Currency unions: an idiot’s guide

ku-xlargeThere’s a lot of talk of currency unions and so on lately in Scotland. What does it all mean? Here’s an idiot’s guide:

1. Anyone, anywhere in the world, can use pounds however they like, subject to local law of course.

2. The creation of new pounds is controlled, or at least guided, by the Bank of England and the government. A higher interest rate means fewer pounds are created, a lower interest rate means more pounds are created. Government borrowing also creates more pounds.

3. The value of the pound on the international market is higher if there are fewer pounds, and lower if there are more pounds – supply. It is also affected by demand, so if there are a lot of people wanting to invest in the Sterling area pounds will be worth more, and if investors pull their money out, like on Black Wednesday, the value of the pound falls.

4. That means that when you have a currency union, there has to be a deal on government borrowing, in order to manage the value of the currency collectively. Otherwise one party could ‘cheat’ by borrowing a lot – printing money – and taking the whole benefit of that but only a small share of the cost of it.

5. A more valuable pound is good in that pounds are worth more, but bad in that it makes imports cheaper and exports more expensive. So a more valuable pound is better for finance, property and so on, and worse for manufacturing.

6. Scotland faces a very serious challenge. We have bucketloads of oil. This can lead to what is called the Resource Curse. Money floods into a country chasing the oil, inflates the value of the currency, and manufacturing goes to the wall while property prices and finance boom. This is part of the story of early 80s Britain.

7. Oil rich countries like Norway or Qatar have sovereign wealth funds, “oil funds”. They put their oil money in the fund and move it out of the country as quick as possible, buying shares, property, premier league football teams and so on. That keeps the value of their currency low.

8. Scotland does not have an oil fund, and it will take time to get one set up, especially in a context where the oil industry is privately owned.

9. So, it is better for Scotland’s manufacturers if we can share our currency, at the very least until we have a functioning oil fund.

10. If London wants to keep its finance sector it needs the oil to keep the value of Sterling high. If you’re a Russian oligarch with holdings in London, you will panic and run at the first sign of Sterling’s value collapsing.

(UPDATE: some people have queried point 10. Wikipedia has oil and gas at 13.2% of UK exports, somewhere in the region of £40bn a year. Don’t forget the effect on the balance of trade of the UK having to import all the oil it currently uses domestically – back of the envelope about 3x the amount it exports.)

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