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Institute sees no need for central bank

USING the pound without a currency union and reforming Scottish banking regulations could help an independent Scotland flourish, according to the right-wing free market think-tank, the Adam Smith Institute.

Financial experts and UK politicians have warned that so-called sterlingisation would leave the Scottish economy adrift without the support of a central bank with fears raised of banks relocating south of the border and even capital flight away from Scotland.

But the Institute argues that "Britain's obstinacy could be Scotland's opportunity to return to a freer, more stable banking system"; that "adaptive sterlingisation" would be a positive boon for a newly-independent Scotland as it would create a more stable financial system and economy and reduce risk-taking within the banking sector.

In a report published today, the think-tank - which stresses that it takes no position on the referendum and produces research for public information purposes only - also points to the dollarized economies of Latin America as providing strong evidence that banking systems fare better without central banks as lenders of last resort.

The Institute says adaptive sterlingisation would "allow competitive, private banks to issue their own promissory notes backed by reserves of GBP - or anything else, including USD, gold, index fund shares or even crypto-currencies like Bitcoin."

It explains: "With each bank given powers to expand and contract its balance sheet relative to demand, this system would be highly adaptive to changes in money demand, preventing demand-side recessions such as the ones that led to the 2008 Great Recession."

The think-tank claims evidence from countries like Ecuador and El Salvador suggests that using a currency without a central bank "far from being problematic, this constraint reduces moral hazard within the financial system and forces banks to be prudent, significantly improving the overall quality of the country's financial institutions. Panama, for example, has the seventh soundest banks in the world".

Sam Bowman, the Institute's Research Director, said: "The Scottish independence debate has repeatedly foundered on the question of currency but if Scots look to their own history they will find that their country is a shining example of how competition in currency and banking can ensure a stable and effective banking system.

"Scotland's free banking era was an economic and intellectual Golden Age and its system of competitive note-issuance was recognised by such thinkers as Adam Smith as one of the root causes of the country's prosperity during this time."

He went on: "The examples of Panama and other dollarized Latin American economies are proof that countries can thrive when they unilaterally adopt another country's currency. Combined with a flexible, adaptive banking system, the unilateral use of another country's currency can instil a discipline in a country's financial sector that neither a national currency nor a currency union can provide."

Mr Bowman added: "Scotland's banking system is almost uniquely primed for such a system of 'adaptive sterlingisation'. The path outlined in this paper would go almost unnoticed by the average Scot until the next big economic shock, when they might just wonder why their system was so much more stable than that of the country they'd left behind."

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