Brexit vote will hit UK, Eurozone and global economies

Brexit Mar16Slowly, but surely, a UK vote to leave the European Union is becoming more likely.  In any referendum, the Yes campaign (in this case called Remain) have to argue a positive case.  But  this is not happening in the UK – and the vote is less than 3 months away.  Unsurprisingly, therefore, as the poll above from the Daily Telegraph shows, voters are currently evenly divided on the issue.

The Leave campaign have an easy job in these circumstances.  They simply have to argue it will be “business as usual” after the vote for the UK, Europe and the global economy.  But a moment’s thought makes it hard to imagine anything less likely, given the weakness of political leadership across the continent.

1. NOBODY IS ARGUING THE CASE FOR THE UK TO STAY
UK voters need to be given positive reasons to vote “Yes”, as happened in the 1975 referendum.  Yet, so far, nobody seems capable of doing this, and so the Leave campaign is gaining momentum:

  • The Cameron government is too scared of its Eurosceptic supporters to put forward the benefits of membership, and the Labour leadership are too busy fighting each other
  • This means the Leave campaign is free to claim that voters have nothing to lose by voting to leave

Another problem is that the two major parties – Conservative and Labour – no longer command the same confidence with voters.  In last year’s election, they won only 2/3rds of the vote between them.  By comparison in October 1974, ahead of the 1975 Referendum where the UK confirmed its EU membership, they won 75% of the votes.

Equally important in 1974 was the fact that the 3rd party – the Liberals – won 18% of the votes and also argued for a Yes vote.  But in the 2015 election, the Eurosceptic UK Independence Party came 3rd with 13% of the vote.  So voters are no longer being given a consensus view by politicians whom they trust.

2. OTHER EUROPEAN GOVERNMENTS HAVE SIMILARLY LOST THE VOTERS’ TRUST
We can see the same issue with other major EU governments:

  • The 2 main French presidential candidates won only 56% of the first round vote in 2012; even in relatively stable Germany, the 3 main parties* only won 75% of the vote in the 2013 election
  • By comparison, the 2 main French candidates won 75% of first round votes in 1974, and the 3 main German parties won over 90% of the vote in 1976
  • Equally significant is that today, as in the UK, the 3rd party in both countries (National Front in France, Alternative für Deutschland in Germany) are Eurosceptic
  • The impact of this political fragmentation can also be seen in Spain, Portugal and Ireland, where recent elections confirm the practical difficulties of even forming governments today

This lack of political consensus would make it very difficult to have a quick Treaty renegotiation to maintain the status quo if the UK did vote to leave – in fact, it might prove impossible for the other 27 countries to agree anything at all.  As former EU senior diplomat and NATO Secretary-General Javier Solana warns:

“Brexit would deal a major economic blow to the UK and the EU. But that is not all. It would also weaken the security, foreign policy, and international standing of both parties.”

3. SCHENGEN’S COLLAPSE HIGHLIGHTS THE PROBLEMS AHEAD
One example of the potential chaos ahead can be seen in the continuing collapse of the Schengen Agreement, as I warned in my BBC interview last summer,  This used to allow borderless travel across large parts of the EU – but even the town of Schengen itself now has border controls on the German side.

According to the European Commission, Germany, France, Austria, Denmark, Norway and Sweden have all re-introduced border controls as a result of the Syrian refugee crisis and the bombing tragedies in Paris and Brussels. Already, therefore, Europe has moved away from “business as usual”.  Few people now expect the Schengen deal to survive.  And as the Commission’s President warned 3 months ago:

“A single currency does not exist if the Schengen fails.

Against this background, it is very hard to believe that politicians would sit down calmly to develop new arrangements which basically preserved the status quo with the UK.  A Leave vote is far more likely to make the UK the scapegoat for all of the EU’s current problems. It would also create major problems for European financial markets themselves, as I argued last month:

  • How high would UK interest rates have to rise, to persuade investors to buy its large and growing debt?
  • How high would Eurozone interest rates have to rise, to compensate investors for the risk of buying the debt of increasingly unstable governments?
  • And in the worst case, what would be the impact on an already uncertain global economy, if financial panic were to hit the UK and EU economies?
  • How would a new US government, under President Trump, or President Cruz, or President Clinton or President Sanders react?

None of us can know the answer.

We can of course hope that all these problems will magically disappear.  But the risks are already much higher than even 3 months ago.  And yet at the same time, there is widespread complacency about the likely outlook.  It is a classic case of an outcome being so painful, people prefer to simply ignore the potential for it to happen.

It is hard to avoid the conclusion that we are living in a very uncertain, and potentially very dangerous, times.

 

* Germany’s Christian Democrat party is allied with Bavaria’s Christian Social Union party, with the main opposition party being the Social Democrats

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 61%
Naphtha Europe, down 58%. “Demand for naphtha continues unabated amid a relatively light spring cracker turnaround schedule in Europe”
Benzene Europe, down 51%. “One factor to consider with regards to the price volatility in Europe is the growing lack of liquidity in recent years”
PTA China, down 41%. “Demand from the downstream polyethylene terephthalate (PET) and polyester fibre industries are expected to peak in the April-June period”
HDPE US export, down 34%. “Expectations of tightening supply because of the onset of the plant turnaround season.”
¥:$, down 11%
S&P 500 stock market index, up 4%

Political earthquake hits Europe in EU elections

EU jobs May14A political earthquake hit Europe in the European Union elections on Sunday night:

  • For the first time since the War, mainstream parties were beaten in major countries
  • In France, the National Front won 25% of the vote, with conservatives 21% and ruling socialist party only 14%
  • In the UK, the Independence Party (UKIP) won 28%, with Labour 25%, and ruling Conservatives on 24%
  • In Greece, origin of the Eurozone crisis, the far-left Syriza party won 26%, with the ruling party on 23% – and the neo-Nazi Golden Dawn on 9%

France’s Prime Minister rightly called it a “ shock, an earthquake that all responsible leaders must respond to“.

In the UK, coalition partners Liberal Democrats saw their vote slump to 7%, and they lost all but one of their MEPs.  This may well herald a potential second earthquake, where the ruling Conservative party form an electoral alliance with UKIP for next year’s general election.  This would create a clear threat that the UK would vote to leave the EU in the Conservative party’s planned 2017 referendum – by when Scotland may have voted for independence from the UK.

One cause of the earthquake is shown in the above chart, highlighting how youth unemployment now averages 25% across the EU.  Very clearly, the supposed Recovery programmes put in place since the Crisis began have not worked.

The key issue now is whether policymakers will listen to the voters and change their approach.  It is clear from the votes in Italy and Spain, where the ruling parties held their position, that voters do not really want the EU to disappear.  But they want their leaders to connect with them on the real issues.

Hard messages have to be given about the choices ahead:

  • Europe is an ageing society, and will not return to the constant growth seen in the BabyBoomer-led SuperCycle
  • It is impossible for pension ages to remain at levels of a century ago, when life expectancy has risen 50% or more
  • Education systems must be radically overhauled to give young people the skills required for today’s economy
  • Energy costs must be reduced to affordable levels, with subsidies for wasteful vanity projects scrapped

Europe does not have long to make these choices.  Voters will not continue to give the mainstream parties ‘one more chance’ forever.

The blog is by nature an optimist.  And so it hopes that today’s leaders will rise to the challenge before it is too late.  But it fears they will instead hide behind the illusion that monetary policy can somehow solve the real issues.

There is a great risk that the European Central Bank will unleash a major new stimulus programme next month.  Yet as the blog argued recently in the Financial Times, deflation is inevitable with ageing populations.  More stimulus would therefore solve nothing, and simply increase debt levels to even-more unaffordable levels.

The plain truth, seemingly obvious to everyone but policymakers, is that the voters want real dialogue and real change – not more money-printing designed to boost financial markets.

The risk for the future is obvious, with Germany’s anti-EU party gaining 7% of the vote.  Germany not only cannot, but will not, pay the bills to bail out today’s failed policies.

Sunday’s results have caused a political earthquake.  It is now up to EU leaders to make the hard choices necessary to set the economy on a new and more sustainable path.  Doing nothing is no longer an option, if they want the EU to survive in its present form.