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December 19, 2013

Independent Scotland Would Seek to Keep Pound; London Says No

A vote for independence from the U.K. in Scotland scheduled for September 2014 could pave the way for a new currency—or not, depending on whom you ask.

The Scottish government, led by the Scottish National Party, issued a 670-page "blueprint for independence" at the end of November that called for many changes—but for an independent Scotland to retain the pound sterling as its currency. However, opposition parties, and London officials, have said keeping the pound is not possible for many reasons.

The British government has said it is not likely to agree to Scotland's retention of the currency, citing issues such as lack of political unity and pointing to the eurozone and its woes as an example of the problems that can ensue when independent political entities share a currency. However, believers have said that London will eventually recognize reality and give in—or that, if it refuses to share, Edinburgh may walk away from its share of the U.K.'s debt.

While there are plenty of other issues of major importance that must be decided should Scotland decide to go it alone, such as whether the newly independent country will still be a member of the European Union—opinions differ on that as well, particularly since Spain would not be likely to welcome a split-off Scotland over fears that its own rebellious Catalonia would follow suit and seek its own independence—the currency issue is one that's getting a lot of folks on both sides of the issue hot under the collar.

Alex Salmond, Scotland's first minister, has insisted that not only would the country keep the pound, but the Bank of England would still come to the rescue if Scottish banks needed a bailout. But British Prime Minister David Cameron called the possibility of Scottish retention of the pound unlikely. Chancellor of the Exchequer George Osborne has said that London was not likely to share its currency with an independent country, and Sir John Major, former British prime minister, said during a London speech that “Independence means Scotland walking away from the U.K. and its institutions. This must include the Bank of England and sterling.”

Others have said that whether or not Scotland wants to retain the pound, Northern Ireland, Wales and, of course, England would have the final vote on the matter. Mark Carney, governor of the Bank of England, has said that he's willing to hold currency talks with Salmond to explore the issue.

Currency traders are supporting the notion of a shared pound, with both Deutsche Bank AG and Citigroup Inc. saying the notion makes sense because of the way Scotland is connected to the British economy.

Fitch Ratings, which explored the possible effects of an independent Scotland on the residual U.K. late in 2012, has not changed its basic position, according to Peter Fitzpatrick, Fitch spokesman. He pointed out that at that time, Fitch said it could not take a stab at rating an independent Scotland because of so many variables, including the question of currency. However, it could and did review how such an event might affect what would be left of the U.K. after such a split.

"If the public debt stock were divided in proportion to GDP, both the residual U.K. and Scotland would be left with identical public debt ratios, and the residual U.K.'s debt profile would therefore be little changed. Our current expectation is that Fitch-rated gilts would remain the responsibility of the residual UK, which would enter into a separate bilateral agreement with an independent Scotland regarding how the latter would contribute to servicing and repayment," the ratings agency said.

Fitch also said that a split of North Sea oil—another Scottish independence hot button—would probably be reached by compromise rather than either a straight geographical or population-size determination, resulting in "marginal" budgetary impact. Overall, Fitch concluded, "Scottish independence would probably be neutral for the sovereign credit profile of the residual U.K. (England, Wales and Northern Ireland)."

Michael Fry, historian and Scots Tory who has come out in support of the nationalist position, cut through most of the arguments on whether Scotland might be "allowed" to retain the pound by saying in a highly critical opinion piece in The Scotsman that England could not prevent such a move without damaging its own economy.

Fry wrote, "Sterling is a fully convertible reserve currency, just like the U.S. dollar and the euro. Any country in the world can, if it wishes, make use of such a currency for both domestic and external transactions. Even Communist Cuba in effect utilizes the U.S. dollar, as a hard currency in parallel to its own soft peso, and it certainly does not ask permission from Washington to do this. Montenegro has adopted the euro, without being a member of the European Union or of its eurozone."

Hong Kong has also adopted the use of the U.S. dollar, "with no involvement from Washington," and when it first gained independence, Ireland retained the use of the pound, adopting it via the Currency Act of 1927. "I do not think Irish governments of those days were in the habit of asking permission from Westminster to do whatever the newly independent country, recently liberated by violence, wanted to do," he said.

Fry said the only way the U.K. could prevent Scotland's use of the pound would be "by abandoning sterling’s status as a fully convertible reserve currency, which would entail introducing exchange controls." This would cause so many complications for businesses, if enforced, that London would end up " reducing itself to the same level in international commerce as Poland or Turkey." It would lose so much business, he said, that "[n]o doubt the world would take note of how this global financial center no longer wanted to be a global financial center."

The entire argument may be moot, and currency traders have a while to wait to find out. The referendum will not be held till September of next year, but 2014 marks the 700th anniversary of the Battle of Bannockburn, when the Scots routed the English. It remains to be seen whether tradition will be upheld.

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