Sterling centre stage in debate on Scotland independence vote

Ireland’s handling of currency matters after Independence in 1928 could offer a path for Scotland

Bank of England and Royal Bank of Scotland banknotes: a yes vote in Scotalnd’s independence referendum could have major consequences for sterling

The Clydesdale Bank’s purple-hued £20 note bears the image of Robert the Bruce on its front and New Lanark, a 18th century village built by philanthropists for mill workers on its reverse.

It is one of two £20 notes the Clydesdale produces. Both are backed by the Bank of England and both are legal tender in the UK, although it is not always easy to spend them outside Scotland. They always attract second glances and often their production prompts refusal. There are few things that annoy Scots more, particularly when it happens in London.

Recently, the Mayor of London Boris Johnson issued a diktat to Transport for London that Scottish notes had to be accepted on the buses, following a series of refusals.

Currency touches nerves, as can be seen with Scotland’s increasingly bad-tempered debate about the currency it will use if voters support independence on September 18th.


Over the past 25 years, the Scottish National Party (SNP) has favoured the full gamut of options that are theoretically possible: an independent currency, the euro, or sterling.

Today, Scottish first minister Alex Salmond insists that an independent Scotland will "keep the pound" in a full currency union with the remaining parts of the UK.

His opponents among the Conservatives, Labour and Liberal Democrats say that Scotland will not be able to do this because the rest of the UK cannot, and will not, agree.

Last week, the Scottish National Party leader suffered a serious blow when he refused/was unable to declare a plan B in a debate with former Labour chancellor of the exchequer Alistair Darling.

The SNP leader had once condemned sterling as “a millstone” around Scotland’s neck that was responsible for much of its woes.

Then, he backed Scotland’s membership of the euro, but that dream faded in much the same way as did his ambition that Scotland would become part of Ireland and Iceland’s “arc of prosperity”.

Many in his party look to Scandinavia for inspiration on currency as they do on many other things, believing that Scotland should have its own currency. Salmond, however, is a gradualist about independence, knowing that that idea is too much of a leap into the unknown for many voters, which is why he favours a currency union.

The policy is not new. In fact, it is a decade old, but was little noticed then. However, Scots are facing the referendum on September 18th, so what was once theoretical is now real.

Scotland’s SNP finance minister, John Swinney, says that a formal monetary union with the rest of the UK, with the Bank of England operating as the central bank, is “the core proposition for us”.

The Bank of England is, he said then, “the Bank of the whole United Kingdom”, adding that the Scottish government wanted it to continue as the lender of last resort to [Scottish] financial institutions.

Salmond’s difficulty is clear, if hard to resolve. An independent Scotland can use sterling, if it chooses, but it cannot do so as part of a currency union unless the rest of the UK agrees.

The SNP leader has always had an à la carte attitude to currency union, believing that the Bank of England would not have oversight of a Scottish budget, for example.

“They don’t seem to understand that if you have a currency union, there are terms and conditions about your taxation, about your spending, ” said Darling.

Last February, Conservative chancellor of the exchequer George Osborne went to Edinburgh to make clear that Salmond could talk about currency union but he was not going to get it.

Evoking the memory of troubled RBS, he told his audience that such a union would not be in the interests of the rest of the UK since Scottish banking assets were worth 12 times Scotland's GDP.

His intervention provoked fury and declarations that Scots would rebel in the face of a diktat from London – particularly one from a Conservative politician.

Furious though they may have been, there is little doubt that Scottish people want to keep sterling. Osborne’s warnings have gnawed at wavering Scottish opinion, leading many, it seems, to decide to vote precisely because of concerns about the currency that will be in their pocket.

Today, the Conservatives, Labour and the Liberal Democrats are all preparing to make manifesto pledges in next year’s general election ruling out a currency union with an independent Scotland.

Scotland cannot be blocked from using sterling as its currency since it is freely traded and convertible, but it can be denied any role in the making of the monetary policy behind it.

In addition, it would not have the Bank of England standing behind it as "the banker of last resort", which was needed when RBS and HBOS ran into trouble in 2008.

For example, the Bank of England then provided £61.6 billion of secret emergency liquidity assistance (ELA) to RBS and HBOS, but the bank was indemnified for the loss by the British taxpayer.

In all, the ELA given to the Scottish banks came to slightly more than half of Scotland’s GDP that year, while the total state support given equalled 211 per cent of Scotland’s GDP.

Using sterling without a currency union – so-called “sterlingisation” – would mean that Scotland’s fortunes would ebb and flow with its balance of payments, backed by North Sea oil revenues, whisky exports, and so on. Today, financial services account for 15 per cent of total Scottish exports, or almost 9 per cent of its GDP. The rest of the UK is the biggest consumer of these services.

Without currency union, the fear is that the Bank of England would require Scottish financial institutions to relocate south of the border if they wished to depend on it in bad times.

“Part of the solution to Scotland’s lender of last resort problem may be to have its own currency and a functioning central bank,” said the National Institute of Economic and Social Research.

Some in the Yes camp increasingly look to Ireland’s example after Independence, where a new currency was created after 1928 but it was pegged to sterling.

Six of Ireland’s nine banks had rights to issue notes dating back to the 1840s, as long as they were backed up by gold, or foreign exchange reserves held by the Bank of England in London .

The role of the Currency Commission set up in Dublin in 1927 was aided by a number of factors, including the fact that nearly all of Ireland's foreign trade was to Britain.

In addition, it did not act as the banker of last resort. First, Irish banks were deeply conservative, so there was little need. Second, the banks had more foreign reserves than the State up to 1963.

The role of financial services in the Irish economy at the time was a fraction of the Scottish equivalent today, while a globalised world has changed much of the rules in finance.

The Currency Commission was replaced in 1943 by the Central Bank of Ireland, although it did not loan money to the banks or, indeed, even to the Government.

The new body did not have the power to limit credit, but it could encourage its expansion – although it preferred to rail against the rise in State spending each year.

The link with sterling was not questioned, even after the declaration of the Republic in 1948 and sterling’s devaluation in 1949 and again in 1967.

However, there were difficulties. In January and February 1955 the London bank rate rose by 1.5 percentage points to 4.5 per cent. Normally, the Irish banking system would quietly have followed suit.

However, Fine Gael’s minister for finance Gerald Sweetman persuaded the banks not to do so.

Capital fled. Bank credit to companies with credit lines in Britain jumped substantially. Prompted by the low real interest rates, imports increased and meat exports fell. Early the following year, the Government imposed heavy import duties. Imports quickly collapsed but so did much of the domestic economy. Emigration surged. In 1957, 1.8 per cent of the population left.

The Irish experience differs from anything on offer in the Scottish debate since even if if Ireland’s model fell short of a currency union, everything was done with the agreement of British ministers and with daily co-operation from the Bank of England.

In the past, Salmond has spoken of how monetary policy is now a card of reduced value in today’s globalised world, where countries are rarely able to control events. Instead, he places weight on fiscal policy.

However, Prof Gavin McCrone, former chief economic adviser to the Scottish Office, reminded the House of Lords Economic Affairs Committee last year that Ireland’s fiscal freedom was limited by the need to maintain the currency link.

Sterlingisation is rejected as a nonsense by the pro-Union campaign, who argue that Scotland's financial services industry accounts for an eighth of the Scottish economy. Nevertheless, supporters of the idea – even if it is not their first option – point to Panama, which uses the dollar. It has a thriving banking industry although one that relies on s secretive habits for some of its success.

Banking assets there equal 215 per cent of GDP, yet it avoided recession after the global banking crisis in 2008. Since mid-2010, according to the International Monetary Fund, the overall loan-to-deposit ratio has exceeded 100 per cent.

For now, however, many Scottish voters recoil at the mention of Panama, seeing images of Latin American instability rather than the type of dour Scottish rectitude of old that would soothe their fears.