In for a penny, in for a pound.
There'll be no going back if Scotland votes for independence from the United Kingdom on Sept. 18.
Opinion polls showing that may happen have prompted investors to sell off the British pound. If a knockout blow is dealt to Scotland's 307-year union with England, that selling could accelerate as the U.K. plunges into a constitutional crisis.
The fate of the pound, which is also known as sterling and is one of the most tangible links of the union, will be front and center in any separation proceedings, as it has been during the campaign.
The nationalists, led by Scotland's First Minister Alex Salmond, hope Scotland will still use the pound through a currency union with what's left of the U.K.— Wales, Northern Ireland and England. The main British political parties, notably the Conservatives and Labour, say that's not going to happen.
Enmeshed are other complexities, such as the division of the U.K.'s 1.3 trillion pounds ($2.1 trillion) or so debt mountain and whether Scotland would be part of the European Union.
Uncertainty reigns — a toxic backdrop for the world's fourth-most traded currency. With polls showing the referendum too close to call, the pound has fallen almost 3 cents this week to a 10-month low of $1.6052 Wednesday.
"Huge uncertainties connected with the costs of separation, defense policy, the currency regime in Scotland and the political fall-out in the U.K. would unlikely be resolved quickly and so volatility is likely to stay at heightened levels," said Jane Foley, senior currency strategist at Rabobank International.
One thing's certain: Scotland will have to start paying its bills come March 24, 2016, the date set for Independence Day, so chosen because it is exactly 309 years since the union was signed.
DITCH ONE UNION, AGREE ANOTHER
For months, the Yes campaign made little headway, with many commentators blaming its plan to enter a currency union with what remains of the U.K. The No campaign rules that out and points to the problems that have afflicted the nearby euro currency union. "No ifs, no buts, we will not share the pound if Scotland separates from the U.K.," said George Osborne, the British Treasury chief.
The nationalists argue an agreement is possible. With the two economies so closely tied, a currency union would reduce transactions costs and uncertainty for both and Scotland would gain financial stability.
But a currency union would require Scotland to share political powers with Britain, meaning it would immediately hand back a chunk of its newly won sovereignty. It could, for example, have to get approval for its budget.
George Buckley, chief U.K. economist at Deutsche Bank, said a currency union would also likely require approval in the rest of the U.K. through a vote. "Popular agreement for a currency union with the newly independent neighbor may be potentially difficult to achieve," he said.
THE PANAMA PRECEDENT
No, it's not a Robert Ludlum thriller.
Even without agreement, Scotland could use the pound. "It's our pound and we're keeping it," Salmond said.
It's not an outlandish idea. Panama uses the dollar though it's not part of the United States, while Montenegro pays its way with euros despite not being in the EU. Because Scotland's economy is well synchronized with the U.K., so-called "sterlingisation" is an option, but it's fraught with problems.
Interest rates would be set by the Bank of England without any regard to what's going on north of the border. Scotland would also need to run up reserves to support its financial system, which means spending cuts and siphoning off money from the North Sea energy resources.
Analysts at BNP Paribas say the idea may be a ruse to force the remaining U.K. into a corner. "The hope would be that by choosing sterlingisation, the Scottish government could force some degree of cooperation from the U.K. government, resulting in something that looked more akin to a currency union," they wrote in a report.
EMBRACING THE EURO
Despite its problems, the euro could be the long-term alternative. By the time Scotland opts to join, the eurozone may have solved its many financial problems.
The nationalists used to back the idea of joining the euro before it was in crisis. Since that crisis, however, euro countries have been pooling many of their financial and political powers under strict rules. It's unclear whether Scotland would like to leave one union with Britain to join another.
One problem with the euro option is that Scotland would likely have to reapply to join the EU if it decides to become independent. It's uncertain how easy that will be. Spain, for example, may balk at the idea of early readmission for Scotland for fear it may encourage other nationalist movements in Europe, notably in the Spanish region of Catalonia.
GOING IT ALONE
An independent Scotland may be tempted to go the full hog and create its own currency, possibly resurrecting the Pound Scots that existed before the union. Other similar-sized European economies such as Norway and Denmark manage just fine.
"Having its own currency would provide the Scottish economy with the flexibility to make the necessary competitive adjustments and having its own central bank means that the appropriate level of interest rates can be set to suit the needs of the Scottish economy," said Neil MacKinnon, global macro strategist at VTB Capital.
It's not straightforward. A new Scottish currency would likely require higher interest rates than those in the U.K., even if it were pegged to the pound. There would be transaction costs in financial deals with the U.K. and Scotland would become vulnerable to shocks in currency markets. Businesses and savers may decide it's not worth the risks and move.
Precedent suggests a new Scottish currency would take time to establish itself. When Ireland won independence from the U.K. in 1922, it took six years for its new currency to be launched and decades for it to trade openly. As recently as the 1990s, Ireland needed to have high interest rates to support the Irish pound.
Still, for all its problems, it is "the only truly independent option of the four," said Deutsche Bank's Buckley.
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