The NIESR “Monetary Union and Fiscal Constraints” (No.288, May, 2014) argues that currency union will not work because the evidence shows that such currency unions have not tended to last. Unfortunately the evidence presented by NIESR is faultily framed: it does not even address the particular international economic and financial environment or forces at play that inform the distinctive circumstances of the UK. The NIESR emphasises the difference in scale between the two economies of Scotland and rUK as the critical feature, rather than a matter of far greater significance; the brooding dominance of the City of London in the UK/rUK and its international financial risk profile that looms heavily over the economy of rUK. In this context a history lesson from the NIESR (dp415, October, 2013) in “dollarization” (eg., Panama and Montenegro) as a form of currency union worthy of contextual consideration is simply neither adequate nor sufficiently relevant.
London has proclaimed its status as the world’s leading financial centre for longer than most analysts can remember. Of the world’s $60-$70 trillion gross trade, a sizeable tranche (far beyond the relatively modest scale of the UK economy) passes transiently through the City one way or another. The City’s curious international position in world banking and finance, combined with the UK/rUK’s uncomfortable, delicate and risky relationship with the City (without the vast buttressing GDP that informs the relationship between the prevailing power of the US economy and Wall Street) is quite unique; the City and rUK is not like US/Wall Street, certainly not like Germany/Frankfurt; nor could it hide behind some feeble comparison with entrepot City states like Singapore. Even the NIESR cannot suddenly paint rUK into the background; a mere face in the world finance-economy crowd, nothing to see here – just another country; not me guv. The UK is not just another country in international banking, finance and trade; and to paraphrase LP Hartley, regarding the UK-City nexus – ‘they do things differently there’.
After the Credit Crunch the UK had to step in to support Irish banks; not out of gratuitous generosity of spirit, but self interest. On 22nd November, 2010 George Osborne described to Parliament a UK rescue loan package for Ireland, including a direct bilateral loan that he estimated at the time to be around around £7Bn, which required an enabling Loans to Ireland Act (2010). This was in addition to £77Bn of loans supplied by the EU to Ireland; which made the UK a participant in the Irish rescue package on two separate fronts. British activity in the Irish financial crisis was not an accident. This gratuitous UK financial assistance to a foreign country was, in Osborne’s words “to help a friend in need”. We do not need to surmise that there was considerably more to it than friendship; and such largesse, freely given, sits very uncomfortably, indeed inexplicably with the ‘official’ (political) response by the UK government to the Scotland-rUK currency union proposal.
Osborne told the UK Parliament that “we are doing this [lending to Ireland] because it is overwhelmingly in Britain’s national interest that we have a stable Irish economy and banking system. The current Irish situation has become unsustainable. Their sovereign debt markets had effectively closed and had little prospect of reopening”. What Osborne did not spell out was that it was the UK’s distinctive place in world financial markets that made his intervention effectively inevitable. Strikingly Osborne did appeal to features of the relationship between the UK and Ireland that were of direct relevance to the Scottish referendum. Osborne justified his rescue package for Ireland by arguing that Ireland accounted for 5% of Britain’s total exports and 40% of Northern Ireland’s exports.
Furthermore, he appealed to the fact that two of the four largest High Street banks in Northern Ireland were Irish-owned, and Irish banks issued sterling. This persuasive list is no doubt significant, but in quantum and interrelationships it pales into insignificance compared with Scotland’s influence on the economy of the UK, or the scale and significance to the UK of Scotland’s financial sector.
When Osborne was asked whether the Irish loan presaged similar interventions in other similarly straitened Eurozone countries, he appealed to history and bonds: “I think there are very specific connections between the UK and Ireland which we don’t have with other countries and that’s why I think it’s completely appropriate we make a bilateral loan in this case”.
For the avoidance of doubt the proposition that the UK would not step in if there was a similar problem in an independent Scotland is patently untenable. The Irish loan was in the interests of the City, in the interests of the larger exposure of the UK to international financial markets and to the prospect of contagion if the UK did not act. This explanation provides the real context to the “help” that was given to Ireland to protect underlying, larger UK financial and banking interests and exposure.
Liam Halligan, writing in the ‘Daily Telegraph’ (3rd May), makes the same point with a candour for which we should be grateful. What Osborne does for Ireland would be done for an independent Scotland, in spades: “As far as the rest of the world is concerned, though, and particularly the main players on global markets, we [Scotland and rUK after independence] would remain one entity. Specifically, if the Scottish banking sector chose to ramp itself up, and then collapsed, London would have no choice but to bail it out.
Whatever pledges the Westminster government makes, whatever is written on the statues and press releases, wouldn’t get close to unraveling, in the eyes of the world, more than three centuries of shared history and collective responsibility. Edinburgh’s problem would be London’s problem – no question. Any other story and, amid the fear and loathing of a serious financial crisis, the rest of the world wouldn’t buy it. Were the financial barbarians to gather at Edinburgh’s gates, the message from the money-men to London would be clear: “Bail out the Scots, or we’ll destroy your banking sector, too”.
Here is reality, what the City understands only too well as the realpolitik of global financial markets. The City knows this because it has probably done more than any other centre in the world to create, nurture and let slip Halligan’s ‘financial barbarians’. Unfortunately, while the NIESR blandly mentions realpolitik in its paper (No.288), either it takes a peculiarly British, complacent, parochial view of its impact, or it simply does not adequately understand the concept; lost in banking concerns in a currency union regarding “special arrangements which could invite the perception of joint bail-out responsibility” between Scotland and rUK, the NIESR fails to see that rUK has in reality little choice in the matter as long as it remains the creature of the City; which appears to be a marriage made forever.
Halligan need not worry about Scottish bank ‘ramping’, because Scotland has already surrendered its banks to the City; that divorce is decreed – the brass plate is in the post. The risks to Scotland of currency union with rUK (the real centre of future risks for both countries) are the precariousness of rUK debt levels and the implicit instability of the City. Currency Union with fiscal restraints works both ways only because both Scotland and rUK cannot afford failure, for different reasons; let us call these reasons not realpolitik, since this concept clearly gives the NIESR real difficulties, but coin a new term – realfinanz.