Three Lessons from the Euro-zone: Why a Sterling Currency Area Will be a Financial Straightjacketon 24 February 2014
When it comes to currency unions, David Cameron is certainly right on one point. A decision to share a currency is necessarily premised on multilateral negotiation, which is why such unions are so tricky to establish let alone to run. The travails of the Euro-zone illustrate precisely these difficulties. In fact, the story of the euro can be read as a set of lessons that will affect the options available in case voters in Scotland opt for independence.
Firstly, the Euro-zone crisis shows just how vulnerable states remain to the vicissitudes of financial markets when part of a currency union. In the aftermath of the global financial crisis, tax receipts fell sharply while governments faced larger unemployment and associated costs. This sudden crunch was enough to squeeze the credit lines used to finance government borrowing. Ireland and Spain, who were otherwise among the best pupils of the Euro-zone in terms of low annual and total debt, very quickly faced huge spikes in interest costs, further weakening public finances. This kind of vulnerability would be amplified in an independent Scotland where public finances will be tied to the price of oil.
The second lesson concerns the inherent flaw of providing for a currency union without a banking union, which is of direct relevance given the large financial services industry present in Scotland. The flow of credit to Ireland stopped completely after its government had to rescue the banking sector to the tune of 40% of GDP. It was in these circumstances that the Irish government had to negotiate a direct credit line from sovereign states i.e. a bailout. Therein lies the third part of the story.
The mechanics of the bailout and subsequent modifications to the rules governing the Euro-zone demonstrate that creditors call the shots when it comes to rescuing a currency union. The only politically feasible option for countries, notably Germany, that lent money to stricken states was austerity measures as a counterpart to cash injections. German voters resented what they saw as funnelling money to financially incontinent governments. The English voting public will share the same instinct in the event of being asked to do likewise for a sterling union.
In each of the three above instances, therefore, the fault line in the single currency was that between the creditor core and the periphery being frozen out of borrowing on the international markets. Of course, the countries using the euro have sought to learn from their bitter experience. That is why the European Central Bank is now at the apex of a system for banking supervision, which entails the power to close dysfunctional establishments. Additionally, EU countries – with the exception of the United Kingdom – signed up to a binding commitment to run balanced budgets. The carrot being dangled to encourage this fiscal self-discipline is access to the permanent Euro-zone bailout fund, the European Stability Mechanism. In the future (in principle) it will be a case of no budgetary prudence, no bailout.
The overall result of these changes is that the euro is now a far more sovereignty-constraining currency union. Taking its cue, for once, from the EU, the government in Westminster is also keenly aware of the need to draw on the sorry experience of the Euro-zone when envisaging a sterling currency union. Mark Carney’s intervention, as head of the Bank of England, on the subject indicated that a Scottish-Rest of United Kingdom currency union could only be envisaged on the most stringent of terms. Supervisory powers over Scottish banks and Holyrood’s purse strings would have to be controlled south of the border.
Naturally, the United Kingdom – just like Germany in the case of the euro – has an overriding interest in maintaining the financial stability of its key trade partner. Keeping the pound is thus a perfectly plausible scenario for an independent Scotland. However, it cannot be done without acknowledging Westminster and the Bank of England’s demands. With the euro as an object lesson in poorly designed currency union before them, British policy-makers will be at pains to avoid repeating the same mistakes. Breaking up the Union will leave Scotland facing the prospect of a sterling currency area that is as much of a straightjacket for public finances as the euro.
Andrew Glencross is a lecturer in International Politics at the University of Stirling. His main research focus is on the interplay of law and politics in the European Union. He is the author of What Makes the EU Viable? (Palgrave 2009), co-editor of EU Federalism and Constitutionalism: The Legacy of Altiero Spinelli (Lexington 2010), and The Politics of European Integration: Political Union or a House Divided? (Wiley 2014). He tweets at @a_glencross.
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