No more Scottish bank notes south of the border?

An economic question that is not momentous, but is nonetheless fascinating (well to me - but that may just be me), is what will happen to existing Scottish bank notes, if Scotland votes for independence.

This is all about one of the eccentricities of the UK's current monetary system, which is that the central bank, the Bank of England, does not have a conventional monopoly on the issuance of bank notes.

Royal Bank of Scotland, Bank of Scotland and Clydesdale can all make and distribute bank notes bearing their respective monikers.

And these are legal tender throughout the UK - as everyone knows, except a few London cabbies and corner shops, who routinely snarl when given them.

Bank power

That said, Bank of England keeps control over the number of Scottish bank notes in issue, by stipulating that RBS, Lloyds (the owner of BoS) and Clydesdale have to hold in their reserves the same amount of UK money (either in cash or on deposit at the Bank of England) as the Scottish notes they issue.

Or to put it another way, the power of the big three Scottish banks to issue bank notes does not degrade the Bank of England's important power to control the supply of money for the whole UK.

In other words, the unity of Scottish and UK bank notes represents comprehensive and deep monetary union between Scotland and the rest of the UK.

Even so, the Bank of England has not always been comfortable with Scottish banks' note issuing privileges. One bank boss told me that the former governor of the Bank of England, Lord King, was keen to consign the Scottish pound to the dustbin of history.

So what would happen to these Scottish bank notes if Scots were to vote for independence?

Well the Bank of England has made clear they would remain legal tender in England, Wales and Northern Ireland till Scotland was formally and constitutionally separated, which would be 2016 on Alex Salmond's timetable (but some think could be a good deal later, given that unravelling the union would be complicated).

Risky

But if the Westminster government maintains its current position, which is that there would be no monetary union with an independent Scotland, then at the moment of formal separation, those RBS, Clydesdale and Bank of Scotland notes would be a foreign currency in England, Northern Ireland and Wales.

The Bank of England would feel obliged to revoke their status as legal tender, because without a detailed monetary union pact (something Tories, Labour and LibDems all say they won't brook) it would no longer have the power to limit the number of Scottish bank notes in issue - and without that power, the rest of the UK would be vulnerable to the risk that excessive Scottish note issuance would impair the value of the rest-of-UK pound.

It would mean, for the avoidance of doubt, that those holding Scottish notes who want to buy stuff in England, Wales or Northern Ireland would have to exchange them for whole-UK sterling at a bureau de change.

What next?

As for the status of these Scottish notes in Scotland, that would be decided by the government of an independent Scotland.

They could remain legal tender there, and could be pegged at parity with the rest-of-UK pound.

Or they could be replaced by a new currency.

Or they could be turned into a free floating currency in their own right.

One interesting point therefore is whether Scots and others holding these notes will be comfortable keeping them, till their future status and value is determined.

It is yet one more example of how one decision, to separate from the UK, would breed a multitude of other important decisions.

Update 9 September, 12:00

I was guilty of a solecism in my column on Scottish bank notes, in describing them as "legal tender".

Apparently they are "legal currency", approved by the UK parliament, but not legal tender - which is a nice distinction, as they say.

Click here for more about the legal status of these notes.

The thrust of my article is unimpaired, which is that if Scots were to vote for independence, the opposition of the Tories, Labour and the LibDems to monetary union with Scotland would mean Scottish bank notes would no longer be - to all intents and purposes - the same as notes issued by the Bank of England in the rest of the UK.

A big thanks to those monetary experts who pointed out my mistake. And sorry to the rest of you.