s GDP and tax take, and increase both the annual deficit and the debt- to-GDP ratio. The oil&gas tax revenues to set against these challenges are unproven and are priced in US dollars. Since the financial crisis international markets are demanding tighter fiscal policies from borrower countries, if those countries want to have large amounts of credit, for long periods and at low interest rates. To meet that challenge the UK has managed to convince markets that its austerity package is good enough when combined with economic growth superior to the Euro-In economies. The EU Member States – apart from the UK, the Czech Republic and new-joiner Croatia - have codified tight fiscal policy into the Treaty on Stability, Coordination and Governance in the Economic and Monetary Union aka the Fiscal Stability Treaty. The UK has an opt-out. This treaty is aimed at establishing that the Euro is “sound money” in all its forms, and at enabling low interest rates, low inflation, good availability of credit, strong banks – and therefore a strong currency. It is the continuation of the logic of the ERM, where the Deutschmark was the “sound money” in the system. The UK, with its somewhat laxer fiscal policy aimed at creating growth and shrugging off the house price crash, constantly found the pound going to the bottom end of its permitted band. At that point the Bank of England was obliged to buy the pound in large quantities and sell its reserves of foreign currency or precious metals. This policy became unsustainable on 16th September 1992 and one remembers, with some deliquescence of the bowel as a breadwinner with a young family and a mortgage, when the base rate hit 15% per annum. Today’s orthodoxy as enshrined in the Fiscal Stability Treaty is that a country’s debt-to-GDP ratio should be below 60%, and that it should eliminate any primary fiscal deficit to achieve that. The UK’s status is a debt-to-GDP ratio of 90% and a primary fiscal deficit of 5%. Salmond has as many plans for the currency as the Ordnance Survey has maps, but, like Captain Mainwaring in a particular episode of ‘Dad’s Army’, he does not seem to be sure which plan will be used in what eventuality (Mainwaring’s answer to Corporal Jones at the point of crisis was to use “any bl**dy plan”): Plan Likelihood Implications A Currency union Zero England backstops Scotland’s creditworthiness, its with the UK banks, its PFI, its pensions etc but Scotland has all the oil&gas and is released from its joint&several liability for 92% of the UK national debt (£1.6 trillion) B Scotland uses the Sub-Zero Scotland retains the implicit backstopping, releases pound but without itself from all liability for UK national debt, and has all formal the oil&gas arrangements, and No separation treaty with England. England vetoes then takes this as Scotland’s membership of the EU, with the strong an excuse for support of Italy, Spain and France refusing to assume Scotland would be regarded as in default by any national debt international investors C Scotland has its Possible but Requires own financial infrastructure own currency, not problematical SNP Prospectus to be independently tested by rating connected to the agencies pound, the euro or Oil&gas needed to support currency, not to increase anything else public spending Current tax&spending deficit must be stopped Higher interest rates D A currency like the High Euro surrogate Danish krone, Denmark joined the ERM on 1/1/99 (the launch date pegged to the Euro of the Euro) and observes a central parity rate of through 7.46038 to the euro with a narrow fluctuation band of membership of the +/-2.25%. ERM Denmark is a signatory to the EU Fiscal Stability Treaty and is bound by all its fiscal and economic provisions E A free-floating Moderate – Euro sybling currency like the only if EU Very low historical volatility of SEK to the Euro; Swedish krona members interest rates track Euro rates allow EU Sweden is a signatory to the EU Fiscal Stability Treaty membership but is not bound by all its fiscal and economic without Euro provisions; however, tax&spend policies are aligned to membership major trading partners in Europe F The plan that dare High Final destination of Plans D and E not speak its name Could be mandated on Scotland if it wishes to join the – join the Euro EU Euro membership requires adherence to the Fiscal Stability Treaty Fiscal Stability Treaty – very important to making the Euro “sound money” in all its forms: Signatories have committed to reduce their debt-to-GDP ratios to 60% by 2030, and to eliminate fiscal deficits to achieve that That severely constrains tax&spending policies where debt-to-GDP exceeds 60% Signatories have committed to further restrain spending and come in at below 60% if they anticipate further “age-related costs” after 2030: i.e. do they have a relatively ageing population? Scotland has a relatively ageing population Its initial debt-to-GDP ratio would be at least 70% in cash and on a rising trajectory already, rising still further if the SNP’s spending plans were fulfilled Scotland, like the UK, would have an extra 20% on top in the form of contingent liabilities, whereas other countries have not used schemes like PFI or bailed out Scotland’s banks in the way the UK has done: their the cash debt and all-in debt are basically the same Scotland’s all-in debt-to-GDP ratio will be 90% upon separation if the allocation is done a per-capita basis, and its deficit will be 5% Denmark’s debt-to-GDP ratio is 45% so it need not eliminate its deficit of 1.2% Sweden’s debt-to-GDP ratio is 41% and its deficit of 1.8% Norway’s debt-to-GDP ratio is 29% and it has a surplus of 18% This structure – subscribed to by most of Europe – creates a benchmark of “sound money”. If Scotland were outside it and not within the pound sterling structure either, it would have to attract money based on a comparison of its own economic and monetary statistics with those of both the pound and euro zones: A. Either by being a “sound money” economy itself – with low debt-to-GDP and a high primary fiscal surplus leading to low interest rates and a strong currency; or B. By outbidding other borrowers with higher interest rates A Scotland with its own currency (Plan C) will start in position B, with the following downside risks: i. Higher interest rates strangle the economy ii. Interest payments increase the primary fiscal deficit iii. The value of the currency drops, leading to the need to… iv. Borrow more v. Raise interest rates further At a given point the end of the line is reached and the only policy option available is to cut spending and increase taxes – in other words to revert to implementing Option A. The medicine offered by the “troika” to the Euro-In countries with debt problems (Greece, Ireland, Spain…) is nothing more than a forced adaptation to “sound money”. Were this to be Scotland’s position – and this should make Scottish voters squirm: The oil&gas tax revenues are used to prop up the currency, not for schools and hospitals Once Option A is reached – a strong currency – the value of the oil&gas tax revenues reduces because they are USDollar-based, and they buy fewer schools and hospitals Reducing debt-to-GDP from 90% of GDP to 60% by 2030 is a reduction of £44 billion from £131 billion to £87 billion in 16 years, or £2.7 billion per annum.
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