A forgotten 300-year-old-solution to Alex Salmond's money problems

Adam Smith or David Hume were no slouches when it came to economics but on the subject of monetary policy, the palm goes not to those superstars of the Scottish Enlightenment but to a man born a generation before them and much less well known.

One of the centrepieces of the SNP’s manifesto for Scottish independence is a pledge to keep the British pound. As far as Alex Salmond is concerned, the future of money is the status quo. Meanwhile, on 18 November, Ben Bernanke, the chairman of the US Federal Reserve, endorsed the viability of digital money in a letter to the US Congress. Within a week, the price of a single Bitcoin – the best-known web-based currency – had passed $1,200 (11 months ago, it was worth just $13.50). For the technocracy of Silicon Valley, the future of money is in the cloud.

These two seemingly unrelated developments are linked. They represent alternative answers to the questions at the centre of all monetary history: who should govern our money and how? The remarkable thing is that both answers were exposed as dangerous errors centuries ago. While the geeks behind Bitcoin can be excused their ignorance of this, the history-loving Scottish First Minister most definitely cannot – because the man who first explained these answers’ failings was none other than the greatest monetary thinker that Scotland has ever produced.

I don’t mean Adam Smith or David Hume. They were no slouches when it came to economics but on the subject of monetary policy, the palm goes not to those superstars of the Scottish Enlightenment but to a man born a generation before them and much less well known: John Law of Lauriston.

While Smith and Hume spent their formative years swotting in the libraries of Oxford and Edinburgh, respectively, Law – the mathematically gifted son of a prosperous Edinburgh goldsmith – hightailed it down to London to learn the practical business of modern banking from the entrepreneurs, inventors, gamblers and quacks who were busy fomenting the financial revolution that was sweeping London in the 1690s.

When he returned to Edinburgh, all the talk was of a possible union with England. The key economic question, then as now, was what to do about the currency. The conventional answer was the one that Alex Salmond echoes today: to adopt the pound sterling, under the control of the then newly founded Bank of England.

John Law was having none of it. He had discovered an economic truth that we know only too well today – that monetary policy has profound effects on employment, output and the distribution of wealth. As a result, he concluded, it would be “contrair to reason to limit the industry of the people” by acquiescing in the use of a currency “not in our power, but in the power of our enemies”.

How many citizens of Spain, where unemployment is at 27 per cent, or of Italy, where GDP today has fallen to the level of 13 years ago, wish their leaders had listened to the laird of Lauriston’s 300-year-old advice that letting other people manage your money is sheer madness? Yet the SNP’s plan, bizarrely, is to re-create the eurozone within the British Isles.

If letting other people decide the value of your currency is daft, what is the alternative? Law first toyed with the idea of creating a national currency with a value that would be linked to Scotland’s stock of land. That was a similar idea to the solution the English were to settle on in time – a gold standard that fixed the value of the pound to that of precious metal.

The principle behind such commodity-based systems is that the simplest way of avoiding a monetary standard controlled by one’s enemies is to plump for one controlled by nobody at all. No one, after all, can conjure up gold, or land, out of nothing.

That is also the logic of Bitcoin. A physical commodity in fixed supply is replaced by a virtual one subject to a preprogrammed ceiling – but the principle is the same. Don’t let someone else manipulate the supply of the money you use; better that it should be free from manipulation by anyone at all.

This second answer to the perennial question of monetary governance is also flawed. The problem – learned the hard way over the course of two centuries under the operation of the gold standard – is that an arbitrary monetary standard is just that: arbitrary.

There is no reason whatsoever to expect gold discoveries to keep pace with economic growth. The supply of land – let alone of Bitcoins – is even less flexible. The result is a ruinous tendency to deflation. The flip side of the relentless rise in price of a single Bitcoin is the relentless fall in the price of everything else, as measured in Bitcoins.

So John Law jettisoned this second answer, too. Having failed to convince his fellow Scots to reject the Acts of Union, he went to France. There, his avant-garde ideas found a readier audience and he engineered an unlikely ascent that culminated in his appointment as the country’s minister of finance.

In 1719, he took France off its gold standard and introduced paper money, issued at the discretion of the national government. It was the first European fiat currency regime, regulated by the world’s first deliberate monetary policy.

Thus Law furnished a third answer to the central question of monetary history – and it is one for the ages. Rather than ceding the control of one’s money to someone else – the Alex Salmond solution – or abandoning it to the vagaries of blind chance – the Bitcoin solution – the ideal way is to manage one’s money oneself and in one’s own national interest.

Such enlightenment, it seems, can be fleeting. David Hume has his statue on Edinbugh’s Royal Mile and there is one of Adam Smith on the High Street. John Law, on the other hand, hasn’t even made it into the Scottish National Portrait Gallery. Much worse than this is that his teachings, too, have been utterly forgotten by those who claim to be the staunchest defenders of his beloved homeland.

Scottish First Minister Alex Salmond at the launch of the White Paper for Scottish Independence in November 2013. Photo: Getty.

Macroeconomist, bond trader and author of Money

This article first appeared in the 04 December 2013 issue of the New Statesman, Burnout Britain

Getty
Show Hide image

It's time the SNP's terrible record in government was exposed

Do not expect the SNP to apologise for these failings anytime soon. They do not really need to, so successful have they have been in creating a new paradigm in Scottish politics.

The only suspense in Scotland’s elections lies in who comes second. So complete is the Scottish National Party’s dominance that the Scottish Conservatives’ manifesto is called ‘A Programme for Opposition’, summing up a campaign in which the Tories and Labour scrap for second while the SNP waltz to victory.

Nicola Sturgeon says it is a matter of when, not if, there is another referendum on Scottish independence; should the UK vote to leave the EU in June, the SNP is likely to push for another independence vote. But all the debates over constitutional questions miss a bigger point: Scotland already has one of the most powerful devolved administrations in the entire world. The SNP has ruled in Holyrood for nine years, and had a majority for the last five. Yet the SNP’s record, particularly for the most disadvantaged in society whom it claims to speak for, is dire.

Let’s begin with higher education. This, after all, is the area in which the SNP are proudest. Five years ago, Alex Salmond declared: “The rocks will melt with the sun before I allow tuition fees to be imposed on Scotland’s students.” He was so enamoured with the SNP’s policy of maintaining free tuition north of the River Tweed that he unveiled them on a commemorative stone at Heriot-Watt University on his last day as First Minister in 2014.

Scotland is by far the worst country in the UK to be a disadvantaged student. The richest Scottish students are 3.53 times more likely to enter university at age 18 via UCAS than the poorest ones, compared with 2.58 in Northern Ireland, 2.56 in Wales and 2.52 in England. Fewer than one in ten young people from the most disadvantaged areas begin to study towards a degree by the age of 20. And the problems are actually getting worse: just 8.4 per cent of entrants to Scotland’s elite universities came from the poorest communities in 2014/15, down from 8.8 per cent the previous year.

Rather than being beneficiaries of free university tuition, poor Scots have actually been victims of it. Protecting Scottish students from university tuition fees has resulted in a £20 million transfer from disadvantaged students to middle-class ones, according to the policy analyst Lucy Hunter Blackburn. Free tuition has been funded by cutting student grants. And, for all Sturgeon’s disingenuous rhetoric that she would not have been able to afford university with the tuition fees south of the border, protecting Scottish students from tuition fees has been funded by loading debts onto the poorest Scottish students. There is an iron law in Scottish universities: poorest kids graduate with the most debt. Students from households earning less than £34,000 typically graduate with between £4,000 to £5,000 more debt than those from families earning more.

The situation in primary and secondary schools is little better. The Scottish Survey of Literacy and Numeracy shows standards of reading, writing and numeracy for 13-14-year-olds all declining since 2011. As if that wasn’t bad enough, the biggest decrease in both writing and numeracy attainment aged 13-14 has been among disadvantaged students.

Educational inequality cripples Scotland from an early age. At the age of five, the vocabulary of the poorest quintile of students is 13 months behind the richest quintile in Scotland. Poor children aged five perform worse than those in England; the gap in cognitive development between children from less well-off backgrounds and others is also bigger in Scotland. Disadvantaged children are the real victims of the SNP’s failure to make good on its pledge, in 2007, to reduce average class sizes in primary schools to 18; they are now 23.3. And this, in turn, can be traced back to the political choice to prioritise spending on free tuition fees over other areas that would help disadvantaged children far more. Between 2010 and 2013, school spending in Scotland fell by five per cent in real terms from 2010 to 2013 while, in England, it rose by three per cent in real terms between 2010 and 2015. Perhaps that explains why, after Easter, 17 schools in Edinburgh  remained closed because of safety concerns, leaving pupils to be taught in other schools and temporary classrooms instead.

The SNP is not only failing Scots in schools and universities. The number of working age adults living in absolute poverty (after housing costs) rose by 80,000 between 2010/11 and 2013/14; the number of children living in absolute poverty also rose by 30,000, and the number of pensioners by 20,000. Pockets of crippling intergenerational deprivation remain too frequent in Scotland: life expectancy in Glasgow is a year lower than in any other part of the UK. Indeed, life expectancy across Scotland is almost two years younger than the rest of the UK, even though Scotland has the highest health expenditure per head of any UK country.

It is a microcosm of wider problems with NHS Scotland. The SNP’s targets for waiting times for hospital admission have been repeatedly missed, including its “guarantee” of a 12-week maximum wait for planned treatment for inpatients. Patients are more likely to have to wait over 31 days for cancer treatment in Scotland than England, and the percentage waiting so long in Scotland has been rising since 2014. There are also grave health inequalities: those in most deprived areas are 2.4 times more likely to have a heart attack than those in the most affluent areas.

Yet perhaps the most shameful part of Scotland’s health record lies in mental health. Patients are 8 per cent more likely to have to wait over 18 weeks for psychological therapy based treatment than in England. Since July 2014, NHS Scotland has also repeatedly missed its targets on children’s mental health.

Do not expect the SNP to apologise for these failings anytime soon. And they do not really need to, so successful have they have been in creating a new paradigm in Scottish politics, in which the independence debate is the only game in town. But none of this should obscure the truth that the SNP have been in government, and with huge power, for nine years. They have floundered - and underprivileged Scots have been the biggest victims of all.

Tim Wigmore is a contributing writer to the New Statesman and the author of Second XI: Cricket In Its Outposts.