Your ‘A-Z Guide’ to the Brexit Negotiations

The UK is now facing a national crisis”, according to Margaret Thatcher’s former Defence Secretary, Michael Portillo, speaking to a dinner in London on Thursday night.  Brexit continues to tear the UK apart, and places the economy at greater and greater risk.

On Thursday, premier Theresa May had unveiled her draft Withdrawal Agreement with the EU27.  Within a few hours, another 5 Ministers had resigned including her Brexit Secretary.  Over the summer, she had already lost her previous Brexit Secretary and her Foreign Secretary, plus other Ministers.  And 5 Ministers – including Michael Gove and Trade Secretary Liam Fox – are now planning to produce their own revised deal on the Irish question, in opposition to the draft agreement

Businesses are far too complacent about the risks of a No Deal Brexit, as I told BBC News on Thursday:

“If the deal went through Parliament, then we could be reassured that we had until the end of 2020 before anything happened. But looking at what’s happened this morning, it seems less likely that’s going to happen, and therefore the default position is that we leave without a deal on 29 March.  And that, I think, panics SMEs, small businesses, because if you don’t know what’s happening that’s worse than almost anything else. “

If you, or a colleague, now need to get up to speed with Brexit developments – and what they may mean for your business and your investments, here is my ‘A – Z Guide to the Brexit Negotiations’:

Article 50 of the Lisbon Treaty sets out the rules for leaving the European Union.  As with most negotiations, it assumed the leaving country would present its proposals for the post-withdrawal period – which would then be finalised with the other members.  But the UK Cabinet was split on the key issues, and so the 2 year’s notice was given on 29 March 2017 without any firm proposals being made for the future UK-EU27 relationship beyond 7 “negotiating principles and “the desire for a “close partnership”.

Brexit means Brexit“, has been the UK’s core statement since Article 50 was tabled.  But as I noted back in September 2016, Brexit can actually mean a variety of different outcomes – and they have very different implications as the chart shows.  At one extreme, the ‘Norway model’ is very similar to full EU membership, but with no say on EU decisions.  Whereas the ‘Canada model’ is simply a free trade agreement offering some access to the Single Market (qv) for goods, but less access for services (which are 80% of the UK economy).  A ‘No Deal Brexit’ (qv) means working under WTO rules with arbitrary tariffs and regulations.

The European Commission manages the day-to-day business of the European Union (qv) on behalf of the European Council, and is effectively its civil service.  Its president is Jean-Claude Juncker and he appointed Michel Barnier to lead the Brexit negotiations.   Barnier’s first step, as mandated by the Council, was to agree within the EU 27 “the overall positions and principles that the EU will pursue“.  He understood that in any negotiation, the team that writes the drafts and controls the timescale usually has the upper hand. The UK’s failure to finalise its own detailed objectives before tabling Article 50 meant it gave up this critical advantage.

The Default date for Brexit is 29 March 2019.  It has also been agreed that if a Withdrawal Agreement (qv) is finalised, then a Transition Agreement (qv) could operate until 31 December 2020.  Unfortunately, many people have therefore assumed they can wait until 2020 before starting to plan for Brexit.  But as the Commission warned in its ‘Guidelines for Brexit Negotiations on 29 April 2017, “nothing is agreed until everything is agreed“. So No Deal also means no Transition Agreement.

The European Union is a treaty-based organisation of 28 countries.  As its website notes, it was “set up with the aim of ending the frequent and bloody wars between neighbours, which culminated in the Second World War“.  The UK joined the original 6 members (Belgium, France, Germany, Italy, Luxembourg and the Netherlands) in 1973, along with Ireland (qv) and Denmark. Further expansions took place, especially after the end of the Cold War between the West and Russia.  At the suggestion of then UK premier Margaret Thatcher, it was agreed to establish a Single Market (qv) and Customs Union based on 4 key freedoms – free movement of goods, services, people and money – and this transformed trading relationships across the continent.

The Financial Settlement or ‘divorce bill’ covers the costs of the programmes that the UK agreed to support during the period of its EU membership.  Like most organisations, the EU operates on a pay-as-you-go basis and only charges member countries as and when bills actually come due.  The UK calculates this to be between £36bn – £39bn (€40bn – €44bn), depending on the assumptions used.

The Labour Party want a General Election if the government fails to get Parliament’s approval for its proposed Withdrawal Agreement.  But there is considerable uncertainty about what might happen next, if Labour won the election.  Some suggest Labour could renegotiate the deal, others that there could be a second referendum. Either option would mean a new government asking the EU to ‘stop the clock’ on Article 50. As a result, support is rising for the idea of a ‘People’s Vote’, or second referendum, as this might be more able to achieve all-party support. The European Parliament elections in May also complicate the picture as a referendum would apparently take 22 weeks to organise.

A Hostile No-Deal would be the worst of all possible outcomes. But Theresa May has warned Parliament that “without a deal the position changes” on the £39bn Financial Settlement, contradicting her Chancellor, Philip Hammond.  We do not know what would happen if the UK refused to pay, but one fears it could lead to a Hostile No-Deal if the EU then reacted very negatively in terms of future co-operation.

Ireland has proved to be a key sticking-point in the negotiations, as nobody wants to disturb the peace created by the Good Friday Agreement in 1998.  The issue is the potential need to reintroduce a border between Ireland and the North to secure the Single Market.  The draft Withdrawal Agreement devotes a full section to this issue, which remains a potential deal-breaker due to Brexiter concerns about N Ireland remaining in the Single Market and the UK remaining in the Customs Union. This expert Explainer from the impartial Institute for Government highlights the key issues.

June 2016 was the date of the referendum that voted to take the UK out of the EU.

Keeping the UK in “a single customs territory” with the EU after Brexit is a key feature of the so-called “temporary backstop arrangement” designed to avoid a hard border with Ireland.  It is intended to operate until a full free trade agreement is finalised between the UK and EU.  It was the most difficult part of the negotiations, and has provoked the most resistance from Brexiters.

Legal issues are, of course, a critical area in the negotiations as the UK currently operates under the jurisdiction of the European Court of Justice  (ECJ), and the UK wants to “take back control” to its own courts.  However, the Withdrawal Agreement confirms that the ECJ will have a continuing role under the Transition Agreement and potentially afterwards if the “backstop” is activated.

Tariffs on Materials and goods would be introduced between the UK and EU27 if there is a No-Deal Brexit.  Less well understood is that the UK’s trading terms would also change with countries outside the EU27, as the UK currently operates under more than 750 free trade and trade-related agreements negotiated by the EU – and it is unlikely that the UK could continue to benefit from them.

No Deal means that the UK would have to operate under WTO rules after 29 March.  This short Ready for Brexit video explains the complications this would create.  The WTO has also warned that the number of Technical Barriers to Trade “has grown significantly” in recent years, and these can often severely restrict trading opportunities. And EU laws would still have a role under WTO rules for all UK products sold into the EU27 under No Deal.  The EU Preparedness Notices, for example, also suggest there could be a ban on UK banks providing financial services as well as a whole host of other restrictions including on travel.

Preparing for Brexit.  My colleagues and I have set up Ready for Brexit. This is a subscription-based ‘one-stop shop’ and provides a curated Directory to the key areas associated with Brexit – Customs & Tariffs, Finance, Legal, Services & Employment, Supply Chain.  It includes Brexit Checklists; a BrexSure self-audit tool to highlight key risks; a Brexit Negotiation Update section linking to all the key official UK and EU websites; Brexplainer video on WTO Rules; plus news & interviews with companies about their preparations for Brexit.

Regulations can often be a much greater barrier to trade than tariffs, as they set out the rules that apply when products and services are sold in an individual country.  The EU never aimed to harmonise regulations across its member countries, as that would be an impossible task.  Instead it has focused on creating a Single Market via mutual recognition of each other’s standards, along with harmonised rules on cross-border areas such as safety, health and the environment.  Regulations are particularly important in the financial services industry, and many businesses are now relocating relevant parts of their operations into the EU27 so they can remain authorised to trade.

The Single Market seeks to guarantee the free movement of goods, services, people and money across the EU without any internal borders or other regulatory obstacles.  It includes a Customs Union, as this short BBC video explains, which seeks to ensure that there are no Customs checks or charges when goods move across individual country borders.  With a No-Deal Brexit, however, the UK will become a Third Country and no longer benefit from these arrangements.

The Transition Agreement covers the period after 29 March, and would allow the UK to operate as if it were still in the EU until 31 December 2020.  The aim is to give negotiators more time to agree how future EU-UK trade in goods and services will operate, and provide guidance for businesses on how the new deal(s) will operate.  But 21 months isn’t very long, as trade deals are very hard to do and generally take 5 – 7 years. The problem is that they create Winners and Losers whenever a market (large or small) is opened up to new foreign competition – and the incumbents usually complain.  The Transition Agreement will only operate if there is a Withdrawal Agreement and so would not happen with a No-Deal Brexit.

Unblocked, or frictionless trade, is a key aim of the negotiators.  Nobody really wants to go back to the pre-1993 world, before the Single Market arrived, when vast numbers of forms had to be filled in and lorries/ships sometimes stopped for hours for border checks.  As Honda explained in the summer (see chart) it could easily take between 2 – 9 days to move goods between the EU27 and UK without a Customs Union, compared to between 5 – 24 hours today.  The cost in terms of time and money would be enormous given that, as Eurotunnel told the Commons Treasury Committee in June, “Over the past 20 years, warehouses have become trucks rolling on the road“.

The draft 585-page Withdrawal Agreement was published on Thursday and sets out the basis for the future UK – EU relationship after Brexit.  The impartial Institute for Government has produced a expert summary of its key points.  But as the resignations have shown, the deal is contentious, with observers suggesting that MPs may vote it down in Parliament next month.

Zig-zag perhaps best describes the process that has led us to this point.  It began long ago when Margaret Thatcher resigned in 1990, as the catalyst was her position over European monetary union.  Her supporters ignored the key fact that the party needed a new leader if it was to have a chance of winning the next election,  and instead blamed Europe for their loss – soon styling themselves as Eurosceptics in her honour.  Fast forward through many zigs and zags  and as I warned in March 2016, – “Slowly and surely, a Brexit win is becoming more likely“.  We can doubtless expect many more in coming months and years.

Italy’s referendum is next test for Eurozone stability

ItalyItaly was one of the 6 founding members of the European Union (EU) in 1957, along with France, the Netherlands, W Germany, Belgium and Luxembourg.  Its referendum next month will therefore be a critical test of whether the Eurozone and EU can survive the pressure from the Populists.

If the Populists win, then the future of the Eurozone and the EU itself will be in doubt.

As often happens at critical moments, the subject of the referendum is of relatively minor importance.  It was called by Premier Matteo Renzi to amend the constitution by approving a reform of Italy’s Parliament.  The problem is that he then made himself the key issue in the referendum, by promising to resign if he lost, as he confirmed to Italian media last week:

If the citizens vote no and want a decrepit system that does not work, I will not be the one to deal with other parties for a caretaker government”

Italy is now in a 2 week blackout period for polling before the vote on 4 December.  But the final polls showed the “No vote” with a comfortable lead.  There is therefore a major risk that Renzi will soon be following UK premier Cameron out of office.  3 quite different Scenarios could then develop:

Another premier takes over.  Italian premiers have historically not lasted long.  Before Renzi took over in 2014, there had been over 50 different premierships since Italy’s first post-War premier, Alcide de Gasperi, resigned in 1954. So maybe, the revolving door revolves again, and a new premier is appointed by the President
New elections are held, and another premier takes over.  Renzi was the 3rd Italian premier in a row to take office without have a personal mandate from an election (neither Mario Monti or Enrico Lette had this).  An election may therefore take place, after which perhaps the revolving door revolves again
New elections are held and an anti-euro coalition takes office.  This would seem to be the base case Scenario, with a probability of at least 50%.  It would likely means that Beppe Grillo’s anti-euro 5 Star Movement would take office with Berlusconi’s Forza Italia and the Northern League, and would then hold a referendum on leaving the euro – with the aim of capping Italian debts and nationalising its banks, as Grillo has promised

Given that around €360bn ($400bn) of all Italian loans are classed as “troubled”, and amount to around one-fifth of total loans, capping the debts would cause major disruption to the Eurozone and global financial systems.  Leaving the euro would also mean, that foreign holders of Italian debt would be paid in Italian lira, not euros.  And presumably this would be after a devaluation of the lira.  So as the Financial Times warned on Monday:

“Since banks do not have to hold capital against their holdings of government bonds, the losses would force many continental banks into immediate bankruptcy. Germany would then realise a massive current account surplus also has its downsides. There is a lot of German wealth waiting to be defaulted on.”

DEMOGRAPHIC REALITY IS NOW CONFRONTING STIMULUS FANTASY
Italy’s real problem is not its Parliament, but that its economic policies haven’t adjusted to the New Normal world. Like most developed countries, politicians of all parties have failed since the end of the BabyBoomer-led SuperCycle, to understand the trade-off that has taken place between increased life expectancy and economic growth.  Italy has a median age of 45 years, and as the chart above shows:

 It now has only 24m in the Wealth Creating 25 – 54 cohort, versus 22m New Olders in the 55+ cohort
 By 2030, it will have just 20m Wealth Creators and 26m New Olders
 This is completely different from the 1950 position, when there were 18m Wealth Creators and only 8m New Olders

In addition, of course, Italy has become the main route for migrants and refugees following the EU’s deal with Turkey. 168k people have already arrived this year, compared to 154k in the whole of 2015 and 170k in 2014. Resources have been further strained by the sequence of earthquakes, which are made worse by the lack of anti-seismic regulations for its buildings.

It is small wonder, therefore, that the 5 Star Movement is building support, having won Rome in this year’s elections, whilst the Lega Nord (Northern League) won the Veneto and Lombardy regions.

Nor is it surprising that investors are starting to panic.  As I discussed on Monday, Italy’s 10 year interest rate has doubled to 2% since the summer.  It could go very much higher if Renzi loses, as the prospect of a vote to leave the eurozone and cap Italy’s debts comes closer.

This is the Great Reckoning in action, and there is probably little that the European Central Bank (ECB) can do to mitigate the position.  In a few weeks’ time, investors may well wonder how they allowed Italian interest rates to trade below US rates for much of the past few years.  And in a few months’ time, it may well seem equally incredible that anyone ever believed ECB’s President Mario Draghi’s 2012 boast that:

“Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”. 

It could be a very difficult H1 in 2017.  Next month’s Italian referendum is followed in March by Dutch elections and in May by France’s Presidential election.  Both may well be won by parties committed to leaving the EU itself.

It is therefore hard to ignore the possibility that by June, the EU could have effectively ceased to exist in its current form.  Developing a contingency plan, in case this develops, could well be the wisest move you make in 2016.

Brexit a disaster for the UK, Europe and the world

Ring of fire Feb15

First, the good news.  It has long been recognised that the UK economy is over-dependent on financial services, and that its housing market – particularly in London – is wildly over-priced in relation to earnings.  The Brexit vote should ensure that both these problems are solved:

  • Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
  • There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
  • This will also undermine the London housing market by removing the support provided by these high-earners
  • In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven”

This is probably not the result that most Leave voters expected when they voted on Thursday.  These voters will also soon find out that Thursday was not the Independence Day they were promised.  It is already obvious that Leave campaigners have no clear idea of what to do next.  They are even divided about whether to immediately trigger the 2-year departure period under Article 50 of the Lisbon Treaty.

Leave voters have more shocks ahead of them, of course:

  • Most believed that the UK would immediately be able to “take control of its borders” and dramatically reduce immigration.  But as I noted during the campaign, the majority of immigration has always been from outside the EU – and could already have been stopped, had the current or previous governments chosen to do this
  • Nor will the National Health Service suddenly benefit from the promised £350m/week ($475m) by stopping UK contributions to the EU.  For a start, more than half of this money already came back to the UK from the EU, and so can’t be spent a second time
  • Even more importantly, nothing is going to happen for at least 2 years whilst the Leave negotiations take place

This, of course, is where the bad news starts.  What will be the reaction of Leave voters as they discover they have been fed half-truths on these and other critical issues?  And what will happen as house prices begin to fall, and jobs in financial services – as well as manufacturing – begin to disappear as companies relocate elsewhere within the EU?

BREXIT VOTE WILL HIT EUROPE AND THE GLOBAL ECONOMY
The bad news is, unfortunately, not restricted to the UK.  Already, alarm has begun to spread across the rest of the EU.  There are strong calls for referendums to take place in 3 of the EU’s 6 founding members – France, Italy and The Netherlands.  It is hard to see how the EU could survive if even one of these votes resulted in a Leave decision.

In turn, of course, this is bound to draw attention once more to the unsolved Eurozone debt crisis.  Can anyone now really continue to believe the European Central Bank’s 2012 promise to do “whatever it takes” to preserve the euro, as set out by its President, Mario Draghi?

The simple fact is that the Brexit vote is the canary in the coalmine.  It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis.    And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.

THE BREXIT VOTE, LIKE THE 2008 CRISIS, WAS NOT A ‘BLACK SWAN’ EVENT
I am used, by now, to my forecasts being ignored by conventional wisdom.  The Brexit vote saw a repeat of the complacency that greeted my warnings in the Financial Times and here before the 2008 financial crisis.  Thus my March warning was again mostly ignored, namely that:

A UK vote to leave the European Union is becoming more likely”.

Instead, like the 2008 crisis, the Brexit vote is already being described as a ‘black swan’ event – impossible to forecast.  This attitude merely supports the status quo, as it means consensus wisdom does not have to challenge its core assumptions.  Instead, it takes comfort in the view that “nobody could have foreseen this happening”.

Critically, this means that the failure of the post-2008 stimulus programmes is still widely ignored.  Yet these have caused global debt levels to climb to more than 3x total GDP, according to McKinsey.  As the map above shows, they have created a debt-fuelled ‘ring of fire’, which now threatens to collapse the entire global economy:

  • China’s reversal of stimulus policies has led to major downturns in the economies of all its commodity suppliers
  • Latin America, Africa, Russia and the Middle East can no longer rely on exports to China to support their growth
  • Japan’s unwise efforts at stimulus via Abenomics have also proved a complete failure
  • Now Brexit will almost inevitably cause a major collapse in London house prices
  • And it will focus attention on the vast debts created by the Eurozone debt crisis
  • It will also unsettle US investors, who have taken margin debt to record levels in the belief that the US Federal Reserve will never let stock market prices fall

TIME FOR STRAIGHT TALKING ON THE IMPACT OF AGEING POPULATIONS ON ECONOMIC GROWTH
It is therefore vital that policymakers now make a new start, whilst there is still time to avoid total financial collapse. Once people begin to realise that all this debt can never be repaid, then interest rates will soar and many currencies collapse.  This is not being alarmist – this is just stating obvious facts.

The critical need is to recognise that demographics, not monetary policy, drive economies.  A world with lots of young BabyBoomers in the Wealth Creating 25-54 age group will inevitably see strong growth.  And if more and more women return to the workforce after childbirth, this will turbo-charge an economic SuperCycle.

This is what happened between 1983 – 2007, when the world saw almost constant growth.  The US recorded just 16 months of recession in 25 years.  But last year saw global GDP decline by a record amount in current dollars, more than in 2009 – a clear warning sign of major trouble ahead.

The issue is very simple. Common sense tells us that the combination of a 50% increase in global life expectancy since 1950, and a 50% fall in fertility rates, means that the world has now reached the “demographic cliff“:

  • 1bn ageing Boomers are joining the low-spending, low-earning New Old 55+ generation for the first time in history
  • They will be more than 1 in 5 of the global population by 2030, twice the percentage in 1950

This is good news, not bad.  Who amongst us, after all, would not choose to have 20 years of life expectancy at age 65 instead of dying?  That is today’s position in the Western world.  And people in the emerging economies are catching up fast.  They can already now expect to live another 15 years at age 65.

The trade-off is lower, or negative growth.  People in this New Old 55+ age group already own most of what they need, and their incomes decline dramatically as they approach retirement.

But this simple fact of life has never been explained to voters.  Instead they have been told since 2008 that policymakers are confident of returning the economy to SuperCycle levels of growth.  No wonder they are growing restless, and starting to mistrust everything they are being told by the supposed experts.

CONCLUSION – TIME TO RESTORE TRUST WITH PLAIN SPEAKING
Policymakers and the media now have a grave responsibility, as do do all of us.

It is critically important that policymakers now recognise they must immediately reverse course on stimulus policies, and come clean with voters about the real economic situation.

Of course this will result in very painful conversations.  But the alternative, of ignoring the warning provided by the Brexit vote, is simply too awful to contemplate.