The all-party agreement (in Westminster) on ruling out a currency union with Scotland took some by surprise, but the reasons are now clear. The Treasury has come out strongly, and publicly, against it, and says that Scotland’s threat not to take on its share of UK debt is not credible.
This is a bigger blow to independence than Mark Carney’s recent speech. The highly unusual letter, from Sir Nicholas Macpherson, permanent secretary to the Treasury, is reproduced below:
‘Currency unions between sovereign states are fraught with difficulty. They
require extraordinary commitment, and a genuine desire to see closer union
between the peoples involved. As the Treasury paper points out, the great
thing about the sterling union between Scotland, Wales, Northern Ireland and
England is that it has all the necessary ingredients: political union, economic
integration and consent. What worries me about the Scottish Government’s
putative currency union is that it would take place against the background of a
weakening union between the two countries, running counter to the direction
of travel in the eurozone.
I would advise strongly against a currency union as currently advocated, if
Scotland were to vote for independence. Why?
First, the Scottish Government is still leaving the option open of moving to a
different currency option in the longer term. Successful currency unions are
based on the near universal belief that they are irreversible. Imagine what
would have happened to Greece two years ago if they had said they were
contemplating reverting to the Drachma.
Secondly, Scotland’s banking sector is far too big in relation to its national
income, which means that there is a very real risk that the continuing UK
would end up bearing most of the liquidity and solvency risk which it creates.
Thirdly, there is the problem of asymmetry. The continuing UK would be at
risk of providing taxpayer support to the Scottish financial sector and
sovereign. An independent Scottish state would not face the same risk as
it is inconceivable that a small economy could bail-out an economy nearly ten
times its size. This asymmetry could only cause continuing UK problems unless
Scotland is prepared to cede substantially more sovereignty on monetary and
fiscal matters than any advocates of independence are currently
Finally, Treasury analysis suggests that fiscal policy in Scotland and the rest of
UK would become increasingly misaligned in the medium term. Of course, if
the Scottish Government had demonstrated a strong commitment to a
rigorous fiscal policy in recent months, it might be possible to discount this.
But recent spending and tax commitments by the Scottish Government point
in the opposite direction, as do their persistently optimistic projections of
North Sea revenues, which are at odds not just with the Treasury but with the
Office of Budget Responsibility and other credible independent forecasters.
There is a substantive point here. If the dashing of Scottish expectations were
perpetually blamed on continuing UK intransigence within the currency union,
relations between the nations of these islands would deteriorate, putting
intolerable pressure on the currency union.
If you follow Treasury advice and this week rule out a currency union in the
event of Scottish independence, you can expect the Scottish Government to
threaten not to take on its share of the United Kingdom’s debt. I do not believe
this is a credible threat. First, the sooner an independent Scotland established
economic credibility, the better it would be for its economic performance. An
extensive wrangle about its share of the debt would increase uncertainty and
hence its funding costs. Secondly, the debt is one of a number of issues which
would have to be settled post independence, where the new Scottish state would
require the cooperation of the international community including the continuing UK.
As for the impact of the threat, much will depend on the markets’ assessment
of the probability of a pro independence vote and the likelihood of the Scottish
Government seeing the threat through. In the short run, any uptick in gilt
yields is likely to be small. And in the worst case scenario, it is more than likely
that the increase in funding costs, which the continuing UK would face, would be
smaller than that which would result from an ill thought out currency union
And so to sum up, I would advise you against entering into a currency union
with an independent Scotland. There is no evidence that adequate proposals
or policy changes to enable the formation of a currency union could be
devised, agreed and implemented by both governments in the foreseeable
SIR NICHOLAS MACPHERSON
Permanent Secretary to H M Treasury
This piece is cross-posted from EconomicsUK.com with permission.