Saturday, February 15, 2014

Sam Bowman of the Adam Smith Institute on Scottish Independence


Sam Bowman, Research Director at the Adam Smith Institute (London) published (14 February 2014) a timely contribution to the current debate on Scottish Independence, now moving from the Westminster, Conservative/Liberal Government’s mainly negative campaign to the beginning of a most revealing highly negative bullying phase.  
Mr Obsborne, the UK Chancellor of the Exchequer (Treasurer), visited Edinburgh yesterday to announce tht should we Scots vote ‘Yes’ for Independence on 18 September, then he would block any attempt by Edinburgh’s Parliament to remain in a currency union with the UK. 
He was joined in this abrupt declaration by confirmatory declarations by both the Labour Party and the Liberal Democrats, suggesting some level of inspired collusion, as any two of the UK parties will likely form a formal or informal coalition in the next government elected in 2015.
Of course, this is likely to be just a part of the pre-Referendum bluster , yet to move to the nasty threats stages, aimed at frightening and intimidating Scottish voters.  Currently, polls show a majority who intend to vote ‘No’, with the ‘Yes’ vote very slowly rising from a low 39%.
So why the defiant bullying and regular bloody phase typical of the British Empire’s response to pre-Independence agitations in its former colonies in the 20th century?
The Adam Smith Institute’s Blog published Sam Bowman’s contribution to the debate HERE.
Note: I agree with Sam’s contribution below.  I should also make two other things clear: first, I am a Fellow of the ASI, and second, I made no comments on the article  before I read it this morning.  I re-publish it here for readers, many of whom reside in the USA, and several have asked me recently about Scottish Independence.  As stated many times before on Lost Legacy, I only discuss politics on Lost Legacy when it refers to the country in which I vote, as Sam’s article does.
Sam Bowman, Research Director at the Adam Smith Institute (London) HERE http://www.adamsmith.org/blog/money-banking/how-scotland-could-flourish-by-unilaterally-keeping-the-pound
“Between 1716 and 1844, Scotland had one of the world’s most stable and robust banking systems. It had no central bank, no lender of last resort, and no bank bailouts. When banks did fail, it was shareholders who were liable for paying back depositors, not taxpayers. Scottish GDP per capita was less than half of England’s in 1750; by the end of the era in 1845 it was nearly the same. Now that George Osborne has ruled out a currency union if Scotland votes for independence, the Scots have an opportunity to return to this system more seamlessly than any other place in the world could.
As I said to the press this week, there’s nothing really stopping Scotland from continuing to use the pound unilaterally. (Unless the remaining UK introduced strict foreign exchange controls, which would be absolutely crazy.)
What the Chancellor's announcement actually means is that the Bank of England (BoE) would no longer consider Scottish interests when it determines monetary policy and that illiquid Scottish banks would no longer be able to use the BoE as a Lender of Last Resort.
I’m not sure that the first point really matters at all. Scotland’s five million people can’t have much of an influence over the BoE’s policy for the UK’s 63 million people as it is. And, frankly, I’m not sure the BoE knows what it’s doing well enough for it to matter whether it cares about you or not.
The second point is the interesting bit. George Selgin has pointed to research by the Federal Reserve Bank of Atlanta about the Latin American countries that unilaterally use the dollar. Because these countries – Panama, Ecuador and El Salvador – lack a Lender of Last Resort, their banking systems have had to be far more prudent and cautious than most of their neighbours.
Panama, which has used the US Dollar for one hundred years, is the most useful example because it is a relatively rich and stable country. A recent IMF report said that:
“By not having a central bank, Panama lacks both a traditional lender of last resort and a mechanism to mitigate systemic liquidity shortages. The authorities emphasized that these features had contributed to the strength and resilience of the system, which relies on banks holding high levels of liquidity beyond the prudential requirement of 30 percent of short-term deposits.”
Panama also lacks any bank reserve requirement rules or deposit insurance. Despite or, more likely, because of these factors, the World Economic Forum’s Global Competitiveness Report ranks Panama seventh in the world for the soundness of its banks.
I suspect that there would also be another upside. Following Walter Bagehot, central banks are only supposed to lend to illiquid banks, not insolvent ones. Yet since the start of the Eurozone crisis the ECB has clearly made significant bond purchases to prop up both insolvent banks and insolvent governments. This may have been a lesser evil than letting them collapse altogether, but it’s hard to say that this kind of moral hazard is not present.
So, given that some countries do survive and even flourish without a central bank, how would Scotland do it?
The basic mechanics, I think, would be this: in a hangover from the old free banking period, Scottish banks currently issue their own banknotes. After independence, they could continue issuing their own notes that entitle the bearer to GBP on demand. BoE pounds, in other words, would be the 'base money' that Scottish banks use to back their own private currencies, in the same way gold was used during the last Scottish free banking era.
A banknote from a Scottish bank would be, in effect, a promissory note redeemable on demand in BoE-issued pound sterling. (Scottish notes are already promissory notes, but issuance is closely regulated by the BoE.) Of course, there should be nothing stopping banks from issuing notes redeemable in something else, like US Dollars, gold, Bitcoins, or Tesco Clubcard points. Scottish banks would have to arrange private clearing houses, as they did in the last free banking era, to provide loans to illiquid banks, or they could follow Panama in simply maintaining very high reserves.
No bank would have monopoly privileges: any ‘bank’ could issue notes and it would be up to the market to decide whether to accept them as money or not. As Selgin explains here, banks free to issue their own notes will set their reserve ratios according to people's demand for money, stabilising nominal spending.
With respect to other regulations, I quote Selgin again:
"It is, in any event, desirable that there be no Scottish public authority capable of bailing out insolvent banks and of thereby introducing a moral hazard. Deposit insurance should be resisted for the same reason. Foreign banks should be admitted, by way of branches rather than subsidiaries, and should enjoy the same rights as Scottish banks. (Of course the major "Scottish" banks are themselves no longer really Scottish anyway.) Finally, re-establishing some form of extended liability (though not necessarily unlimited liability) wouldn't be a bad idea."
We take no position on Scottish independence — it is up to Scottish voters to decide. And while a return to free banking in Scotland may seem fanciful, this week’s announcement makes it much more likely. Keeping the pound and treating it as the ‘specie’ on which banks can base their notes would make the transition virtually seamless for the average Scot, while giving them a banking system that is unrivalled anywhere in the world for being stable, open, and free."

8 Comments:

Blogger airth10 said...

Scottish independence is a bad idea.

2:35 pm  
Blogger Gavin Kennedy said...

airth 10
Now why am I not surprised?
I have no wish to get into an argument with your good self.
You do not vote in Scotland.
Similarly, I do not vote in North America, or anywhere else, hence my self denying ordinance often stated on Lost Legacy that I refrain from commenting on the politics in any country except the one I live in, namely Scotland.
Gavin

3:36 pm  
Blogger rickstersherpa@msn.com said...

It would be an interesting experiment if Scotland adopted "free banking" if it obtained independence. I wonder though if it could gain admittance to the European Union without being compelled to except the Euro, with all the problems that poses for a small country with an open market.

As for Scottish independence, I agree that I have no go in that fight, although I see no fundamental problem with the idea. For the same reason I believe an independent Quecbec is a decision that belongs to our neighbors to the north.

4:14 pm  
Blogger rickstersherpa@msn.com said...

I think if Scotland was to engage in a free banking experiment would be very interesting, especially in the European context. I am sure David Glaser at "Uneasy Money" would find it fascinating (although I do hope it would be a net benefit for common people of Scotland.

I have no dog in the fight on Scottish independence. I do note that Scotland had a long history as an independent state before 1715, and the Act of Union was not without coercion, although an understandable action given the religious and international politics of the time. Times are now different and the Scots will make their decision based on their interests.

Similarly, in 1861 holding the Union of the United States together, and preventing the creation of a an aggressive, imperialist, slave holding republic in North America made the Civil War a tragic necessity. I am not sure now if different parts of the U.S. want to go their separate ways it would be such bad thing.

4:25 pm  
Blogger Gavin Kennedy said...

rickstersherpa

Thank your for your letter.
I like the 'no dogs in the fight' statement'.
Gavin

7:57 pm  
Blogger fireisk.co.uk said...

Well in that case we'd better not continue this journey towards Democracy and fairness. If you say it, it must be true?

8:14 pm  
Blogger Gavin Kennedy said...

Fireisk
Thanks for your comment.
I didn't quite understand it, however.
Gavin

1:03 pm  
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11:16 am  

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