Should an independent Scotland try to form a sterling pact with England, join the euro, or create its own currency?
Have its own currency
A Scottish currency – let's call it a Scotdollar – would be a simple solution. Royal Bank of Scotland, Bank of Scotland and Clydesdale already print their own notes, so a switch in name and letting it float against other currencies would not be much of a leap.
But as Iceland has discovered, currencies belonging to small countries can rise and fall with alarming regularity, causing havoc for exporters. And pain comes with a fall. A decline in the value of the Scotdollar would push up the cost of imports and send inflation soaring. Businesses would say they could not plan with such uncertainty.
To solve the problem, Iceland wants to join the euro.
Join the euro
Joining the 17-member currency could be a boon to Scotland. With a raft of new rules in place to prevent another banking crash, the euro could prove a safe haven in an uncertain world.
But not everyone is equal inside the euro, as the Germans have made clear in their dealings with the troubled Greeks, Portuguese, Irish and Cypriots, who have taken some unpleasant medicine in recent months.
Many economists believe the strains inside the currency union are so great that it will eventually fall apart, bringing huge costs to an independent Scotland.
Sterling pact with England
While it might be simpler maintaining a currency union of two rather than 17, the same strains could appear very quickly. George Osborne says there is a compelling case for the Scottish, who export 30% of their goods and services to the rest of the UK, to form a sterling union, but not for England, Wales and Northern Ireland, who send only 5% of output to Scotland.
But would Edinburgh agree a pact unless it brought equal status and power on the Bank of England board? That would be a high price for the Bank to pay. And could Scotland, or England come to that, stay within agreed tax-and-spend limits when local electorates want higher spending?
Sterling pact without Bank of England
Maintaining Scottish sterling and telling everyone it is worth the same as the English version, without any agreement with London, would mimic the arrangement in Ecuador, El Salvador and Panama, which use the US dollar as currency.
It can have the same pitfalls as a currency pact. The plan can fall apart over time if Scottish wages fail to keep pace with the UK's. A Mars bar may become more expensive in Scotland relative to incomes, and either the price falls or the Mars bar disappears.
Adopt the dollar
Ecuador, El Salvador and Panama use the dollar for everything, while countries such as Costa Rica have a currency that most islanders ignore in favour of the dollar. Either way, the dollar is king. It could work for Scotland – it is the currency oil is traded in and might cement links with the US.
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