Join a currency union, and you end up part of a nation state

I don’t go to very many speeches by important-sounding people (it is rarely worth it). But I made an exception yesterday for Mark Carney, who was up in Edinburgh giving a speech about what makes a successful currency union.

He was keen to point out (over and over) that whether an independent Scotland would join with England in currency union and what the terms of any deal might be, are nothing to do with him. He runs a “technocratic organisation” that simply implements the instructions it is given by the government.

However, whatever he might think about the politics (and I know that he is a great fan of a book called What Money Can’t Buy by Michael J Sandel) his talk made it pretty clear that in his view, the SNP is going to find it very hard to get what it says it wants – fiscal independence alongside monetary union. A successful currency union always “requires some ceding of national sovereignty”.

There are excellent reasons for wanting to be inside a currency union with a like-minded country. It makes people more likely to invest across borders when they don’t have to bother with exchange rates; it means everyone has access to more liquid financial markets; and if you have a history of inflation or bad financial management, you can cut your borrowing costs by taking on another country’s financial credibility via their currency.

It can also help with pricing transparency, said Carney, encourage the free flow of labour, and “improve the flow of technology and ideas”. Sounds brilliant, doesn’t it? No wonder the SNP wants to stay in the currency union it is already part of.

But there is a problem. Well, a problem for anyone who wants to live in an independent country and be in currency union. Being in a union can bring huge stresses: if you are uncompetitive, but stuck with a shared currency, you can’t devalue your way out of trouble, and so on. That brings us (or Carney) to what makes a successful currency union.

The answer is to have that union inside a nation state. So it works in the US and in Canada. It doesn’t work in Europe. That’s partly down to having a common language and integrated labour market, but, says Carney, it’s also down to the major feature of successful currency unions – they are also banking unions.

They have a joint deposit guarantee scheme, common supervisory schemes and access to the same central bank as a lender of last resort. They share institutions, and in particular, a “national backstop” in the form of their supranational central bank. But “pooling risk” like this automatically implies a “loss of sovereignty”.

After all, a backstop puts sovereign (taxpayer) funds at risk, and with a deposit guarantee scheme, “all member states must be persuaded that they won’t simply be left with the bill for the mistakes of others”.


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It doesn’t stop there. Successful unions don’t just have “common fiscal backing”. They have shared fiscal arrangements – they have a system that transfers cash between regions (the worse-performing get money from the better via a central government); something that helps “mitigate the loss of exchange rate flexibility”.

Europe is heading down the road (with some difficulty) to fiscal union, or at least a “set of robust fiscal rules” in order to survive. When it is done, it will look much like a huge nation state. The degree of fiscal risk sharing, said Carney, is “likely to be significant”. Join a currency union, and you end up part of a nation state.

Look at it all like that and you might find yourself wondering exactly what the point of demands for Scottish independence really are – it clearly isn’t possible to downgrade from being part of a nation state to being in a currency union with the bigger part of that state.

As I have said before, Scotland is effectively a member of five unions (the Crown, defence, currency, European, parliamentary). The SNP plans to keep four of those intact, and as things stand, shift the dial on the fifth (parliamentary union).

But if you believe Mark Carney (and as he says, the politics of the case are nothing to do with him), it is clear the dial can’t be shifted very far. It’s all a bit more ‘devo max’ than independence, isn’t it?

As Bill Jamieson puts in The Scotsman, Scotland has set out on what looks to be a very “steep learning curve about the meaning of sovereignty and its limits”.

* You can find the full speech here should you feel up to it.

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11 Responses

  1. 30/01/2014, Merryn wrote

    Here is another view. Asia expert Jim Walker on why there is “no question” Scotland will keep using sterling http://www.thesundaytimes.co.uk/sto/news/uk_news/scotland/article1357418.ece

    • 04/02/2014, 4caster wrote

      Yes, another option for “independent” Scotland would be to use sterling as a currency without the agreement of the rest of the UK or and Bank of England: just like certain former Yugoslav states have used the Euro (and previously the Deutchemark) rather than the earlier alternative of dinars: and like Zimbabwe today uses the US dollar. But that option reduces Scotland’s sovereignty even more, because she would have absolutely no influence on how the currency is run, and she would be totally responsible for controlling and guaranteeing her own banking system.

  2. 30/01/2014, SimonW wrote

    I think it’s more “cynical” than that; a “socialist” Scottish “independence” movement really wants all the power without the responsibility to go with it… much like the banks’ taking all the gains then “socialising” the losses. This is what “new socialism” really is!

  3. 31/01/2014, JamesH wrote

    If the UK Govt. continues to disparage a currency union the markets will pressurise the UK Treasury for clarification, just as they did on UK Debt.
    “It’s a mad dog that bites itself”

  4. 03/02/2014, davidstuart wrote

    How a country can be independent AND be a member of the European Union is beyond me! If being an EU member doesn’t involve a loss of sovereignty, then I don’t know what does! In other words, all this talk of Scottish independence is just nonsense! After the financial crisis of 2008 and the collapse of the “Celtic tigers”, Salmond’s case for independence got a lot weaker; the more time goes on and the real issues are looked at, the more improbable it seems. I don’t want to be in a currency union with an “independent” Scotland and according to the polls, neither do 90% of the rest of the UK.

  5. 04/02/2014, JamesH wrote

    david stuart Re.your assertion “according to the Polls 90% against currency union”

    Panel base opinion poll 29/12/13. A sample of 1011 people in England ,Wales & Northern Ireland were asked-
    “If Independence does happen do you think that Scotland and the rest of the UK should continue using the pound in an agreed sterling area ?”
    YES 71%
    NO 13%
    DONT KNOW 16%

  6. 04/02/2014, EM99 wrote

    Hi,
    Reading this blog, you would think that there is no good reason for independence. That may be your personal view but as a journalist shouldn’t you look at the other side? For instance here is a good article by Dominic Frisby http://www.independent.co.uk/voices/comment/why-an-independent-scotland-could-become-the-richest-country-on-earth-9096120.html
    Whilst I support an independent Scotland and believe it would be great for England as well as Scotland I understand that the process may be intimidating for some. I don’t think that anybody is well served by just looking at all the potential problems that arise by change. The blog posts on Independence would do more of a service if they attempted to analyse both sides of the debate.

    • 04/02/2014, AlexH75 wrote

      I think you’ll find that the blog’s author has already made her mind up on independence. I do, however, find it perplexing that she decides to reside in Scotland, as she never seems to have anything good to say about the country……

  7. 04/02/2014, kcod wrote

    Let us imagine that Scotland did leave the Sterling area – what currency would it choose? Probably the Euro since they wish to remain in the EU.

    But then can you reasonably be in the Euro-area and not sign up to the Schengen Agreement (that guarantees the absence of border controls) – no, not realistically.

    So, what does that imply for England and Scotland? Well, since England has not signed up to the Schengen Agreement, it will imply the introduction of rigorous border controls between England and Scotland – at every road, rail, sea and air crossing for both people and goods.

    That should slow things down a bit!

    But it will also provide a whole new area of smuggling opportunities – although we do have the advantage that Hadrians Wall (left over from Roman times) still exists to some degree. So perhaps we will be able to keep the Scots out.

    And the banks will make an additional killing on the exchange rate margin for all the goods and money that continues to traverse the border.

    Does anyone out there understand why such HUGE margins are applied to monetary exchange when it is just a few bits down a piece of fibre-optic and a quick multiply, add/subtract in a computer?

    • 04/02/2014, 4caster wrote

      The easy answer to that is for the rest of the UK (rUK) to join Schengen too. Then there would be no need for border controls anywhere. Much of Europe prefers that arrangement.
      But if rUK prefers to stay out of Schengen, she will be free either to control the Scottish border or not. Likewise Scotland may or may not decide to impose border controls on rUK.
      A similar dilemma might arise if the Republic of Ireland were to decide to join Schengen. Its border with the UK province of Northern Ireland is largely uncontrolled. Would the UK want to control it more effectively?

  8. 04/02/2014, 4caster wrote

    The Scottish Nationalists want it both ways. Carney put it very succinctly. All international treaties involve some loss of sovereignty, but none more than a currency union. There is no point in Scotland becoming independent and then tying its fiscal and monetary policies to the dictates of the Bank of England.
    But Merryn’s other three “unions” (the Crown, Defence and European) are red herrings. Scotland can stay under the Crown, like Canada and several other countries; she can be in the EU, NATO and the Commonwealth – always provided those entities will allow her to remain a member. The EU aside, no-one has suggested that belonging to them brings serious loss of independence.

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