Pound at all time low

UK Economy in Meltdown – What would be different?

Robin McAlpine – 7th October 2022

As the UK economy melts down I though it might be useful to do a quick primer about how an independent could deal with the fallout, how it can go about solving the problems the UK is creating for us. I hope this is of use and not too boring…

If Scotland is going to be successfully independent we need to make sure a few of the fundamentals go right in the early days of independence. We need to ensure that we have a workable currency which has the right value for the Scottish economy. We need to develop a credible fiscal strategy for the early years. And both of these require a solid monetary and tax policy.

Starting with currency, when I say a workable currency I mean either our own Scottish currency or a currency union – any option which gives us access to and the support of a proper central bank. That means either a Sterling Union (which has been ruled out) or joining the EU and adopting the Euro (which is a bad idea right now and in any case not possible for quite a few years).

So we need our own currency. Keeping it at the right value for the Scottish economy means that during a transitionary period there should be no big shocks of devaluation. If a Scottish currency fell substantially below the value of Sterling it could push prices in the shops up which wouldn’t be helpful. In the longer term it also means that we wouldn’t want it to rise too fast or far as that would reduce prices in the shops but handicap exporters.

The solution is to peg the currency and then transition to a free-floating currency. That means a peg which keeps it at the value of Sterling within steadily increasing ‘bounds’. Bounds just mean ‘how far above or below we will allow it to go’. If your bound is five per cent, a the value of a Scottish currency can rise or fall by up to five per cent before action is taken.

If action is required you use a number of strategies, particularly the use of a foreign currency reserve. That is a large national savings account held in other countries’ currencies. If you use it to buy up your own currency it pushes its value higher; if you sell your own currency your reserves get bigger and the currency value drops.

The risk with a peg is a ‘speculative attack’. Very loosely, this is where someone thinks your currency value is too high, buys lots of it using IOUs, either then waits or sells Scottish currency to drop the value, pays off the IOU in a different currency and banks the difference. What you have to do is either ‘play chicken’ and keep pushing the prices up faster than they can bring it down, or don’t bother and float your currency.

This is why the majority of speculative attacks fail – and Scotland has another advantage in the early years. To begin with money traders won’t actually hold a lot of Scottish currency which makes a speculative attack much harder. Scotland really doesn’t need to worry about speculative attacks in the first few years.

And we shouldn’t want to peg the currency for long. When currencies rise and fall in value it is actually the market pushing the currency towards a more appropriate level for their economy – Scotland shouldn’t want a currency valued much higher or much lower than desirable. So economic and monetary indicators should be watched closely and the peg widened and dropped as quickly as possible.

From the beginning and especially from the moment of floating you need to underpin your currency for your economy and for borrowing. Most people think that is something to do with ‘credit ratings’, but that’s a small part of it. The key is strong economic fundamentals – which means investing into Scotland (which is what lending to a government is) must give you solid returns.

This is why the UK is in crisis – it has been very heavily reliant on the economy of London and this is now ‘over-developed’. London has profited from constant asset inflation (not least because of Quantitative Easing) and those are now ‘too hot’. There is not enough productive investment that the economy can absorb, so Sterling is falling.

Scotland is not in that position; our energy alone gives us enormous capacity to successfully absorb investment. In fact our economy has been so under-developed inside the UK that there is lots of scope for absorbing investment as we transition to a national economy. That gives investors confidence.

Then we want to escape permanently the UK’s ‘cheap money’ policy which was used to inflate asset values and encourage households to borrow and spend to cover up for the fact that wages weren’t rising. Scotland doesn’t want short term speculative investment and a debt economy but a productive economy where long-term investment rewards the investor.

So we want to maintain higher interest rates (which is now being done in the UK, not strategically but out of desperation over inflation). The problem with this is household debt – so we need a major debt reduction strategy for Scottish households after independence (not space here to detail that).

Good investment opportunities and a solid interest rate and inflation policy underpins the value of the currency. In fact preventing the currency becoming too strong might be a key issue for monetary policy (though that is mostly good for households). And that underpins borrowing capacity.

Scotland wouldn’t have much credit history so would have a lower credit rating than the UK, but credit ratings tell you less about your borrowing costs than people think – there is massive variation of borrowing costs inside a single credit rating level and it is absolutely routine that countries with a lower credit rating can still borrow less expensively than those with higher credit ratings.

Scotland may still pay a small premium for borrowing early on, but it is not anything to worry about. There are ways to avoid it anyway – over 80 per cent of the assets in the economy are held in the domestic currency (especially pensions and mortgages). A broad policy plan to encourage that money to invest in Scottish Government bonds can give access to a lot of borrowing.

This is in your own currency so is low risk and low cost. All of this means that Scotland can borrow just fine based on a clear strategy. To make all of this work we should publish an open and transparent ‘business plan’ for the first ten years of independence. Set out clearly and honestly what your strategy is and lenders will have confidence. We can also publish full national accounts and a transparent nation balance sheet.

(The UK doesn’t do this because too many of its assets look less impressive if you write them down and share that in public – so UK national accounting is opaque.)

So now we can spend – and we absolutely have to spend. Scotland has been treated like a regional economy for 300 years and we must make a rapid transition to having the profile of a normal national economy. To do that we must invest heavily in a major industrial policy.

Running deficits is crucial – we must put more into the economy than we take out over the first decade. We can’t do that forever but it is essential early on. So we need a fiscal strategy.

That should be based on full employment and in particular a strategy for greater economic equality. This creates enormous tax efficiency and raises tax revenue without raising taxes. That should be explicit policy. Then we can crack down on tax evasion and avoidance with a competent tax code (the UK tax code is twelve times as long as the King James Bible…).

We also have massive ‘failure demand’ in Scotland, the cost to public services of picking up the pieces of UK inequality and austerity. You have social problems so you pay for remedial action, leaving no money to prevent the problems, round and round in a circle. So we need a period of targeted investment to break the UK’s failure cycle in Scotland. That must be effective and strictly time-limited.

Do all of this and by the end of ten years you should be able to set annual budgets which are close to balanced. And then you can get on with being a normal country.

The independence movement needs a strategy like this. All of the above is a fast preview of what Common Weal is going to put forward as a strategy in the big piece of work we are finalising just now. I hope that it proves useful in trying to create some strategic direction for the independence movement.

For just now, I hope the above race-through of the issues gives you enough to understand what is happening in the contemporary British economy and how we can make the argument that Scottish independence is the right solution to the crisis in which we find ourselves.

5 thoughts on “UK Economy in Meltdown – What would be different?”

  1. Robin suggests:

    “The solution is to peg the currency and then transition to a free-floating currency. The risk with a peg is a ‘speculative attack’ (but) the majority of speculative attacks fail”.

    But not on Black Wednesday in 1992, when Britain was (effectively) booted off its ‘peg’ to the ERM (European Exchange Rate Mechanism) as a result of massive, sustained and successful speculative attacks. (Ah! Memories of John Major, Norman Lamont and George Soros.)

    Of course, the ERM was itself designed as a ‘transition’ to a free-floating currency, in that case the EURO. It also included just the kind of ‘bounds’ above and below target suggested by Robin for a new Scottish currency, but a lot of good that did sterling at the time, or indeed the eventual establishment of the EURO itself, with negative consequences that stretch forward (Greece, anyone?) for decades.

    I’m not saying Robin is wrong in what he suggests; just that these issues are very, very complicated, and with outcomes difficult to predict. So it might be possible for a new Scottish currency to transition successfully to a stable, free-floating independent status, but equally possibly, it might not.

    There would be no certainty of outcome, however well-intentioned and expertly-driven the management of the transition. And given the mediocrity of Scotland’s current political and management class, I wouldn’t be holding my breath.

  2. I have some comments on two particular issues in Robin’s article:
    This is why the majority of speculative attacks fail – and Scotland has another advantage in the early years. To begin with money traders won’t actually hold a lot of Scottish currency which makes a speculative attack much harder. Scotland really doesn’t need to worry about speculative attacks in the first few years.
    How do you know that money traders won’t hold a lot of Scottish currency at an early stage? There are a lot of sources of outflow of currency that could cause this to happen quite quickly. Examples; (1) the redemption of £75bn of mortgage debt which will involve exchanging the equivalent value of SCP to pay off the sterling denominated mortgage debt. (2) There is also a huge volume of sterling denominated non-mortgage consumer debt. (3) annual outflow of currency into rUK based pension funds – something in the range of £3-5bn annually (4) the Scottish economy is heavily penetrated by foreign investment which results in large capital outflows.
    Scotland may still pay a small premium for borrowing early on, but it is not anything to worry about. There are ways to avoid it anyway – over 80 per cent of the assets in the economy are held in the domestic currency (especially pensions and mortgages). A broad policy plan to encourage that money to invest in Scottish Government bonds can give access to a lot of borrowing.
    Pension and mortgage assets will not initially be held in the domestic currency. Mortgage assets will first have to be exchanged from sterling into SCPs – an outflow of £75bn worth of SCPs (the SCP value will depend on the FX rate). The majority of pension assets are in sterling – only Scottish based pension funds such as the local authority funds will be based in SCPs and even then may well retain large sterling based assets. This needs to be addressed by creating a Scottish National Pension Fund into which Scottish citizens’ sterling pension assets can be transferred, exchanging sterling for SCP. This needs to be important part of any 10 year plan.
    One issue nobody seems to have thought about is that pension contributions are subject to tax relief. Now why on earth would a Scottish government grant tax relief on pension contributions being made in sterling into funds based in the rUK? Tax relief has to be conditional upon pension contributions being made into a pension fund(s) based in Scotland and which invest their capital in supporting the development of a productive Scottish economy.
    In any case with our own currency and central bank the ScotGov will be able to borrow at whatever rate of interest it chooses. Monetary sovereignty effectively neutralises the power of money markets. If the markets decide not to buy ScotGov bonds that would not block the implementation of the fiscal policy. If government spending is supporting the development of a productive economy the bond markets will be more than keen to acquire Scottish currency in the form of ScotGov bonds. Let’s get things the right way round. Money markets only have power because governments concede it to them…..and they do that because financial interests infect our politics, our government and our political institutions.

  3. Speaking as an activist with a very basic understanding of the economic matters discussed above … How does all of this play out during an independence campaign ? How do we give voters the confidence to vote for an uncertain future without being dishonest ? How do we explain in two minutes ‘on the doorstep that independence is a better economic option for the people of Scotland? There do not appear to be any answers coming from the Scottish government so I look forward to the new CW publication…

  4. florian albert

    What is unconvincing about Robin McAlpine’s article is the assumption that the economic and social problems which have bedevilled much of Scotland for half a century can be dealt with in a decade by the arrival of a determined new political dispensation. It is unconvincing in the same way that Corbynism was and – very recently – Liz Truss’s project for ‘Growth, growth, growth.’
    In fact, these last two failed projects had, at least, some connection with the political requirement of achieving power through elections.
    In Scotland, those advocating radical change from the left have, to all intents and purposes, no connection with voters.
    While Common Weal proposes the publication of various policy documents, there is – again – no sign that these will
    resonate with voters.
    In June 2014, CW produced a 130 page programme ahead of the Referendum. It failed to make an impact.
    In September 2015, a 150 page equivalent came out ahead of the 2016 Holyrood election. It suffered a similar fate.
    Since 20124, Nicola Sturgeon has ruled at Holyrood unchallenged, not least from the left.
    If the left in Scotland wants political and social change, it will have to engage directly with voters – in elections.

  5. Andrew Currie

    Excellent debate.
    Agree with Florian and Alan about engaging directly with voters. You’ve got less than 2 minutes to catch their interest and by election/Indy time, they have already made up their minds.
    The financial bogey man is a great tool of intimidation by the PTB boys club.
    Having a solid, currency plan established in the electorate minds well before indy would be a good idea to negate the intimidation.

    Re bonds, try this one from Thomas Edison…

    “If the Nation can issue a dollar bond, it can issue a dollar bill. The element that makes a bond good makes the bill good. The difference between the bond and the bill is that the bond let’s the money brokers collect twice the amount of the bond and an additional 20 percent. ( Total of the principal and interest by the time the bond is paid off).
    Whereas the currency, the honest sort provided by the Constitution, pays nobody but those
    who contribute in some useful way.
    It is absurd to say our country can issue bonds but cannot issue currency. Both are promises to pay, but one fattens the userers and the other helps the people.
    If the currency issued by the people were no good, then the bonds would be no good either.”

    Why not split the money creation, say 50/50 between Treasury and the Private banks to get control on inflation and still keep a leash on the bankers.

    Re currency raiders….those assaults on a Nation’s currency are an act of war or terrorism, at the very least and should be treated as such. Bounties work.
    “Hanging a crow or two on a fence by the corn field” is a good warning.
    Keeps the rest nervous

    And yes Jim, money markets are pretty much BS, where gvts have betrayed the Trust of the people and subrogated the citizens via bonds/ bondage.

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