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Carney’s intervention is fatal to the credibility of Salmond’s currency plan

The Governor of the Bank of England made clear that a successful currency union requires fiscal union, the very thing the Scottish First Minister is in politics to end with the rest of the UK.

By William Bain

Scotland’s First Minister is truly a citizen of the world. He travels to the Ryder Cup in Illinois to pledge Scottish government borrowing costs would be lower than the UK’s in the event of separation. He borrows from the sweeping history of economic governance in Europe and beyond going back a century to promise a Benelux style currency union. But today, finally, his campaign to take Scotland out of the United Kingdom crashed into the credibility buffers at high speed – to use an American aphorism, it jumped the shark. In a crucial series of observations, the Governor of the Bank of England made clear what Scots have seen with our eyes and heard with our ears – that a successful currency union requires fiscal union, the very thing Alex Salmond is in politics to end with the rest of the UK. People in the eurozone have paid a terrible price for that crucial failure in higher unemployment and slashed living standards. As I discovered in discussions with President Van Rompuy’s office in Brussels last October, Eurozone member states are now correcting that disastrous error by putting in place mechanisms for sharing fiscal risk and evening out economic demand, but a Yes vote would repeat that tragic mistake here on these islands.

For months, the SNP-dominated Yes campaign refused to spell out what its Plan B for its currency, central bank, and lender of last resort options would be should a full currency union be unachievable in negotiations with the UK government after a Yes vote. Essentially, Plan B had to be one of three options – a form of sterlingisation of the pound without a central bank or lender of last resort; applying to join the eurozone as part of its negotiations to re-join the EU; or establishing a separate Scottish currency with a Scottish central bank.

There are strong reasons for doubting whether a currency union on the Belgium-Luxembourg model would be possible in any case. Firstly, it would involve the continuing United Kingdom to hand over exclusive sovereignty over the UK’s central bank – the Bank of England – thereby turning the institution into a supra-national central bank of not just one but two states. Under the present legislation, shares in the Bank of England cannot be owned by foreign states. Under the Financial Services Act 2012, in the event of a future financial crisis, the UK chancellor calls the shots and can direct the Bank of England’s governor to take specific action to restore financial stability. Who would take charge if the Bank of England was augmented to become an ECB-by-the-Thames? Who would set the monetary policy framework, and any inflation target for the sterling zone? Who would set the terms of what financial stability meant – the UK dhancellor or the Scottish finance minister? Who would take the lead on regulation of the banking sector? Would the Bank have been liable for Scottish sovereign debt in addition to liabilities from any future systemic failure in the Scottish banking system? The Treasury’s analysis finds no supervening economic benefit from such an arrangement, and points to the fact that the UK has economic co-operation with France and Germany but doesn’t share a central bank or macro-economic framework with them as separate states.

Secondly, any currency union to create a sterling zone would require a fiscal treaty applicable to both states controlling levels of public expenditure, deficits and total public borrowing in both the UK and a separate Scotland. General elections in both states would pale in significance compared with the permanent fiscal restraints imposed by the treaty. The same model applies in relation to the fiscal pact between the eurozone-17 and eight other EU states who have opted into the pact voluntarily. It permanently limits the sovereignty of contracting states over fiscal policy. So such an arrangement would not only require the consent of Scots through the independence referendum, even though they could not be guaranteed that it is what we would end up with, but it also requires the economic and political consent of the elected government and MPs of the other parts of the United Kingdom too. It is a step fraught not only with profound and long-lasting economic consequences, but vital questions about democracy and national sovereignty too.

In 2013, Salmond told Channel 4 News his currency union, as backed up by his Fiscal Commission, would echo the designs of Belgium and Luxembourg in 1921. But he omitted to mention that these states eventually concluded that monetary union was not enough, and established a political union, too, with several shared institutions, such as a court, an executive council, and even a joint-Parliamentary body. Political, together with fiscal union, are precisely the kinds of co-operation with England, Wales and Northern Ireland, which the SNP are intent on denying Scots through their plans to leave the UK.

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The First Minister has finally been pushed into declaring what Plan B is should such a currency union prove non-negotiable for the reasons expressed earlier. His Fiscal Commission explicitly said that a form of unilateral usage of the pound  – sterlingisation – even on the Isle of Man model was not likely to be a long-term solution, and warned: “Advanced economies of a significant scale tend not to operate in such a monetary framework”.

So the questions for the Yes campaign are mounting given the Governor’s intervention today. Explain to businesses how they are supposed to operate in Scotland without a credible lender of last resort standing behind the banking and financial services system if a formal currency union is unachievable? Tell home owners why they should have to pay £1,300 more on their mortgages per year if effective bank interests rise just 1 per cent above UK levels because of the lack of a credible central bank? Tell people with store cards, personal loans, credit cards and other unsecured debt how much more they would pay in a separate Scotland just to service their debts because interest rate costs were higher, worsening living standards for many households already on the edge?

Tell savers who will protect their deposits in the bank or building society, should there ever be another financial crisis, if there is no lender of last resort? Countries adopting a form of sterlingisation, such as Panama, Ecuador, and El Salvador, have adopted higher capital requirements for their banks to reduce risk and avoid a run on the banks in each case – what impact will this have on bank lending to businesses and individuals in a separate Scottish state? How would it suit the needs of Scotland’s economy to have the Bank of England set an interest rate and other aspects of monetary policy without any Scottish input whatsoever? Who would help Scotland if we faced a future sovereign debt crisis? Why should Scots have to tolerate higher government borrowing costs or effective bank lending rates caused by such a flawed macroeconomic framework? And why should the financial markets determine the fiscal policies of a separate Scotland, as is the case in other states who follow such a currency model, like the Isle of Man’s?

This is a key day in Scotland’s referendum – it has made the choice ever clearer for millions of Scots voters: if we want to keep sterling, and keep our bank deposits safe with the Bank of England as our central bank and lender of last resort, only a vote to keep Scotland in the United Kingdom can guarantee this. To do otherwise is to engage in a reckless gamble with our savings, our homes, our jobs, and our public services with a plan for separation which does not deserve Scotland’s trust.

William Bain is Labour MP for Glasgow North East

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