We need to talk about currency - and why energy could be crucial

For the past 18 months, the US currency has been accelerating like a SpaceX rocket against the pound and the euro.

This has big implications for Scotland. The currency question is going to dominate any independence referendum. And if we do become independent in short order – whether tethered to sterling or launching our own money – our monetary choice will impact immediately on economic policy. But this will all take place against a background of international exchange rate turmoil and rampant inflation. We need to factor these things into the indy debate.

An independent Scotland that opts to keep sterling pro tem will find the cost of imports rising as the old UK currency weakens against the dollar. This time last year you needed to spend circa 73 pence to buy a dollar’s worth of imports. Today you need to find around 84 pence. That’s a 15% price hike. Which explains what you are now paying at the petrol pump and supermarket checkout. There is no sign the pound will recover value any time soon. Why?

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There are two sides to the explanation. First, the weakness of the UK economy post-Brexit. Just look at all those lorries struggling to carry goods to the EU, now stuck at Dover. Investment in the UK economy has basically flatlined since the Brexit vote, a sure sign that nobody thinks Britain is a place any longer where you can make profits. So hot money is flowing into the United States instead. This is the other side of the equation.

Despite America being riven by vicious culture wars, the world’s investors are pulling up stakes everywhere and sending their cash to Wall Street. This is the cause of the rise in the value of the dollar. What is making the world’s financial community fall in love with America again? One strong reason is that the US central bank, the Fed, is committed to raising interest rates to combat inflation. If America is offering higher rates than everyone else, it will attract the world’s cash.

Here in the UK, the Bank of England has been slow to raise interest rates because it is fearful of triggering a recession. If Liz Truss becomes PM, she is promising to spend, spend, spend, thus adding to inflationary demand. If the Bank retaliates by raising rates faster, the result will be inflation and recession at the same time. Which suggests that remaining tied to sterling is a one-way ticket to economic crisis for indy Scotland. Anyone for an economic Plan B?

This brings us back to Europe.

Any independence debate will focus on rejoining the EU. But there is a wee problem. The euro is also tanking against the dollar. Again, one reason is that interest rates are higher stateside. But much more is involved. Economists are worried that the fall in the value of the euro compared with the dollar is much worse than can be explained by the simple gap in interest rates. Many are concerned that there is now a fundamental gap between European productivity and inventiveness compared to America. That the long-term prospects for the EU economy are poor. That is bad news for an indy Scotland joining the EU.

Basically, the EU economic model is broken. It depended on Germany importing cheap gas from Russia and selling expensive machinery and cars to China. Putin’s invasion of Ukraine has closed Germany’s access to cheap gas while Beijing’s rapid return to economic self-sufficiency has closed Chinese markets to Berlin. Meanwhile, slow growth and inflation are strangling EU consumer demand. Unless the Germans suddenly decide to loosen fiscal policy and buy from the rest of Europe, the EU economy is headed for a period of stagnation.

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Anyone thinking that an indy Scotland rejoining the EU will produce instant growth is barking up the wrong economic tree. Linking to the sinking euro will add to inflation while a constricted EU market offers no instant bonanza for Scottish exports. True, joining the Free Trade Association quickly will at least get us back in the Single Market and so reduce export tariffs. So there are gains to be made. But joining a declining EU is no panacea for indy Scotland, as we will be reminded in the referendum.

What to do? Independence gives us political control over our vast energy reserves at a time when rising oil and gas prices are hurting living standards and throttling growth. I was surprised that Gordon MacIntyre-Kemp did not make more of this in his recent National piece on the reasons for independence. Indy is key to tackling both inflation and the cost of living crisis. We need to make the case that an independent Scotland can provide cheap energy to its citizens, especially the poorest. And that by limiting energy price rises, inflation can be dampened in the wider Scottish economy.

I’m not daft enough to ignore the costs of such a programme, even for only five million people. Essentially, we would be foregoing the windfall profits available (that could be ploughed into future investment) by spending on immediate consumption. This would have the advantage of shoring up consumer demand while reducing the likelihood of recession. However, subsidy is a dangerous weapon as it distorts the allocation of resources and becomes politically addictive. Nevertheless, emergencies require bold thinking.

Next, we need to consider the implications for a new Scottish currency. Establishing a currency during a period of exchange rate volatility is not easy. But then building a new nation was never going to be simple. Here I have to pay tribute to the work of Tim Rideout and the Scottish Currency Group for assiduously educating the movement and the nation on the need for (and mechanics of) creating a Scottish currency. No state in waiting has ever enjoyed such an in-depth discussion regarding its currency options. Pity the politicians skipped this bit.

The chances of operating a fixed exchange rate in Scotland in the current volatile global scene are low and we should recognise that. It might be possible through some currency board system where the authorities only issue Scottish currency to the extent that they hold foreign and gold reserves.

That would fix the Scottish pound against sterling but limit the extent of its issue. In which case we could use the Scottish pound for a restricted set of transactions, such as guaranteeing the value of sterling pensions.

More likely, though, we will have to let the Scottish currency float against the dollar, sterling and euro. Given our energy reserves, I think the markets will soon deem Scotland to have a strong investment potential in a period of energy inflation. Meaning they will buy Scottish currency and bonds.

Our ultimate problem might be holding the Scottish pound down in value, not shoring it up.