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A thread about currencies and capital markets...
When a government wants to borrow money from the financial markets, it does so by selling bonds; a bond is a promise to pay out a certain amount of interest (the 'coupon') to the owner every quarter, until the bond 'matures' after a fixed number of years ...
1/15
1/15
... whereupon the issuing government will buy it back at the face value (in effect, paying back the loan).
Any government can place bonds in any currency it likes; it's own, or any another country's, so the question of 'access to financial markets' doesn't arise.
2/15
Any government can place bonds in any currency it likes; it's own, or any another country's, so the question of 'access to financial markets' doesn't arise.
2/15
The only question that matters is whether the bonds will be attractive enough to investors (usually, in the first instance, large banks, insurance companies and pension funds). That depends on the interest rate offered.
3/15
3/15
The interest rate that a bond-buyer will look for depends on how risky they think the investment would be - if there is a significant risk of them losing their money, they will seek a higher interest rate than if their money is very safe.
4/15
4/15
The buyer has to assess the risk that the country issuing the bond may be unable to pay the coupon, or to redeem the bond when it is due (this is called 'defaulting').
A country with a high risk of default, or a record of having done so in the past (e.g. Argentina)...
5/15
A country with a high risk of default, or a record of having done so in the past (e.g. Argentina)...
5/15
... is going to have to pay a higher interest rate than one with low risk (e.g. Norway).
That applies when the country is borrowing in another country's currency. On the other hand, if a country issues bonds in its *own* currency...
6/15
That applies when the country is borrowing in another country's currency. On the other hand, if a country issues bonds in its *own* currency...
6/15
... then it can't default because in the last resort it can always borrow from its Central Bank (i.e. have its Central Bank print more money).
However, doing so will create an oversupply of that currency and so reduce that currency's value relative to others.
7/15
However, doing so will create an oversupply of that currency and so reduce that currency's value relative to others.
7/15
In this case, bond investors will take account of this, too, when deciding what interest rate they're looking for: if they think there's a risk of the currency being devalued by, say, 5% a year because of the Central Bank issuing too much of it, then ...
8/15
8/15
... they'll look for at least an extra 5% on the interest rate.
How this applies to an independent Welsh government is that:
9/15
How this applies to an independent Welsh government is that:
9/15
If it used Sterling as its currency, then it would have to keep its deficit low because it would almost certainly have to pay a higher interest rate on its debts, as investors would consider it riskier to buy bonds from Wales than from the rump-UK. 10/15
Hence in practice the government would have to be careful not to overspend, and keep its books closely balanced. This would be a Good Thing in and of itself, and lead to prosperity in the long term, but would feel tough in the short term.
11/15
11/15
If it used its own currency, then it the short term it would have more flexibility because it could borrow from its own Central Bank rather than having to engage with the markets straight away (though some limited bond-issuance in foreign currencies ...12/15
...may still be necessary to finance imports). This would depress the currency's value in the short term, but that would be no bad thing as it would make Welsh exports more competitive and stimulate investment; ...
13/15
13/15
... the value would then rise again as this investment led to higher productivity. This would also be a Good Thing, and involve less short-term hardship than sticking with Sterling.
14/15
14/15
For that reason my own position is that it would be preferable to an independent Wales to have its own currency from the outset. There's *much* more about this topic in the series of blog articles I wrote for the Gwlad website last year.
15/15
15/15
