ADVICE FROM ADAM SMITH

This article was written by written by Sam Bowman, director of research at the Adam Smith Institute, who seems to have a less patronising view of Panama that the failed chancellor, Darling. It is reproduced here without permission and the pictures (except Sam's portrait) are my additions. Darling and his friends have tried to paint a picture of use of sterling without a formal agreement, as some sort of dodgy "South American" idea. In fact Panama has the 7th most stable banking system in the world. (Canada leads, with Sweden, Luxembourg and Australia following. The UK is not looking too great, according to Moody's... That was kept a bit quiet!) 

When Scottish voters go to the polls in their independence referendum next month, they may ultimately make their decision on the basis of a single question: if we voted Yes, what currency would we use? The question has massive implications for Scotland’s economy, and since the “Plan A” of a formal currency union between Scotland and the rest of the UK was ruled out by the chancellor, doubts about “Plan B” have dominated the campaign.

Alex Salmond has suggested that “Plan B” may be unilateral use of sterling without a currency union, a system known as “sterlingisation”. As I argue in a new paper for the Adam Smith Institute released today, with the right reforms to Scottish financial regulation, Plan B should be Plan A.

The “adaptive sterlingisation” plan would work like this: the Scottish government would announce no change in its use of sterling as the currency it does business in. Scottish banks currently issue their own notes that are backed on a one-to-one basis by sterling notes held at the Bank of England (million pound “Giants” and hundred-million pound “Titans”). Post-independence, they should be free to issue notes backed by their sterling reserves without restriction.

These notes would be redeemable on demand for pounds sterling. But as promissory notes, the banks would be free to issue more or less of them according to their customers’ demand to hold cash. This would act as a market-based mechanism to stabilise demand during downturns, preventing the sort of economic catastrophe that the Eurozone is now enduring.

But to keep Scottish banks honest and prudent, the financial regulations that currently protect established banks from failure would have to be removed. Deposit insurance currently means that depositors have no incentive to put their money into safer banks, because riskier banks can pay more interest without any downside for the depositor.

This should be replaced by extended liability over shareholders in the event that a bank fails. This would mean that even an insolvent bank would still be able to honour most of its liabilities. Although shareholders would be liable in the event of bank panics in the short run, in the long run, the cost of this would be borne by the depositors themselves in the form of bank charges (to compensate shareholders for the increased risk of owning shares).

Central banks are usually seen as an essential part of a financial system, acting as an unlimited lender of last resort to illiquid banks. And a sterlingised Scotland would have no central bank, so solvent but illiquid banks would have to create their own ways of accessing short-term funds.

But this is not as big a problem as it may seem. International capital markets are now highly efficient and could probably be relied upon to lend to solvent banks in a tight spot. Or in a return to an older way of doing things, private clearing houses could be established by banks to provide the same function.

All that Scotland would lack was an institution that could provide unlimited funds to a bank. But central banks can be a double-edged sword, supporting insolvent banks and lending either too freely to irresponsible banks or not enough during systemic panics (as happened during the Great Depression).

Panama City: Makes london look a bit tatty.

And looking at the “dollarised” economies of Latin America, having no central bank may be a good thing. Panama, Ecuador and El Salvador all use the US dollar without formal agreement with the US, and all have remarkably healthy financial systems. Ecuador dollarised to end a financial crisis in the early 2000s, and along with El Salvador has been praised by the Federal Reserve of Atlanta for the success of its dollarisation policy. But Panama, which has used the US dollar in this way for over a century, might be the best model.

Panama’s banks also lack the regulations that a sterlingised Scotland should look to drop, and it has no central bank. Because of this, its banks are extremely careful – according to the World Economic Forum, the country has the seventh soundest banks in the world, and does extremely well on all of the Forum’s measures of financial health.

During the eighteenth and nineteenth centuries, Scotland had a monetary and financial system similar to the one I propose in this report. The so-called “free banking” era gave birth to the Scottish Enlightenment. At the start of the period, Scots were half as rich as their English neighbours; by the end of it they had almost overtaken them. None other than Adam Smith wrote in the Wealth of Nations that Scotland’s banking system deserved much of the praise for this flourishing.

It may be difficult to persuade Salmond of the benefits of market regulation over state regulation, but he has surprised in the past. If Scots want a financial system that is more stable than the one they – or the rest of the UK – have now, Adam Smith may have one more lesson for them.

OH DEAR DARLING, WHAT DO YOU SAY TO THIS?

In a press release from the Adam Smith Institute, champion of liberal capitalism and no friend to the Social Democracy favoured by Scots, Kate Andrews, Research Director, demolishes Better Together's suggestion that the SNP's lack of a plan B* matters so much. She writes:

"An independent Scotland could flourish either by using the pound sterling without the permission of the rUK (or by setting up a "ScotPound" pegged to sterling through a currency board, which would achieve a similar end). This 'sterlingization' would emulate a number of Latin American countries that use the US Dollar without an official agreement with the US government. Because Scottish banks would not have access to a currency-printing lender of last resort, they would have to make their own provisions for illiquidity, and would necessarily act more prudently.

"Scotland actually had this system of 'free banking' during the 18th and 19th centuries, during which time its economy boomed relative to England's and its banks were remarkably secure. And Panama, which uses the US Dollar in this way, has the seventh most stable financial system in the world.

"Everyone says Mr Salmond needs a Plan B if the rUK does not agree to a currency union with Scotland. But unilateral adoption should be Plan A, making Scotland's economy more stable and secure. The UK's obstinacy would be Scotland's opportunity."

*Of course there are various other plans beside Plan A. The FM made it clear that a Fiscal Commission has laid out alternatives. The Scottish government, however, agrees with the Fiscal Commission (and the Adam Smith Institute), that a currency sharing option is the best option, not just for Scotland but for the UK as well.

DON'T DO THAT, GEORGE

It always seemed to me that the current Conservative government largely comprised a bunch of over-privileged, upper middle class to lower upper class men from what the English somewhat weirdly call “public” school (as most of the public never get near them) and Oxbridge. After the relative egalitarianism of the previous 18-year spell of  Tory misrule, it was a return to the days of the old school tie.

In practical terms that meant that what you got was a bunch of incompetent Hooray Henrys, in post because of who they knew, rather than what they knew, and with absolutely no idea of what species populated the world outside of their own class (except for Nanny and Cook, the Butler and possibly the Head Gardener).

Scary, of course. But if these people had any saving grace it was that they were largely “gentlemen”. You know what I mean: “a chap’s word is A CHAP'S bond” dontcha know?

Well, that seems to have gone out the window.

A matter of days after the now infamous love bombing from the Olympic Park, which went disastrously wrong,  Gideon George Oliver Osborne (if they’d just transposed his two middle names, we could have called him Gogo), broke the terms of the Edinburgh agreement, which states [in more legal language] that the two governments agree to work together to co-operate with the free will of the Scottish population. He came to Scotland to tell us we couldn't hang on to the pound in an independent Scotland. I can't help but feel that it was a pretty silly thing to say.

It smacks of desperation.  It is pretty obviously designed to put the frighteners on Scots. It wouldn't be for the good of the UK economy or the Scottish economy, because, although our currency would be strong, we'd still have to do business with a UK whose currency wasn't worth the paper it was printed on. It appears to be a nasty move on Osborne's part, designed to scare, perhaps better described as bully boy (as opposed to Bullingdon Boy) tactics, which I suppose is what you get in “public school” playgrounds and “dorms” when a responsible member of staff isn't around to control the children.

Everyone knows that the pound is an internationally traded currency, and as such anyone can use it anywhere, with or without the agreement of the Bank of England, so technically they can't even say we can't use it. We can. We just can't use it with their blessing.

But it doesn't seem to be a threat that was ever designed to be carried out. It would damage the English and RUK economies. Almost certainly the pound would tumble without Scottish exports. Companies operating across the border would be lumbered with administration costs of working in two currencies (and although that works between Eire and Ulster, there are costs involved).

However, Osborne says the opposite to all this, and in what we know already has been agreed with Ed Balls and Osborne's glove puppet, Alexander, he adds: "I don't think any other chancellor of the exchequer would come to a different view."

This, in itself, is odd, given that ex-chancellor, Alistair Darling, the Tory’s stooge in Better Together, famously said exactly the opposite! Not to mention the SOS for Scotland and one of the No campaigns academic advisors!

My purpose in writing this is not to go into detailed analysis of the situation, which is, in any case, beyond my economic understanding. That is more expertly covered here by Iain MacWhirter, and the options open to our government here by James Kelly. I felt however, obliged to comment upon to what I see as some sort of change in their strategy. An almost desperate turning nasty, or nastier, of the campaign, precipitated, I have no doubt, by private polling showing that they are losing the argument.

It could, of course, work. There will be those who will be frightened at the idea of starting out with another currency. Of course people will worry about pensions paid in pounds by English pension companies (or the RUK government on contributions paid over a lifetime to London). There will be people who will swallow the “border posts” stories. Barbed wire posts set up to ensure that no pounds escape from England into the badlands of the Scottish borders, no matter how many pictures you put up of postless borders between other countries.

Mind you, if this were the plan, it might have been better to make the announcement a little closer to the time, when the truth would have more difficulty in getting out. 

But I suspect many will see it for what it is: a dirty tricks campaign designed to coerce Scotland to stay with the Uk and let the smug Tory boys continue to enjoy the benefits of Scottish exports to prop up their 19^th century dreams of importance and world statesmanship, and to not suffer the indignity of being the government that lost Scotland.

Those who take the trouble to read a little more than the tabloid stories of the “Hammer blow for SNP” type, will perhaps note what the Adam Smith Institute says.

No one likes a bully, Gideon George… and, I suspect, this may well be another blunder in a long list of blunders that will backfire badly. It can hardly be doubted that, if the referendum is to be won by lies, deceptions and tricks, it will not lead to a happy nor a permanent settlement of the matter. And it won't win you international respect.

Perhaps he should have listened to Joyce Grenfell “Don’t do that, George", which I add here for your entertainment.