John Ball, former lecturer in economics at Swansea University
Those of us who believe in independence are perhaps looking a little too much at what is happening in Scotland, yet an interesting poll published earlier this month resonates here in Wales: if the economic case stands up, fully 75% would vote for Scottish independence.
Once again, the economy is centre stage. Such a significant result is interesting because there is no doubt in my mind that the Scottish referendum was lost on two fundamental economic issues; currency and the suggestion that a future independent government could not balance the budget. Both these topics gave ‘project fear’ ammunition and – so far as relevance to Wales is concerned – need to be answered once and for all.
The first is currency.
Whilst there are many in the independence movement who hanker after a new, Welsh currency, the economic reality means that – certainly in the short to medium term – the best option is the continued use of the pound. There is no reason why, in an independent state, the pound could not continue to be used.
There are several different systems which are not necessarily mutually exclusive. The first and obvious is a Currency Union and probably the best option. During the Scottish referendum, the then Governor of the Bank of England suggested that a currency union would be needed.
In fact, for all intents and purposes, a currency union based on the pound already exists. There is already a nine-member sterling currency union and although its members are not sovereign states, they are to a great extent fully self-governing so far as economic and fiscal policy is concerned. Each have their own banknotes reflecting their individuality and Welsh banknotes although designated in pounds would carry appropriate designs reflecting our individuality.
Unions may be formal or informal. An informal currency union exists where separate states unilaterally adopt the currency of one of its members; this informal arrangement does neither imply or require any further economic or monetary union and would be appropriate for Wales. The advantages of such an arrangement are clear; international competitiveness is maintained through the use of a recognised hard currency, there is no exchange rate risk and no transactions costs within the British Isles and other members of the currency union.
The principal disadvantage is that there is no influence over monetary policy, but with interest rates currently at an all-time low and likely to stay that way into the foreseeable future, this is not an issue.
In a Currency Union (which would include Scotland) the Bank of England would be the ultimate issuer of bank notes and remain lender of last resort. During the 2014 referendum the “better together” campaign insisted that an independent Scotland could not continue to use the pound. But there is an important and fundamental issue here – the Bank of England is independent of government and whilst it might consult, or be consulted by the UK government, it is not an arm of government.
During the referendum campaign the then governor emphasised this independence and told the BB:
“The Bank has operational independence in the conduct of monetary policy – others, that is elected officials make decisions about our remit, our mandate. They will make the decisions about the currency – whether there is a currency union between Scotland and the rest of the United Kingdom in the event of a yes vote in the referendum.”
In the absence of a currency union Sterlingisation would be an alternative. The pound would remain the currency but used without the consent of the Bank of England. The weakness is that the Bank would not act as lender of last resort although the likelihood of an event requiring such protection is remote and, in any event, such a duty would rest with the Wales Central Bank. In addition, there would be limited control over interest rates although with rates likely to remain at or close to zero probably for the remainder of the decade, this is not an issue.
This arrangement would work over the longer term, as is the case with some Latin American countries that use the US Dollar without the direct consent of the Federal Reserve.
In terms of economic stability (in the absence of a currency union) this might be the best option, certainly until any turbulence following independence settles. Since the referendum support for sterlingisation has increased (in Scotland but applies equally to Wales) has come from two important sources. Lord Mervyn King, former Governor of the Bank of England has pointed out that there is no reason why Scotland could not continue to use the pound within such a scheme. The Adam Smith Institute has suggested an “adaptive sterlingisation” which not only allows continued use of the pound but outlines an approach that would strengthen the economy.
Finally, there use of Seigniorage, essentially a system where the pound continues to be used based on a “fee” to the Bank of England.
It is not unusual for countries to use non-domestic currency. Nine countries or dependencies outside the Eurozone use the Euro, eleven countries the US dollar, seven share the East Caribbean Dollar, nine the West African Franc and five the Central African Franc. There are in addition nine currency unions the majority of which are informal.
The 19 countries currently using the Euro do not have a domestic currency and in a lesson for Wales, the five fastest growing economies in Europe (the three Baltic States, Slovenia and Slovakia) use the Euro which is clearly not their “domestic” currency.
How would using the pound as a non-domestic currency work? Whichever is the way forward, the mechanics of its use do not present a problem, it would very much be business as usual. Firstly, there is a substantial advantage in having the major international clearing banks in Wales. They would want the straightforwardness of use of the pound to continue and would make that clear to any potential intransigence from the UK government or the Bank of England.
Secondly, more and more financial transactions are made electronically, and although varying by demography and sector, some 60% of all purchases are through international card payments and in addition almost 100% of wages, salaries and business transactions; thus little “money” changes hands.
In summary, economic activity, tax and spending priorities, social welfare, economic development and indeed all undertakings by the new Welsh government would quite clearly not be affected by the continued use of the pound. It is worth repeating – the small nations of Europe have not been hampered by being part of a non-domestic currency, indeed they have benefited from it.
There is a non-economic issue in the use of the pound – psychology. The people of Wales know the pound, it is part of everyday life and there is no question they would require this familiarisation to continue. I was in Malta at the time the country changed from the Maltese Lire to the Euro. Whatever the economic arguments, there was ill feeling at the loss of the currency still referred to – even after half a century of independence – as “the pound.”
The second major issue is the balanced budget.
It is important that we take an honest approach, and it needs to be understood that no country in the world pays its way solely on taxation. Politicians’ convenient (and uniformed) public pronouncements that they aim for a balanced budget is nonsense. There is invariably a gap between taxation and spending. This is addressed through the sale of Government Bonds, these carry an annual interest (“the coupon”), a redemption date and can be denominated in a currency other than the domestic currency – although for Wales, with the continued use of the pound this would not arise.
The life of such bonds varies from short term – a few years – to much longer. Some countries (including Ireland and Austria) have successfully issued bonds with a one-hundred-year maturity, although this exceptional. There would be a market for Welsh Government Bonds.
Bonds are sought after investments because of their relative security; indeed, so safe are such bonds that many countries currently carry a negative interest rate. Even countries with doubtful economies successfully issue bonds. Recent issues have been taken up by investors in Argentina, despite that country defaulting no less than nine times. Recent bond issues by European countries that suffered after 2008 have been in demand, notably Greece.
Despite all the recent problems it is informative to note that Greek 10-year sovereign bonds, currently offer a coupon of 1% one of the highest in Europe. In a world where many government bonds are offering zero, or less than zero coupon, investors are seeking a return.
The interest rate (“coupon”) offered reflects the level of risk – the greater the risk, the higher the interest rate and vice versa. In addition to the interest rate, all countries have a credit rating, which in turn affects the coupon. Currently, the UK is offering record low coupon and has AAA credit status.
Both these factors will come into play when the new Welsh government needs to borrow. The credit rating is an unknown factor although unlikely to be an issue given both that we were previously part of an AAA country and the currency being used is a safe hard currency. Uncertainty also applies to the interest rate although given these same reasons, is likely to be low.
There is however the risk of the unknown and it is possible that the market might seek a higher return than from other countries. Here there is an advantage. The GERW reports indicate that at present we are paying over £2bn in interest charges for debt incurred by the UK. If needed this amount would be available to a Welsh Treasury and would provide a safe cushion of borrowing costs.
However, in the current world of zero or near zero interest rates, a Welsh government could borrow over the long term at almost no cost and the current £2billion would be put to better use.
There are two related financial matters that also need to be addressed; Wales share of UK international currency reserves and contribution to the UK’s National Debt.
It is not unreasonable to assume that Wales allocation of each reflects its population share of the UK; currently 5%. Taking figures published by HM Treasury (which interestingly are published in US dollars); Wales’ 5% share of international currency reserves would amount to £7bn. This is a greater amount than several of Europe’s smaller nations including Ireland, Iceland, the Baltic states and about two thirds of Finland’s. It should be noted that this is the gross figure which includes some debt servicing and liabilities.
The interesting financial debt facing a new Welsh government is the contribution toward the UK’s National Debt, currently £2trn. Opponents of independence have leapt upon this, suggesting that even a relatively small amount of 5% would wreck the country’s finance. In practice – whatever the rights and wrongs – and in keeping with almost all indebted countries, the UK pays interest only on the debt, currently £48bn.
There has been no contribution to the overall amount since the 1960s. Wales 5% share would amount to £2.4bn, almost exactly the amount already being paid by the Welsh taxpayer in interest charges.
Clearly there will be a period of negotiation after the successful independence referendum. Things will not happen overnight. Nevertheless, it remains important to be aware of the major financial indicators in advance of such negotiations.
Which are positive, whatever the naysayers may say. So forget ‘project fear’ – an independent Wales would have no problem choosing a currency and managing its budget.