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Report backs 'sterlingisation' plan

Using the pound without a formal currency union could give an independent Scotland a more stable economy than the rest of the UK, a leading think tank has suggested.

A new report from the Adam Smith Institute said that "sterlingisation", combined with reforms to banking regulations, could lead to banks taking fewer risks, reducing the likelihood of future financial crises.

Sam Bowman, research director at the Adam Smith Institute and the author of the report, said Scotland was "almost uniquely primed for such a system of 'adaptive sterlingisation'".

The prospect of Scotland using the pound with the formal agreement of the rest of the UK, and without the back-up of having the Bank of England as a lender of last resort, was raised as Alex Salmond comes under increasing pressure in the run-up to next month's referendum to set out an alternative to a currency union.

The three main parties at Westminster have repeatedly said they would not sign up to such an agreement with Scotland if it left the UK, leading to demands for the First Minister to state his "plan B".

Crawford Beveridge, chairman of the Scottish Government's Fiscal Commission Working Group, said earlier this week that an independent Scotland could use the pound without a currency union on a transitional basis after a Yes vote - adding such a period could potentially last between six months and 50 years.

But the report from the Adam Smith Institute suggested sterlingisation could be preferable to a currency union.

It said that coupled with banking reforms " sterlingisation could give Scotland a stable monetary arrangement that, paradoxically, made Scotland's economy more stable than the UK's".

Mr Bowman said: " The Scottish independence debate has repeatedly foundered on the question of currency, but if Scots look to their own history they will find that their country is a shining example of how competition in currency and banking can ensure a stable and effective banking system.

"Scotland's free banking era was an economic and intellectual golden age, and its system of competitive note-issuance was recognised by such thinkers as Adam Smith as one of the root causes of the country's prosperity during this time."

He continued: " The examples of Panama and other dollarised Latin American economies are proof that countries can thrive when they unilaterally adopt another country's currency.

"Combined with a flexible, adaptive banking system, the unilateral use of another country's currency can instil a discipline in a country's financial sector that neither a national currency nor a currency union can provide. Scotland's banking system is almost uniquely primed for such a system of 'adaptive sterlingisation'.

"The path outlined in this paper would go almost unnoticed by the average Scot - until the next big economic shock, when they might just wonder why their system was so much more stable than that of the country they'd left behind."

Using sterling outside of a currency union would " largely represent a return to the Scottish 'free banking' era of the 18th and 19th centuries", the report argued, adding this was "an era of remarkable economic and financial stability".

It said: " Between 1716 and 1844, Scotland had one of the world's most stable and robust banking systems.

"It had no central bank, no government-backed lender of last resort, and no bank bailouts.

"When banks did fail, it was shareholders who were liable for paying back depositors, not taxpayers. The economy flourished."

It also argued that countries such as Panama, Ecuador and El Salvador, using the dollar without any agreement from the US, had "forced banks in these countries to be far more prudent and cautious than most of their neighbours".

The report added: " Panama, which has been dollarised for over a century, has a strikingly open and stable financial system.

" There is ample evidence from history and economic theory that an independent Scotland would not suffer from being outside a currency union with the rest of the United Kingdom.

"But it would be best if it was done alongside a programme of financial reforms that did not give any bank or group of banks monopoly powers on note-issuance and allowed the market to decide what money to use.

"The reform programme outlined in this paper may be a break with recent practice, but Scotland once thrived without a central bank and some countries continue to do so today."

SNP Westminster Treasury spokesman Stewart Hosie said it was a "very interesting report".

But he told BBC Radio Scotland's Good Morning Scotland: "While this determines that Scotland could use sterling in any circumstances, it is one of the viable options, a formal currency union remains the best one."

Scottish Labour finance spokesman Iain Gray told the same programme: "Using the pound informally in the way Panama uses the US dollar would be disaster for Scotland.

"Using the pound the way they use the dollar would destroy our financial services sector, it would also bring about unprecedented spending cuts in schools and hospitals, it would push up the cost of credit for car loans and mortgage repayments for Scottish families."

He claimed Conservative prime minister Margaret Thatcher had led the last government that had looked to the Adam Smith Institute for economic ideas and as a result "they let key Scottish industries go to the wall".

Mr Gray continued: " We have in Scotland a financial services sector, a 21st-century, modern financial services industry which employs 200,000 people.

"What they're suggesting is we let that go to the wall, replace it with a currency model from Ecuador and El Salvador, and we replace it with a banking system from the 1700s."


From Belfast Telegraph