Scotonomics: Will an independent Scotland’s new currency rise or fall?

When Scotland launches its own currency, one of the following three things will definitely occur: It will either be stronger or weaker against the pound or retain parity.

Naturally, people seek certainty about their economic future. During the independence campaign, I remember an audience member on an episode of Question Time shouting out in frustration: “We don’t want opinions. We want facts.”

Everyone applauded.

If only it were so simple. Even when the facts are available, economists disagree. So, there is no chance of agreement when we peer into the future and discuss the value of a new Scottish currency.

When Scotland has its own currency again, no one can say with anything approaching certainty what will happen to that currency. The same is true of the UK pound and all other currencies. Will a new Scottish currency fall or rise in relation to the euro, dollar, or pound? The uncomfortable answer is that no one knows.

Everyone, not just economists, looks at the future and distorts it to reflect their own world views and biases. So, we must be wary of predictions (including mine!). We must try to see through the biases and understand the assumptions and worldview of the person making those predictions.

As a real-world economist, I believe my predictions are more sound than those of mainstream economists, who believe the opposite! Two economists can examine a situation and predict (or guess) the exact opposite outcome. Perhaps the best example of this guessing game is currencies.

How can Ronald McDonald guess that the new Scottish currency would fall 30% upon its introduction while Richard Murphy (above) suggested Scotland’s currency would be worth more than the UK pound? And more importantly, where does this leave the average Scot considering supporting a new currency after independence?

READ MORE: Unionists were wrong to leap on Scotonomics interview with Mark Blyth

The main problem with this mainstream view is that what looks good in their models is rarely reflected in the real world When you hear opposing views, it is a good idea to delve deeper into those assumptions to see if you feel comfortable supporting those predictions. Mark Blyth’s recent opinion on the Scottish currency was framed and supported by mainstream economic assumptions. All of which we would dispute.

These models are built on neoclassical assumptions, which include a world of full employment, rational actors, and equilibrium. None of these assumptions hold outside of their mathematical models. They also mostly ignore the impact of currency portfolios. They assume the trade balance (people swapping currencies to buy things in that currency) is the most important factor in the price of a currency. Swapping currencies for trade makes up around 10% of the total trade in currencies. This is like predicting the winner of a football match by only counting the number of throw-ins by each team.

Another significant assumption is that those who engage in currency trades cannot affect the results, which is nonsensical in a world where massive trading houses dominate the market.

Criticism of the neoclassical approach is easy to find, even within the mainstream. During his tenure as chairman of the Federal Reserve, Alan Greenspan said: “Despite extensive efforts on the part of analysts, to my knowledge, no (neoclassical) model projecting directional movements in exchange rates is significantly superior to tossing a coin.”

READ MORE: Mark Blyth: Unionists ‘taking my words on independence out of context’

One neoclassical model is the BEER Methodology. Scottish Academic Ronald McDonald has spent more than 25 years on this framework. His BEER model attempts to predict foreign exchange rates based on three main “economic fundamentals”: GDP per capita/net foreign assets/terms of trade. He used this to predict a 30% fall in the new Scottish currency. I wrote an extended response to this exceptionally poor bit of research in 2022.

What does the European Central Bank think? Well, it found that the BEER model “delivers highly inaccurate forecasts” for three countries, including the UK. Also: “The link between real exchange rates and economic fundamentals is feeble and the link between exchange rates movements and current accounts is much less predictable than often assumed.”

The report concluded that “the literature does not provide much evidence about the predictive content” of any of the models. None of this, of course, stopped almost every UK paper from publishing Ronald’s politically motivated bit of guesswork. In this case, his assumptions = his conclusions.

• We adopt a wholly different worldview. Where:
• The real world is one of underemployment
• Portfolio capital has a much more significant role
• There is no natural drift to any equilibrium
• Actors are irrational and are affected by loss aversion, blind faith, following the herd etc
• Simply by trading, traders alter the outcome
• What happened in the past affects the future;

and most importantly, the future is cloaked in “fundamental uncertainty”. In other words, the world is so complicated that no one knows!

We believe that this real-world view must be considered to better understand the foreign exchange market. This allows us to counter currency claims made by mainstream economists. We do not dismiss experts’ opinions, but we question and challenge the assumptions on which they have made their predictions or guesses. And we put forward our own argument. This is the basis of scientific discourse. So here goes.

The National: Scottish money Let’s assume a free-floating currency was created around 2030. The Scottish government did not take on the UK government’s debt, and a progressive Scottish government was in place that supported wellbeing policies such as a job guarantee. Then, looking at the historical evidence of newly independent northern nations, the underlying strength of the Scottish economy, based on its natural resources, its potential for population and GDP growth, and the normal flow of currencies to rise and fall but return roughly close to the previous value, the Scottish pound would retain its value against the UK pound in the first few years of independence.

That’s my opinion. My job is to persuade you that it is more sound than the opposing view.