Europe, Brexit and the credit cycle

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by Alasdair Macleod, GoldMoney:

Europe’s financial and systemic troubles have retreated from the headlines. This is partly due to the financial media’s attention switching to President Trump and the US budget negotiations, partly due to Brexit and the preoccupation with Britain’s problems, and partly due to evidence of economic recovery in the Eurozone, at long last. And finally, anyone who can put digit to computer key has been absorbed by the cryptocurrency phenomenon.

Just because commentary is focused elsewhere does not mean Europe’s troubles are receding. Far from it, new challenges lie ahead. This article provides an overview of the current state of play from the European point of view, and seeks to identify the investment and currency risks. We start with Brexit.

At least there’s some money on the table

Last week, sufficient agreement had been obtained from the Brexit negotiations to allow the EU’s negotiators to recommend to the Council and the European Parliament to proceed to the next step, which is to discuss trade. That has now been approved.

There were three areas agreed in outline: the money, estimated at up to €50bn, the rights of EU and UK citizens, and the Irish border. Only one of these matters, the other two being little more than side issues deployed by the EU negotiators to squeeze as much money as possible from the British.

Yes, it was about the money. As I’ve pointed out before, Brussels’ administration costs are almost the same as Britain’s net annual contribution of €8bn.[i] Without the UK, the EU is in serious financial trouble, particularly when Brussels plans to set up its own standing army, and integrate all the member states into united states of Europe. It used the myth of Britain’s on-going commitment to financing future projects to come up with estimates of up to €100bn, when no liability for these projects, the RAL, or reste à liquider actually exists.[ii]

While the main-stream media focused on Britain’s problems, it missed the simple truth that the EU faces a far larger problem. Pace observing Libertarians; an overtly free market approach, with Britain just walking away was never politically practical. It would have created enormous damage for Europe. In the circumstances, the British negotiators held their nerve, and won the game of chicken.

What came out of last week’s agreement was basically a fifteen-page statement of intent, the detail to be worked on later. It was, as has subsequently been pointed out by two Brexit-supporting cabinet ministers (David Davis and Michael Gove) no commitment at all, no more than a gentlemen’s agreement. Also, on the money question, Brussels will have to itemise the expenses Britain is liable for to an expected maximum of €50bn. Given that legally Britain has no liability for that highway project being planned in, say, Slovenia, Brussels can still go whistle.

There are line items that are justifiable, such as Britain’s stake in the ECB, and indeed in the European Investment Bank, which is based in London. There are the pensions for MEPs and other Brussels staff of British origin offsetting the value of these stakes. And so on. The money will end up being a fudge, because the gap between the net liabilities between Britain and the EU is probably less than €10bn either way.

The way round this, to save Brussels from itself, is to agree to a two-year interim period, during which current arrangements will be extended, and Britain will continue to pay membership fees of €16bn over the two years. Anything over that will have to be properly expensed, which means further money should not be used to finance Brussels’ establishment costs. Brussels needs to make alternative arrangements after Britain finally leaves, presumably getting Germany, France, and other leading members to up their ante. The transitional arrangement will ease Brussel’s pain in this respect.

Main-stream media and Remainers alike have all stated that the difficult negotiations lie ahead. They are wrong. Agreeing an outline on the money was the sticking point. On trade, which we now move onto, there is a fundamental difference between negotiating a trade agreement where none existed before, and Brexit. Britain already complies with all EU trade regulations, a fact which is accepted by all member states. The British government seeks to pass all these regulations onto the British statute book, so there will be no reason for not continuing with current trade arrangements with the EU.

There can be little doubt that in time, EU and UK trade regulations will drift apart. But this is not a problem either, because anything sold from Britain (or from elsewhere into the EU for that matter) will have to conform to EU regulations. Similarly, UK product sold in the US has to comply with US regulations. Tariffs are a separate subject, so any tariffs imposed on British products post-Brexit is a purely political matter.

Assuming the transition period of two years is implemented, that means the new trade arrangements will apply from March 1921. However, the agreement must be completed by March 2019, unless elements of it are deferred into the transition period. This will give time for industry to lobby both Brussels and individual governments for no tariffs, which we can be sure is the preferred outcome for the large international corporations, particularly when their supply chains are spread round multiple EU jurisdictions, including the UK.

Therefore, trade in physical goods is likely to continue on more or less the current free trade basis, not least because without a satisfactory agreement from the British point of view, Brussels will get no money. 

There is much kerfuffle about services, which in sentiment echoes the debate twenty-plus years ago about Britain having to join the euro. What we are seeing is lobbying through the media by large financial corporations, notably the powerful American banks, to protect their investment in London. Post-Brexit, will they move their operations to Frankfurt, Paris, or possibly Milan? Will they hell as like. 

These centres are parochial backwaters, dominated by insular nationalistic and bureaucratic cultures. Foreign-owned businesses are effectively second-class to local organisations, effectively barred from making local acquisitions. It was never a problem in London. Why was it that despite the introduction of the euro without sterling, forecast to drive businesses from London to Frankfurt and Paris, the major European players chose to base their investment banking activities in London? Because that is where the international business is. This will not change, post-Brexit, one iota.

It is feared the EU will insist services such as euro clearing leave London for an EU location. To the extent that governments have control over these matters, there is nothing London can do about it, Brexit or no Brexit. But where these services are provided is a mostly a matter for the banks, not governments. This is the uncomfortable truth for the EU. Financial services are only under their control from a regulatory point of view. And if they over-regulate, which is normal for the EU, service providers simply decamp. Brexit should therefore encourage a bit of competition for Brussels regulators, to the benefit of us all.

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