Could an independent Scotland really hang on to the pound as its national currency?And on what terms? Simon Wilson investigates.
What's happened?
The whole debate about Scotland's future currency is back at the heart of the independence question, after what appears to be the mother of all gaffes by a Westminster coalition minister.
Two months after George Osborne, Ed Balls and Danny Alexander all definitively ruled out the possibility of a rump UK (rUK) agreeing to a currency union with an independent Scotland, an unnamed "government minister at the heart of the pro-union campaign" told a Guardian journalist last weekend that "of course there would be a currency union" in the event of independence.
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The minister, described by The Guardian as someone "who would play a central role in negotiations after a Yes vote", speculated that "there would be a highly complex set of negotiations after a Yes vote, with many moving pieces. The UK wants to keep Trident nuclear weapons at Faslane, and the Scottish government wants a currency union you can see the outlines of a deal".
Why does this matter?
Because it gives credence to the Yes campaign's insistence that Westminster's position on a currency union is a gigantic bluff, designed to scare Scots into voting No. In response, Alex Salmond dismissed the specific example of a deal over Trident: he remains publicly committed to removing nuclear weapons from an independent Scotland within the first parliament. But he gleefully pounced on the minister's comments to argue that the No campaign had been "holed below the waterline".
The sense of unionist disarray was compounded when the face of Better Together, Alistair Darling, mooted that the UK parties might need to give their voters a referendum on any currency union with Scotland thus conceding that it is a possibility.
Why doesn't Westminster want a currency union?
Because under the terms of a formal currency union, the UK would be expected to bail out the Scottish government and financial institutions if they got into trouble, but Scotland would never be in a position to reciprocate. Moreover, Scotland's banking sector far exceeds its national income immediately compounding the risk to the UK.
In other words, any currency union would be grossly unbalanced, and also inherently unstable especially since the SNP have no great record of rigorous fiscal policy and have also trialled the idea that a currency might only be a transitional arrangement.
"Successful currency unions are based on the near universal belief that they are irreversible," wrote Treasury chief Sir Nicholas Macpherson in his formal advice on the subject, made public by George Osborne. "Imagine what would have happened to Greece two years ago if they had said they were contemplating returning to the drachma."
Do all economists agree?
Of course not! Anton Muscatelli, a professor of economics at Glasgow, supports the Yes campaign's view that the increased transaction costs for rUK firms of anything between 0.1% and 0.5% of GDP (or £500m - £2.5bn) make a currency union the best option.
He argues in the FT this week that without one, Scotland/rUK trade flows would decline significantly, and that a currency union between Scotland and rUK would be very different from the European Monetary Union, as the area would be vastly more integrated at inception than the eurozone economies and it could learn from the EMU's mistakes on the fiscal front.
The respected Chinese economist Leslie Young also argues that, unlike the eurozone, the two governments would quickly work in harness to take decisive action.
What are Scotland's other options?
It could carry on using the pound sterling anyway, in the same way that countries such as Panama, Ecuador and El Salvador use the US dollar without "permission". Some argue (for example Sam Bowman of the Adam Smith Institute) that this would be Scotland's best option, since it avoids the moral hazard implicit in having the Bank of England as a lender of last resort the kind of guarantee that has allowed some eurozone banks and governments to borrow their way into crisis.
However, given the importance of Scotland's financial services, most would argue that such an arrangement would be a non-starter, since it leaves Edinburgh with no control of its monetary policy and no central bank; financial and other firms would head south in droves.
A more obvious Plan B, if it turns out Westminster is not bluffing, would be for an independent Scotland to have its own currency, a Scottish pound either pegged to sterling or variable, though either solution would probably be vulnerable to speculative attacks and increase the risk of capital flight.
The optimism factor
Will the currency gaffe shift voting intentions? It's unlikely, says John McDermott on his FT blog: polls suggest that voters' opinions on whether there will be a currency union tend to reflect rather than determine their views on independence. Thus Yes voters already agree with Salmond that Westminster is bluffing; No voters already disagree.
What should really be worrying the Better Together campaign is the shift among voters towards economic optimism. More people still think independence would be bad for Scotland's economy, rather than good. But the gap has narrowed massively from +17% in September 2013 to just +5% now. If that trend continues, and turns positive for the optimists, all bets are off.
