Salmond feels the heat over plan to go it alone

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When Ecuador adopted the dollar in 2000 in a desperate bid to restore stability, one economist likened it to a fat woman buying a dress two sizes too small in the hope that it would make her slim.

Alex Salmond, Scotland’s first minister, has drawn similar derision for suggesting the country could opt unilaterally to use the pound, in the absence of monetary union after a vote for independence.

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In branding it the “Panama plan”, Alastair Darling, leader of the pro-union campaign, would no doubt like to hint at a future of economic dependence and second-rank financial institutions.

Yet Panama, one of the first countries to adopt the currency of a powerful neighbour, is often seen as an example of successful “dollarisation”. It adopted the greenback in 1904, shortly after splitting from Colombia under the shadow of US guns – and has maintained low inflation and interest rates, while developing a thriving financial sector and a mortgage market that is the envy of Latin American neighbours.

Steve Hanke, a professor at Johns Hopkins University in Baltimore, who helped Ecuador and Montenegro adopt the dollar and Deutsche Mark respectively, argues the policy has been a resounding success that could “elegantly solve the whole currency problem” for Scotland. “It disciplines the fiscal and financial system because you can’t go to the central bank and force the governor to print money,” he said.

Other economists are far more ambivalent. Countries who adopt others’ currencies are usually tiny, as in the case of Andorra or Monaco; in transition, as were the former communist countries that switched to the euro; or desperate to restore stability. As Angus Armstrong, director of macroeconomic research at the National Institute of Economic and Social Research, puts it: “you borrow credibility”.

For such an arrangement to work, they need to be small, open economies that are closely aligned with that of the currency they are adopting. But Jeffrey Frankel, a Harvard professor who has written extensively on currency unions, cites as additional criteria, “a strong (even desperate) need to import monetary stability . . . a desire for further close integration . . . and access to an adequate level of reserves”.

These are not necessarily the criteria a newly independent Scotland would wish to meet. Moreover, by unilaterally adopting the pound, it would cede control of monetary policy and lose the ability to backstop the banking sector.

Mr Armstrong notes that financial institutions could be forced to move their headquarters from a country that could no longer act as lender of last resort, while use of the pound would not guarantee low borrowing costs.

“In Europe, we’ve seen that getting rid of currency risk is not enough – it can be substituted into country or credit risk,” he said. “People are playing with fire with this stuff”.

Mr Frankel makes the further point that, “Panama is so small that it’s pretty credible – no Panamanian thinks the Fed is going to take into account the welfare of the Panamanian economy. In the case of the UK, it’s different. The Scots probably would expect to influence the Bank of England . . . and they wouldn’t get it.”

Then there are the political implications. Ecuador has proved that it is possible to borrow a neighbour’s currency without sharing their policies: Rafael Correa, currently sheltering Julian Assange in Ecuador’s London embassy, has made anti-US rhetoric a hallmark of his administration.

Yet dollarisation can certainly make it harder to rebel. When the US issued an arrest warrant for Manuel Noriega, Panama’s military dictator, in the late 1980s, it backed up its threats by cutting off the supply of paper currency and freezing Panamanian accounts in New York: gross domestic product shrank by almost a fifth in a year.

An independent Scotland would not need Westminster’s approval to use the pound – but it would have to hope for an amicable split.