The experience of Greece provides an another example of the importance of Scotland issuing its own currency

One of the scare stories we hear about Scottish independence is that Greece’s economic and social troubles in the early 2010s should be taken as warning for an independent Scotland. The truth is that Greece’s story strongly points us in one direction, away from using Sterling and taking advantage of the significant control offered by issuing your own currency.

An institutional approach

It is exceptionally important that we learn the right lessons as we plan for Scotland to become independent again. It is all too easy to look at our economy and society in the 2020s and draw false analogies. Every country is different and our informal institutions – like our cultural habits – and more formal ones – like the energy market or our labour market – have developed under a unique set of circumstances. A simple comparison for good ‘we are like Norway’ or bad ‘we will be like Zimbabwe’ may seem obvious but once you scratch the surface, the similarities and therefore the appropriateness for comparison disappear.

To better understand the events which we can learn from, we must take the time to take a deeper look at things that, on the surface, may seem similar.

One of the common myths that we hear, even from within the independence movement, is the idea that Scotland could face the ‘Bond vigilantes’ that seemed to derail the Greek economy in the early 2010s. In general the circumstances that affected Greece as part of the EU/Eurozone in the post GFC crisis have no significant similarities with an independent Scotland using its own currency. It is a false analogy and it highlights the importance of Scotland issuing its own currency.

However, and this is the BIG one, it is relevant for Scotland if it continues to use Sterling after day one of independence. Then and only then can we see the lessons. We can also use Greece’s experience if Scotland was to become part of the Euro Zone (assuming the EU looks very similar in 2040ish to where it does now). The experience of Greece provides an another clear example of the importance of issuing your own currency.

What happened?

Briefly, because most people know this, post GFC, investors lost confidence in Greek Government Bonds. There was a concern that the country would/could default on its debt. Greek Bonds were downgraded by the Rating Agencies and this ensured that sellers had to sell those assets.

The market was pricing these factors in and it was becoming eye-watering difficult for Greece to sell its bonds. In a bid to sell bonds, Greece’s interest rates increased from 4.8% in 2008 to 9% in 2010, and then reached 22.50% in 2012. A crisis ensued.

Owing to the specific institutional design of the European Union at the time, Greece was unable to increase Government spending without borrowing or raising taxes. Unable to increase deficit spending thorugh money creation (a tool only available to the issuer of the currency) the Greek government were forced to accept massive austerity.

Public spending was slashed by 32% across sectors, with public health expenditure falling by nearly 43% between 2009 and 2017

According to this report by Amnesty International.

All the pain of those austerity policies without any gain. The Greek economy is 20% smaller now than it was in 2007!

This is a story to scare any policymaker when they look at Scotland in the same light. Huge austerity and massive interest rates compounding the problems by increasing unemployment.

However, we have to understand the institutional factors to see if this is a similar situation that could affect an independent Scotland, and if so, how can we structure our institutions to avoid this situation.

The background

The context of the ‘crisis’ in Greece is often forgotten. Once you understand the position of Greece within the EU the bond crisis seems inevitable. So let’s break down a few of the institutions. The first is to consider Greece’s trade position. See below: Figures in Euros.

Greece’s Trade Balance Since Joining The Euro

By 2008 Greece’s trade deficit was around 15% of GDP. A huge figure and the largest in the EU. This was a structural weakness and being part of the EU drastically impacted the trade deficit. By comparison Scotland runs a 2-3% GDP trade deficit.

The role of small countries (mainly in Europe’s south) within the EU is as a destination for exports for larger countries, especially Germany. The role of Greece is to suck up the excess capacity of the big nations. And as you can see they do a great job. To keep incomes high in Germany it needed to sell stuff to Greece. Germany needed Greece as much, if not more, than Greece needed Germany. This is very important. The structure of the Eurozone supported Germany. German policymakers were aware that structural weaknesses were developing in Greece but did little to help. The export bubble kept on growing………

So what does this mean for the economy when there is a big trade deficit? Not much when the world is booming and the economy is growing. But when the economy takes a downturn things change. If you don’t have daft fiscal rules and / or you issue your own currency then is little to worry about. If not, then you end up with some mix of fiscal, monetary and industrial austerity. The institutions not the economic outlook determine the response.

Others see the connection between currency and crisis more clearly than many in the independence movement including our policymakers.

Writing in an American Law Journal in 2014 (definitely no dog in the fight when it comes to Scotland’s currency choice) ‘Lessons for Scotland from Greece’s Euro Tragedy’, researcher Lisa Tripp from Atlanta’s John Marshall Law School wrote,

Should Scotland choose to enter a currency union with the UK or the E.U., it is not outside the realm of possibility that Scotland could find itself, as a small member of a large pound or euro-based currency union, in a position similar to what Greece has found itself in. This is particularly so when the Conservative party has long championed austerity policies and the Labour party appears to have capitulated and dropped its opposition to austerity.

Note also the awareness of American academics about Labour back in 2014!

The institutional design of the Euro

During the early 2000s the Euro was relatively cheap for German exporters. As the most powerful nation in the EU Germany tends to dictate the interest rates and strength of the Euro. It is kept competitive to support their high value exports. People across the globe are happy to pay for the high tech unique german exports and having a competitive currency really helps boost those exports. But on the flip side, it is relatively expensive for Greece’s exports. Most of the Greek exports – refined petroleum, aluminium and olives, cheese etc – can be sourced cheaper elsewhere. So once they adopted the Euro is was impossible for them to close the trade gap.

By using the Euro, they were structurally supported to have a trade deficit. This is not despite the system it is because of the system. There are 27 EU countries. Only 9 run a surplus (intra-trade), meaning 18 nations have a trade deficit. By design.

So we can already see the seeds of a crisis. When the world is booming and the economy is growing a trade deficit is managable but when the economy takes a downturn things can change. Think of it this way. When there is a trade deficit the financial wealth is being sucked out of the economy (the foreign sector is in surplus). This being the case, the government has two options. Allow private wealth to take the hit and see consumption and saving fall or inject public money (by running a deficit) into the system. In sum, when there is a trade deficit either the government or the public fill the gap. Every government quite rightly takes the second option deciding that the state is able to deal with financial instability better than businesses and households.

So ‘because’ of the trade deficit and the desire for people to not be poorer, the government deficit grows. The government deficit is, to a large extent, determined by the other two sectors in the economy: the non government sector and the foreign sector. The govt deficit reacts to movements in the other two sectors.

As highlight above this is HOW THE SYSTEM IS DESIGNED for Greece within the EU/Euro. The trade deficit means that Greek government debt to GDP will rise (all things being equal). Considering the institutional structure of the Eurozone (there being no Fiscal authority to support government spending) this position is unsustainable. At some point the pigeons will come home to roost. They did in 2010. And they shat all over the public.

Again an institutional analysis is very important

If Greece was running a large trade deficit and assuming it did not use the Euro, it would likely devalue its currency in order to make its exports cheaper and imports more expensive. This is not a painless exercise but it does enable to government to avoid drastic reductions in public spending i.e. austerity. It could also do other things like increase tariffs, introduce initiatives to buy local, invest in capacity building and creating strategic stocks etc. An ‘internal devaluation’ is what many countries have done for centuries in order to rebalance trade.

But as Greece wasn’t issuing its own currency it couldn’t do this! It had the Euro and it must take the value – set as it is by the ECB. So it sat back and waited for the inevitable to happen. If it had its own currency it would have had the options, including to devalue, to avoid this situation.

The situation that arose in Greece could easily happen to any currency user. This is the lesson that Scotland must learn.

As long as Scotland uses Sterling after it is independent a similar situation could happen. The price of Sterling is set by conditions in the South East of England and that would continue to be the case while we use the UK currency. A similar effect in Europe, with the currency being valued to support the big economics: just look at Greece!.

The story is one of risk and danger for being a currency user – not a scare story for an independent monetary sovereign nation.

The European Central Bank and the overall monetary/fiscal mix in Europe

A further analysis of the ECB provides more (slightly technical) context that is very important too. The story of the Greek Sovereign Debt Crisis is one of a dereliction of duty by the ECB. I will let Dr Thibault Laurentjoye take up the story:

As Dr Laurentjoy says, as soon as investors stopped buying Greek Government debt the ECB (as the centre of the central banking system in Europe) could/should have stepped in and bought those bonds. This would have stabilised the market and Greece would have still been able to sell bonds and avoid the massive austerity that followed. This is another example of institutional failure.

Bonds could have been purchased by the ECB to set the rate on Greek government debt at 5%, or 3% or 1%. But it choose not to do this. During that period it was politically difficult for the ECB to purchase the bonds. So here is another lesson. Even when the system can be used to avoid austerity it won’t always come to the public’s aid.

The crisis ended not with default but when the ECB stepped in and said it would do ‘whatever it needed’ to support the Euro and member states bonds.

All of this could have been easily avoided if the ECB had supported the Greek economy in early the late 2000s.

It should have first realised that the institution of the Euro was partly to blame and looked to use its power to rebalance the Eurozone economy. As Dr Laurentjoy highlighted, the central bank will always be there to buy bonds to stabilise the interest rate because that is one of its core reasons for it existing. Stabilising the interest rate by buying and selling bonds is what central banks, like the FED and the Bank of England, do every day. But you can’t assume that someone else’s Central Bank is going to do this for you – or you can end up like Greece. When you use someone else’s currency and you can’t guarantee a friendly central banker at the end of the phone line you could be in very serious trouble. And do we think that the BoE would be sympathetic to an Indy Scotland?

The importance of Scotland issuing its own currency

The lesson Scotland should learn from the EU sovereign debt crisis is clear.

Using another currency significantly limits the levers you have to deal with any type of economic shock.

A wider useful lesson to learn is that for Scotland – with its own currency – a Scottish Central Bank can buy bonds (should we wish to issue them to the foreign market) denominated in s£ to stabilise interest rates. It can in essence, act like every other (functioning) Central Bank in the world.

An independent Scotland can run a trade deficit and still deficit spend. It will not be financially constrained. Designing our institutions to support this will enable the Scottish Government to take a very different approach to managing the economy. That is the point of independence isn’t it?

Managing your own currency does not ensure a bright future and without a shadow of a doubt small nations like Scotland can be battered by international crisis. From day one, the Scottish government will be ‘resource constrained’, like every other nation and many tough decisions will have to be taken. However, it can protect itself from being bullied by market forces if it has its own currency and the right institutions in place.

If these are the lessons to learn, why on earth aren’t we listening? The official Scottish Government plan is to still have a S£ ‘as soon as practically’ possible. The message should be clearer: We will use a Scottish currency on day one of independence.

An independence Scotland with its own currency wouldn’t be Greece without the sun. But one using Sterling might well end up like that.