Scottish nationalists are in a
quandary: how to dissolve the three-century bond with the United Kingdom while
preserving their monetary link with the British pound.
And Hong Kong may provide the
answer.
Nationalists want to retain
the British pound if they win September’s independence vote, but U.K. political
leaders ruled out sharing sterling earlier this month. They fear taxpayers
would have to back Scotland in times of economic trouble, much as shared use of
the euro forced Germany to bail out Greece.
Ditch the union if you want,
but say goodbye to sterling, is the message from London.
This creates a bit of a fankle
– a Scottish term for a state of disarray, even panic – for the Scottish
nationalists. But they may have another card to play.
A currency board could allow
Scotland to effectively keep the pound even without consent from the Bank of
England, said John Greenwood, the chief economist at Invesco who helped design
Hong Kong’s dollar peg, which has held for 31 years.
“If Scotland were to set up a
currency board for a Scottish pound that remained at parity (1:1) with the
English pound, the trade, current and capital account balances of Scotland
would remain broadly unchanged, unless there was some major change in the
economic circumstances of either country,” he said in an email.
This arrangement would require
sufficient foreign reserves in British pounds to fully cover the amount of
currency in circulation and the total held on deposit by commercial banks for
interbank clearing transactions. Hong Kong, for example, holds $312.2 billion. See more Financial News
Some naysayers argue it might
be hard for Scotland to build up such reserves.
Nomura, in a research report,
contends that raising the required amount of reserves could be a “painful”
process for Scotland. The bank asks how much of the U.K’s foreign reserves an
independent Scotland would be entitled to in the event of a breakup, estimating
that a share proportional to the size of the Scottish economy would only
provide $4.5 billion, or about 7% of the total reserves needed for a currency
board. Scotland may also have to negotiate to draw down its share of the U.K.’s
reserves held by the IMF.
A currency board might also
make the Scottish pound vulnerable to speculative attack. Defending a currency
board against short sellers can be politically painful, said Joseph Yam, a
research fellow at the Chinese University of Hong Kong who as chief executive
of the Hong Kong Monetary Authority, fought off speculators including George
Soros’ Quantum Fund during the Asian Financial Crisis.
“In the case of capital
outflow, for whatever reasons, interest rates could rocket to very high levels
and severe pain correspondingly inflicted on those shorting the currency as
well as the economy; the latter may be so politically unacceptable as to lead
to political pressure to abandon the currency board arrangement,” he said in an
email.
The Hong Kong Monetary
Authority declined to comment on whether it had been consulted over a Scottish
currency board.
Britain has been beaten by
speculators before. George Soros’
attacks on “Black Wednesday” in 1992 forced the U.K. to break its fixed
exchange rate with the precursor of the euro, trashing the economic credibility
of the British conservative government, which would spend 13 years out of
power.
The Bank of England hiked
interest rates from 8.8% to as much as 15% before capitulating. Current Prime
Minister David Cameron, then aged 25, worked behind the scenes on the
government’s policy response.
Mr. Greenwood agrees that
speculative attacks would be possible. However, he said, “If Scotland were to
follow the disciplines of Hong Kong in relation to fiscal policy, banking
soundness, and the avoidance of leverage then there should be nothing to fear,
and the Scottish pound could maintain parity with the English pound.”
Hong Kong defended its peg
during the Asian crisis by buying up HK$118 billion of stocks and index
futures, a move which later drew praise from Mr. Soros himself.
The above article is a repost from WSJ
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