With votes on the Scottish independence referendum still being counted, it is worthwhile pondering what the nation state will look like if the Scots choose to secede from the union.

There are fundamental questions that will need to be answered, such as how public debt, social services, and gas field revenues will be divided. But perhaps the most pressing one will centres around what currency the country will use should it emancipate itself.

The Adam Smith Institute weighed in, suggesting in a paper that Scotland pursue dollarization (or sterlingization), which involves adopting foreign currency without taking on board the associated monetary policy.

The think tank believes this could pave the way for Scotland to return to free banking.

For those unfamiliar with the concept, it is a system whereby private banks are subject to no special regulation via a central bank, and nor is there a lender of last resort. Instead shareholders are liable to depositors in the event of a bank failure.

Furthermore, banks issue their own money, based on individual reserves, held either in gold or a foreign currency, such as the pound.

The think tank argues that Scotland’s financial system would be better off by removing reserve ratio requirements, capital adequacy ratios, reforming deposit insurance laws and easing the barriers of entry to foreign banks.

This is premised on the belief that by exposing banks to unfettered market forces, they would be more prudent with their lending, and money supply would be far more responsive to changes in demand. Furthermore, domestic inflation or fiscal crises can also be avoided because the government cannot monetarise its deficits.

The paper backs its claims by looking at history.

Between 1716 and 1844, Scotland used a free banking system, which was characterised by “remarkable economic and financial stability which only ended when large banks successfully lobbied Westminster for government protections from competition”.

Furthermore, the paper notes that of the 48 crises that took place between 1793 and 1933, 41 took place in unfree banking systems, and half took place where there was a lender of last resort.

The institute also notes that several small South American nations successfully use free banking today.

Panama has used free banking for over a century, which the IMF has lauded for showing that there is no need for a “trade-off between generating optimal institutional arrangements and macroeconomic stability”.

According to the World Economic Forum’s 2013/2014 competitiveness survey, Panama is ranked 7th for soundness of banks, 7th for affordability of financial services, and 8th for access to loans. This makes a compelling case for the people of Scotland. Should they grasp the nettle of political freedom, let’s hope they grasp the economic one as well.