Saturday, February 15, 2014

Economy: Does An Independent Scotland Really Need The Pound?

(Drivebycuriosity) - Scotland wants to be independent. In September a referendum will decide if the region will separate from U.K. The British government isn´t amused. London warns Scotland if they choose independence they might not keep the pound as currency.

So what? I think an independent Scotland doesn`t need the British currency, they would even be better off with a currency of their own. In this case the Scots can choose if they want to be really independent and let their currency float freely on the currency markets.

With a free floating Scottish currency the country would get even more independence. If their economy is weak (shrinking GDP, rising jobless rate) they could lower interest rates which should lead to a devaluation of their currency. In this case Scottish exporters would benefit because they can sell their products cheaper on the global markets and foreign competitors would be handicapped because their prices would rise compared to the prices of Scottish products. This should boost exports and hamper imports resulting in a stronger Scottish economy.

If the Scottish economy is booming and heating up inflation the country could lift interest rates which would revalue their currency. A rising Scottish currency would make Scottish products more expensive on the global markets, imported goods would get cheaper. Both processes should slow down the Scottish economy and dampen inflation. 

Scotland also could bind their currency to the pound, the Euro or even to U.S. dollar. Would Scotland chose the Euro for instance, they would have to defend the price of their currency to keep the exchange rate to the Euro unchanged (fixed). If their currency would start falling they would would have to buy their own currency on the currency markets and pay with Euros. This requires of course sufficient supplies of Euros (currency reserves). Alternatively Scotland could raise interest rates which could make their currency more attractive and stabilize the exchange rate to the dollar.

The advantage of a currency peg - say to the Euro - would be that the country could avoid revaluations and devaluations which could hamper trade with the Euro zone. But in this case Scotland would have to give up a large part of their economic independence. If they would attempt lower interest rates than those of the Euro zone their currency would get under pressure and they would fast run out of Euro reserves, on the other hand higher interest rates would attract money from the Euro zone which would lead to a revaluation or foil the planned rate hikes.

Soon we will see how the Scots decides.

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