Scotland should vote yes in 2014 but only if …

I am in Perth today speaking at a public service employees union congress. The talk is based on a major report we have just finished tracking the implications of public spending cutbacks in Australia on the volume and quality of public service delivery. We did several case studies – one of which was child protection – and the cutbacks will lead to increased child abuse in Australia without doubt. The story is pretty grim and I will write about it once the Report is made public by the commissioning party. But with travel (Perth is a long flight from anywhere and I have to get back to Newcastle tonight – 6 hours) and commitments I haven’t much time to wax lyrical on my blog. But I have been meaning to write about the upcoming Scottish referendum on independence from Britain and it fits a nice theme with yesterday’s blog – The demise of social democratic parties – they are all neo-liberals now – where I argued that good intentions come to naught if the economic policy paradigm used is erroneous. I would recommend the Scots vote yes at the 2014 referendum. But only if they introduce their own unpegged, floating currency and avoid any talk of joining the Eurozone. Further, the yes vote should be conditional on the government committing itself to achieving full employment on the back of their newly created currency sovereignty. Then the yes vote will improve welfare for the Scottish people. If they continue to use the British pound – then nothing will be gained.

Clearly I am not qualified to write about the cultural and political underpinnings of the desire by Scottish nationalists to become an independent nation again after losing that status in 1707.

I have read John Prebble on the fall of the clan system and the – Highland Clearances and the Glencoe massacre. My assessment is that Prebble’s interpretation was more accurate (that is, it was a deliberate strategy to remove the Highlanders and Islanders from Scotland) than those who claim that the population decline in rural Scotland was driven purely by economic and social factors.

But all these nationalist sentiments, though important in the debate, are beyond my remit. In general I wish nationalism would disappear but I am a realist.

The Scottish Government published its White Paper – Choosing Scotland’s Future: A National Conversation: Independence and Responsibility in the Modern World – in August 2007, where it canvasses the issue of independence.

In its most basic form, independence (moving from the current state of devolution) would:

… involve bringing to an end the United Kingdom Parliament’s powers to legislate for Scotland, and the competence of United Kingdom Ministers to exercise executive powers in respect of Scotland … and the Scottish Parliament and Scottish Government would acquire responsibility for all domestic and international policy, similar to that of independent states everywhere, subject to the provisions of the European Union Treaties and other inherited treaty obligations.

These are essential criteria for a nation to enjoy sovereignty.

The legal transition would be simplified because Scotland already has “its own legal system, borders, and other independent institutions” as a result of the various acts of union that have been enacted since England took control.

The institutional structure of governance, courts and judiciary are already established and the transition would be easy.

The White Paper also notes that:

With independence, the Scottish Government would assume from United Kingdom Government Ministers full Ministerial responsibility and functions for currently reserved areas, in addition to their existing powers in devolved areas, and would be accountable to the Scottish Parliament for their exercise of these responsibilities.

There would be a lot of cross-border demarcations to sort out in terms of existing departmental structures and purview. None of which would require any rocket scientists being called in.

There are a lot of issues relating to “such matters as: apportionment of the national debt; allocation of reserved assets, such as the United Kingdom official reserves, the BBC, and overseas missions of the Foreign Office; future liabilities on public sector pensions, and social security benefits; the split of the defence estate and the equipment of the armed forces.”

In the public debate, the question of North Sea oil has been central. The polarisation of views is clear.

In this article from the Economist Magazine (April 14, 2012) – The Scottish play – we confront the question “would an independent Scotland be an impoverished backwater or a land flowing with oil and money.”

The Article provides the following answer, which is not inconsistent with my analysis of the available data:

Scotland’s accounts of revenue and expenditure, based on Treasury data, show that it is not a ward of the state, grossly subsidised from Westminster. In fact it performs better than all regions outside the south-east of England … In 2010-11 Scotland’s GDP was £145 billion ($225 billion) including a geographical share of North Sea oil and gas, around 10% of Britain’s, with 8.4% of the population.

Historically Scotland has received bigger grants per head from central government than Wales, for example-in part a tacit acknowledgment that it contributes handsomely to oil revenues, which in 2010-11 amounted to £8.8 billion. An independent Scotland would lose that subsidy, but gain the right to collect taxes on hydrocarbons locally. For the moment, Scotland’s day-to-day accounts would look little different to now.

Analysts, however, argue that in the longer-term, the North Sea oil will run dry and there are “hidden liabilities” involved in decommissioning the oil and gas installations, which the British government is currently liable for.

The other issue surrounding the British-Scottish relationship is if the Scots get the lion-share (excuse the pun) of the North Sea oil revenue (they are claiming 90 per cent although they would get nothing if the Shetland and Orkney Islands, in turn, achieved independence from Scotland) what share of the banking bailouts will they have to wear?

The Economist article notes that the “financial-services industry” in Scotland is in deep trouble. The 2008 bailout of the two largest Scottish banks – Royal Bank of Scotland (RBS) and HBOS – required the British government injecting significant funds. Would the Scots have to pay the British Government back?

However, I think this issue would become irrelevant if the Scottish government achieved true independence. They would have all the funds necessary to nationalise the banking sector and guarantee deposits in the new currency. They could offer the British government some settlement in the new Scottish pound.

But if they do not introduce their own sovereign currency then these matters become more important.

The Economist article provides some commentary on that issue:

… most testing for Scotland’s future would be the question of its currency. Mr Salmond’s hopes of joining the euro have soured-for now he plans to stick with the pound. Yet the euro zone has amply demonstrated the dangers of entering a monetary union without fiscal union. Soothing niceties from Cheshire-cat politicians no longer reassure bond markets-Scotland would pay a premium for being part of a monetary union that could break. It would have no central bank, no monetary freedom and limited fiscal autonomy.

The White paper says that “an independent Scotland would have responsibility for macro-economics, defence and foreign affairs in a way that would not be possible while Scotland remains within the United Kingdom”.

The most important point is that to be truly independent the Scottish Government would have to gain “full Ministerial responsibility”, including all central banking and treasury functions.

They could not realistically have responsibility for macro-economic policy if they joined the Euro or kept the British pound.

The White Paper says on currency:

However extensive internal devolution may be, it is necessarily the case that the United Kingdom as a single state would have a single currency, whether sterling as at present or, at some future date, the euro. To join the euro, Scotland would therefore remain dependent on a decision of the United Kingdom Government and a referendum across the whole of the United Kingdom, rather than being able to join at a time best suited to Scottish economic circumstances.

The desire to join the Eurozone, which has now given way to a claim that an independent Scotland would retain the British pound tells you that the independence movement has not been motivated or informed by any deep understanding of how modern monetary systems function.

The statements about fiscal autonomy and full fiscal responsibilities are fraught with misconceptions given that the Government does not propose full currency sovereignty.

The absence of their own central bank would completely compromise the new government’s capacity to advance public purpose independent of policy settings from Westminster.

To understand this point, I would advise readers to become acquainted with the following blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3

Then you should read these more specific blogs – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3.

A sovereign government in a fiat monetary system has specific capacities relating to the conduct of the sovereign currency. It is the only body that can issue this currency. It is a monopoly issuer, which means that the government can never be revenue-constrained in a technical sense (voluntary constraints ignored). This means exactly this – it can spend whenever it wants to and has no imperative to seeks funds to facilitate the spending.

This is in sharp contradistinction with a household (generalising to any non-government entity) which uses the currency of issue. Households have to fund every dollar they spend either by earning income, running down saving, and/or borrowing.

Clearly, a household cannot spend more than its revenue indefinitely because it would imply total asset liquidation then continuously increasing debt. A household cannot sustain permanently increasing debt. So the budget choices facing a household are limited and prevent permanent deficits.

These household dynamics and constraints can never apply intrinsically to a sovereign government in a fiat monetary system.

There is also a sharp distinction between a state within a federal system (which uses the federal currency and has no central banking capacity) and a truly sovereign national government.

A sovereign government does not need to save to spend – in fact, the concept of the currency issuer saving in the currency that it issues is nonsensical.

A sovereign government can sustain deficits indefinitely without destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose.

Further, the sovereign government is the sole source of net financial assets (created by deficit spending) for the non-government sector. All transactions between agents in the non-government sector net to zero. For every asset created in the non-government sector there is a corresponding liability created $-for-$. No net wealth can be created. It is only through transactions between the government and the non-government sector create (destroy) net financial assets in the non-government sector.

This accounting reality means that if the non-government sector wants to net save overall in the currency of issue then the government has to be in deficit $-for-$. The accumulated wealth in the currency of issue is also the accounting record of the accumulated deficits $-for-$.

So when the government runs a surplus, the non-government sector has to be in deficit. There are distributional possibilities between the foreign and domestic components of the non-government sector but overall that sector’s outcome is the mirror image of the government balance.

If Scotland wants to be truly independent it has to have its own currency.

Then all the issues about what ratings the public debt would get from the bond markets and the rating agencies and all the rest of the nonsense would fade away into irrelevance.

South Sudan

In 2011, South Sudan became the World’s latest sovereign country. When South Sudan create a new nation in 2011 they started in the right way from the perspective of the monetary system.

First, they introduced their own currency under the legal framework of the Bank of South Sudan Act 2011. On July 18, 2011, the new government introduced the – South Sudanese pound – which was floated at par to the Sudanese pound.

Second, they ensured that all legal monetary obligations between the government and non-government sectors, such as all tax liabilities, were only negotiable in that currency.

Third, they created the – Central Bank of South Sudan – which is an essential aspect of currency sovereignty. There was a bit of fun early on. The BBC news reported (August 17, 2011) – South Sudanese Pound as Legal Tender – which clarified the intent and legality of the Bank of South Sudan Act, 2011 “with regard to dealing in South Sudanese Pound as Legal Tender.”

The memo said that:

All public budgets, financial records and accounts, required by any law or established or maintained in South Sudan, shall be or be assessed in South Sudanese Pounds. Payments of money when required in any indictment or other legal proceedings other than for the enforcement of a foreign currency obligation shall be stated in South Sudanese Pounds.

Further:

Compulsory payments shall be assessed and required to be paid in South Sudanese Pounds … includes the payments of taxes (either direct or indirect), customs duties, excises, levies, fees, charges and penalties, as well as any payment to public utilities ….

From a Modern Monetary Theory (MMT) perspective this is impeccable.

The new government in South Sudan clearly understands that in a fiat monetary system the currency has no intrinsic worth. They have also clearly made the connection between the fact that their government spending is not revenue-constrained because they have their own currency but at the same time they have to provide an incentive for the citizens to demand that currency.

The starting point of this new understanding is that taxation functions to promote offers from private individuals to government of goods and services in return for the necessary funds to extinguish the tax liabilities

In this way, it is clear that the imposition of taxes creates unemployment (people seeking paid work) in the non-government sector and allows a transfer of real goods and services from the non-government to the government sector, which in turn, facilitates the government’s economic and social program.

The crucial point is that the funds necessary to pay the tax liabilities are provided to the non-government sector by government spending. Accordingly, government spending provides the paid work which eliminates the unemployment created by the taxes.

The purpose of State Money is for the government to move real resources from private to public domain. It does so by first levying a tax, which creates a notional demand for its currency of issue. To obtain funds needed to pay taxes and net save, non-government agents offer real goods and services for sale in exchange for the needed units of the currency. This includes, of-course, the offer of labour by the unemployed. The obvious conclusion is that unemployment occurs when net government spending is too low to accommodate the need to pay taxes and the desire to net save.

This analysis also sets the limits on government spending. It is clear that government spending has to be sufficient to allow taxes to be paid. In addition, net government spending is required to meet the private desire to save (accumulate net financial assets). From the previous paragraph it is also clear that if the Government doesn’t spend enough to cover taxes and desire to save the manifestation of this deficiency will be unemployment.

So it is now possible to see why mass unemployment arises. It is the introduction of State Money (government taxing and spending) into a non-monetary economics that raises the spectre of involuntary unemployment. As a matter of accounting, for aggregate output to be sold, total spending must equal total income (whether actual income generated in production is fully spent or not each period). Involuntary unemployment is idle labour offered for sale with no buyers at current prices (wages).

Unemployment occurs when the private sector, in aggregate, desires to earn the monetary unit of account, but doesn’t desire to spend all it earns, other things equal. As a result, involuntary inventory accumulation among sellers of goods and services translates into decreased output and employment. In this situation, nominal (or real) wage cuts per se do not clear the labour market, unless those cuts somehow eliminate the private sector desire to net save, and thereby increase spending.

Keynesians have used the term demand-deficient unemployment. In a MMT conception, the basis of this deficiency is at all times inadequate net government spending, given the private spending decisions in force at any particular time.

Accordingly, the concept of fiscal sustainability does not entertain notions that the continuous deficits required to finance non-government net saving desires in the currency of issue will ultimately require high taxes. Taxes in the future might be higher or lower or unchanged. These
movements have nothing to do with “funding” government spending.

To understand how taxes are used to attenuate demand please read this blog – Functional finance and modern monetary theory.

The memo also noted that it was common practice among government and financial institutions, etc to “draft official or private contracts etc in “foreign currency” and:

This practice of dealing in a foreign currency rather than in our legal currency is not acceptable … The South Sudanese Pound is the legal tender and should not be refused or rejected by anyone, as provided in section 46 of the Bank of South Sudan Act, 2011.

Conclusion

I think Scotland would be well advised to ensure its referendum includes the fact that independence would involve a separate sovereign currency. Then the Scottish Government could achieve its goals to enhance the common good and it could avoid the nonsensical fiscal austerity that has captured the British government.

I don’t pretend that running a nation of 5 million odd people with limited resource diversification is easy. But I suspect the people would be better off overall with true independence.

However, if they keep the British pound, then independence will achieve little – other than soothe the nationalist desires.

Scotland should follow South Sudan’s example. If it did its future would be much brighter than it will be for that tiny African nation. But at least from a monetary perspective the South Sudanese government is on the right track.

Chickens in style

I am a vegetarian so I am all for treating animals with respect and style. So I should be happy that an English hedge fund manager has decided to treat his chickens to a state of sumptuous elegance.

The UK Daily Telegraph story (September 25, 2012) – Crispin Odey’s chickens come home to (a luxury) roost – reported that the hedge fund boss will spend £130,000 on stone alone to build a very nice “Palladian-style chicken house”.

Here is a snapshot of the architect’s plans showing the north elevation.

The description in the planning application goes:

The temple’s roof – adorned with an Anthemia statuette – will be fashioned in grey zinc; the pediments, cornice, architrave and frieze are in English oak; and the columns, pilasters and rusticated stone plinth are being hewn from finest grey Forest of Dean sandstone.

You can see more of the Drawings and other documents – HERE.

All I hope is that he doesn’t plan to eat any of the chickens!

Then there is the ethical issues of having that much cash when poverty is rising quickly in the UK on the back of the fiscal austerity program imposed by the British government. I will leave that for another day.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.