Scotland should choose the krone

If Scotland regains independence, what should it do with its currency? Scottish banks currently print their own bank-notes, but these are British pounds subject to control by the Bank of England. They are not truly a Scottish currency.

The simplest thing would be to follow the Irish example—but that should give Scotland pause for thought. The newly independent Ireland issued its own currency in 1927, but it was still backed by British sterling securities, such that Irish banknotes were marked “payable in London” until 1961. The currency remained pegged one-for-one to the pound until 1979, after which it became pegged to the European monetary system. But as the British pound rose sharply due to North Sea oil and Margaret Thatcher’s hard monetary policies, the Irish currency lost value. Ireland joined the euro at its creation in 1999 and from that moment on ceased to have its own currency or monetary policy. This loss of control proved catastrophic for Ireland’s economy.

If Scotland abandons the link with the British pound, it could decide to let its currency float freely, or seek an alternative peg. Like Ireland, it could join the European Monetary Union (in 2009, Scotland sent £7.7bn of its £21.1bn of its non-oil exports to seven eurozone countries.) What is unclear is whether it would qualify for membership: if Scotland assumed its share of the British national debt, it could have a debt-to-GDP ratio exceeding 100 per cent. As a result of recent debt problems in Greece, Ireland, and Portugal, it is doubtful that the monetary union would admit any new members until they had a debt-to-GDP ratio below 60 per cent.

As Scotland is so dependent upon oil exports, it should consider pegging its currency to that of other commodity-producing countries. Three candidates would stand out: the Russian ruble, the Australian dollar, and the Norwegian krone.

Russia is a major oil exporter and its economy has closely tracked movements in the oil price, but its currency is probably a poor anchor for Scotland because the central bank has allowed inflation to run at double-digit rates during most of the 2000s. If Scotland imported Russian monetary policy, it would also have high inflation.

The Australian dollar is a more compelling alternative because the country is primarily a commodity exporter and its dollar has traditionally tracked movements in commodity prices. It fell sharply with commodity prices during 2008 and 2009 and then rebounded when Chinese demand sent prices up again. The risk posed by the Aussie dollar is its sensitivity to China—Australia now sends close to 25 per cent of its exports there. There are no other countries pegged to the Australian dollar, but it would be an ideal peg for most southern hemisphere countries because it has a responsible central bank which restrains inflation. If Argentina had pegged to the Aussie dollar rather than the US dollar ten years ago, it would not have had the severe financial crisis which led to a debt default and devaluation, and the president fleeing in a helicopter.

The Norwegian krone could also be a credible candidate for a peg because, like Scotland, Norway is an oil producer. The nations are of similar size: Norway has almost 5m people and a GDP of just under $480bn. Scotland has 5.2m people and a GDP of about $210bn. Norway produces 2.1m barrels of oil per day and has 5.7bn barrels of oil reserves. Scotland produces 1.3m barrels per day with reserves of 2.7bn.

Norway never joined the European Union, so its monetary policy is autonomous. Its central bank has an inflation target and between 2009-11 it raised interest rates from 1.25 per cent to 2.25 per cent in order to restrain prices—this combination of sound monetary policy and oil wealth has caused the krone to appreciate against the British pound since 2000. These considerations mean there are would be minimal risks for Scotland in pegging to the krone.