• MammothWhale

A Response to John Kay Part 1

I briefly respond to a few points made by economist John Kay on Scotland's currency options.

Today I want to respond to some points made by John Kay during his currency talk at the Fellowship of the Royal Society of Edinburgh. You can listen to his talk by clicking here, or read his essay version by clicking here. I have not found the time to listen to his entire talk, so will be replying more directly to his essay.

Modern Monetary Theory

Due to time constraints and the length of his essay we will cover other critiques at a future date. We will start our response in relation to his comments on Modern Monetary Theory. He writes:

"MMT originates in the United States of America and its advocates are perhaps unduly influenced by US practice and experience. The dollar is the premier international reserve currency and 80% of all foreign exchange holdings are of dollar or euros. Almost half of all dollar notes are thought to be outside the United States. It is tempting, and not wholly fanciful, to think that demand for dollars and dollar securities is inexhaustible. That would certainly not be true of the demand for freshly minted bawbees (new Scottish currency)."

This argument originates from the idea that MMT only applies to the US, because it is a closed economy that can (largely) ignore the external sector and the dollar is the currency of the world. If other countries, such as an independent Scotland, were to adopt this model then this would lead to dangerous depreciation, lower wages and increasing inflation.

I find both Kay's and the original "Only the US can do MMT" myth quite odd. Most of the case studies I cite in my articles are, in fact, not the US.

When I've previously spoken about an independent Scotland's exchange rate, inflation and debt issuance, I cite examples such as Japan, Australia and Canada. When writing about how spending actually works, I used the UK monetary system.

In response to these same critiques, Associate Professor of Economics Eric Tymoigne also cites Mexico when looking at the relationship between current account deficits and exchange rates.

It's also worth noting that one of the founders of MMT, Bill Mitchell, is Australian. So the suggestion that only the US can do MMT, or that MMT was developed in the US, is simply incorrect. Whilst the US may be "more sovereign" than other monetary sovereign countries, no one expects countries like the UK, Japan, Australia or Canada to default on their debt. To save time, I'd encourage readers to look at Tymoigne's full response in the paper I've linked above, or read Brian Romanchuk's blog by clicking here.

Government and Currency

Kay touches on the challenges of Scotland transitioning to a new currency, in particular what it would mean for private contracts around pensions and mortgages. He writes:

"In the light of these considerations, it is essential that any discussion of currency options after independence make clear that a future Scottish Government would have no intention of changing the terms of its own existing contracts or of legislating to change the terms of private contracts. This assurance should particularly include, but should not be confined to, agreements governing savings and loans, employment and pensions."

I agree with Kay that an independent Scotland should avoid forcing any new currency. I already briefly wrote a response to general unionist critiques in relation to Scotland transitioning to a new Scottish currency, which you can read by clicking here. Economist Warren Mosler has already laid out the principle of how an independent Scotland should introduce a new currency, with economist Dr Timothy Rideout going into greater detail. Mosler's talk on a new Scottish currency can be listened to by clicking here, and Rideout's talk by clicking here.

Let us start off with mortgages. First, the value of a new Scottish currency should be, for the very short-term, pegged to the UK pound. This would offer a 1:1 value when Scottish residents opt for a currency exchange. On top of this, I would suggest that any exchange should be met with a premium when receiving the new Scottish currency, which would further encourage residents to switch to a new currency. This premium could be 1% or 2%, but would be the decision for the Scottish Reserve Bank.

On mortgages, I suspect providers will allow a currency conversion on their current contracts without much push from the Scottish Government. Mortgage providers who refuse to allow a currency conversion on current contracts will simply damage their own loan book. This is self-harming and self-defeating for themselves - yet certain unionists will argue this is somehow rational. If mortgage providers do take a self-harming approach, the Scottish Government could set conditions that only allow providers to continue operating in Scotland if they provide a currency switch on contracts. Call me crazy, but I suspect providers want to keep their customers.

To once again save time, I will turn to chartered accountant Richard Murphy on his comments on pensions, which you can ready by clicking here.

Monetary Freedom

Kay touches on the degree an independent Scotland might have with monetary freedom, by looking at countries such as Norway, Denmark and Sweden (Nordic countries). Norway is only cited in a single sentence, so there is not much to go on there. Denmark gets considerable coverage, with Kay highlighting the state pegs its currency to the Euro to stop the Danish Krone from appreciating - in relation to Denmark's consistent trade surplus. Scotland is not in this position, so the Denmark comparison leaves little satisfaction. But Sweden, in the EU and outside the Eurozone, does leave an interesting discussion. Where I do take issue is his final comments, where he writes:

"Small open economies like Sweden – or an independent Scotland – may theoretically be able to run an independent monetary policy; but in practice their larger neighbours exercise considerable influence and the central bank cannot diverge too far from them."

Whilst the movement of rates may be similar, the rates set by the Swedish and EU's central banks do in fact differ in their respective levels. Notice that divergencies occur before and after the 2008 financial crisis (during the financial crisis it was the interest of central banks to have low interest rates).

What is worth noting is that whilst the context of Denamrk, Norway, and Sweden's currencies do in fact differ, this doesn't change the fact their economic models share striking similarities. With their differing degrees of monetary sovereignty, but yet all with their own currency, the Nordics share high social expenditure, high public sector employment, employment protection, union contracts, state ownership, and more. No country will ever truly have complete sovereignty to the point of total influence, but clearly monetary sovereignty sets the direction for the state to head towards.

Scottish EU Membership

I would by lying if I said I didn't roll my eyes when I read the following comment by Kay:

"There are greater impediments to Scotland joining the EU than arguments over exchange rates: the analogue of the Irish Border problem is the obvious one; and opposition from members such as Belgium and Spain, who have their own reasons for discouraging separatism, is another."

We know this is not true. The then-Foreign Minister of Spain in 2013, Jose Manuel Garcia-Margallo, confirmed that as long as the UK and Scotland agreed to any transition to independence in the event of a Yes vote in 2014 then Spain would in fact have no objection to Scotland re-joining the EU. These comments were repeated by Spanish politicians in 2017. For Belgium, who are also being told to prepare for Scottish independence, has made noises before for Scotland to be "fast-tracked" into the EU. In realpolitik terms, the only country that will ultimately decide if Scotland re-joins the EU or not post-independence is Scotland.

The EU is an expansionist project. The suggestion it would reject a state of millions of people with a decent chunk of geographical claim to the North of the continent is ridiculous.

That is all I have time for today, but at some point in the future I shall return to Kay's essay for a follow up.