Scottish Independence: Scotland Should Forget Currency Union and Use Pound Unilaterally

An independent Scotland should carry on using the pound outside of any formal currency union with the UK, according to a thinktank.

The Adam Smith Institute (ASI), which promotes free market ideas, said in a report that Scotland's economy would be better off and its financial sector more secure if it used sterling unilaterally.

At the centre of the debate around Scottish independence, on which Scots will have a referendum in September, is the question of which currency it should use.

Alex Salmond, leader of the Scottish National Party (SNP) and a figurehead of the 'Yes' campaign, has said he would carry on using sterling under a formal currency union with the UK because the pound belongs to Scotland as much as England, Wales and Northern Ireland.

But the three main Westminster parties – Labour, Conservatives and Liberal Democrats – have all said there is no guarantee an independent Scotland would be allowed into a sterling union with the rest of the UK.

In what it terms "adaptive sterlingisation", the ASI argues that Scottish banks should be allowed to issue promissory notes underpinned by reserves of sterling.

This would negate the need for a central bank and allow the financial system the flexibility to create new money by lending where there's demand, boosting the economy and making it more efficient.

Allowing no one bank a monopoly on the issuance of promissory notes would also aid competition, claims the ASI.

And by getting rid of the "lender of last resort", as central banks are known, banks would be less inclined to act recklessly because they would not have guaranteed insurance from the state to bail them out if they run into trouble.

"No Scottish public authority should be invested with any power to bail out insolvent banks under any circumstances," said the ASI report, authored by research director Sam Bowman.

"Similarly, if deposit insurance exists, the costs should be borne by the depositor so that consumers have an incentive to choose safer banks.

"In order that banks keep the optimal level of reserves for a given point in the business cycle, reserve requirements must be abandoned, as well as implicit and explicit government bail-outs.

"This will ensure that banks are neither incentivised to leverage too much nor too little. Instead, debt-to-equity swaps for depositors and extended liability on shareholders should be introduced in the event of bank collapses to allow banks to fulfil their financial obligations."

The ASI report draws on Scotland's financial history for inspiration. It describes the 18<sup>th and 19<sup>th centuries as a "golden age" for Scottish finance.

Banks would issue de facto promissory notes that could be exchanged for gold or silver. They would lend out more than they had in reserve – as modern banks do but under a tight regulatory regime – posing the risk of overissuance if there was a sudden run on the institution by depositors who thought it was insolvent.

The newly formed Royal Bank of Scotland (RBS) fabricated a run on its rival the Bank of Scotland (BoS) by exchanging its own notes for those of the BoS, then turning up at the BoS and redeeming them on mass.

"However, over time a stable system emerged, including provisions against runs of this kind (in this case, achieved by including 'options clauses' on banknotes that gave the bank's directors the option to pay the bearer at a later date with 5% interest) and the establishment of private clearing houses that allowed banks to provide and access short-term loans to avoid short-term liquidity issues," said the ASI report, urging that a similar system should be allowed to develop if Scotland gains independence.