UK voters were never very bothered about membership of the European Union (EU) before the Brexit vote last year. Opinion polls instead showed they shared the general feeling of voters everywhere – that their country was heading in the wrong direction, and it was time for a change. Now, last week’s Conservative Party conference showed that the government itself, and the prime minister, have also lost all sense of direction.
The problem is that nobody has any idea of a what a post-Brexit world would look like for the UK. The Leave campaigners famously told the voters it would be a land where the UK would no longer “give” £350m/week ($455m) to Brussels, and could instead spend this money on improving health care and other worthy objectives. This, of course, was a lie, as the head of the National Statistics Agency has since confirmed. But then-premier Cameron failed to call out the lie at the time – fearing it would split his Conservative Party if he did.
15 months later, this lie has again come centre stage as the Foreign Secretary, Boris Johnson, revived it before the Conference as part of his bid to replace premier May:
“Once we have settled our accounts, we will take back control of roughly £350 million per week. It would be a fine thing, as many of us have pointed out, if a lot of that money went on the NHS.”
As a result, the splits in the Conservative Party are out in the open, with its former chairman now calling for a leadership election and claiming at least 30 law-makers already support the move. Bookmakers now expect May to leave office this year (offering odds of just evens), and suggest the UK will have a new election next year (odds of 2/1), despite the fact that Parliament has nearly 5 years to run.
May’s problem is two-fold:
As the photo shows, she was humiliated in her main speech to the Conference by a prankster handing her a P45 form (the UK’s legal dismissal notice), and claiming Johnson had asked him to do it
Her previous set-piece speech in Florence on negotiations with Brussels over the UK’s exit arrangements had also rebounded, as it made clear the Cabinet was divided on the terms that should be negotiated
Voters don’t like being lied to, and they don’t like governments that are unable to govern because of internal splits – particularly when the splits are over such a critical issue as the UK’s economic future. Unsurprisingly, therefore, the opposition Labour party are now favorites to win the next election, and their leader, Jeremy Corbyn, is favourite to become the next prime minister. This, of course, would confirm my suggestion 2 years ago:
“My local MP, Jeremy Corbyn, won the UK Labour Party leadership election on Saturday with a 60% majority. An anti-NATO socialist, he has represented the constituency for 32 years, and has never held even a junior ministerial post. Now, he could possibly become the UK’s next Prime Minister.
“His path to power depends on two developments taking place, neither of which are impossible to imagine. First, he needs to win back the 40 seats that Labour lost to the Scottish Nationalists in May. And then he has to hope the ruling Conservative Party tears itself apart during the up-coming Europe Referendum.”
Unfortunately, Corbyn would be unlikely to resolve the mess over Brexit. In the past, before becoming leader, he took the Trotskyist view that the EU is a capitalist club, set up to defraud the workers. He has since refused to confirm or deny his views on the subject, but he did take very little part in the Referendum campaign last year. Had he been more active in arguing the official Labour Party position of Remain, it is unlikely that Leave would have won.
Today, he is far more concerned over the likely result of a Labour Party win on financial markets, with his shadow Finance Minister admitting recently they were “war-gaming” in advance of an expected currency crisis. UK interest rates are already rising, as foreign buyers wonder whether they should continue to hold their current 28% share of the UK government bond market. Clearly, it is highly likely that a Labour government would need to return to capital controls after a 40-year break, to protect their finances.
A VERY HARD BREXIT IS BECOMING ALMOST CERTAIN
The confusion and growing chaos in the political world means that the detail of Brexit negotiations has taken a back seat. The UK has still to make detailed proposals on the 3 critical issues that need to be settled before any trade talks can begin – rights of EU/UK citizens post-Brexit; status of the N Ireland/Ireland border; UK debts to Brussels for previously agreed spending. And most European governments are now far more focused on domestic concerns:
As I warned a year ago, the Populist Alternative für Deutschland did indeed “gain enough seats to make a continuation of the current “Grand Coalition” between the CDU/CSU/SDP impossible” in Germany
Spain has to somehow resolve the Catalan crisis, following last week’s violence over the independence referendum
Italy has autonomy referenda taking place in the wealthy Lombardy and Venice regions in 2 weeks, and then faces a difficult national election where the populist 5 Star movement leads most opinion polls. The scope for political chaos is clear, as the wealthy Northern regions want to reduce their tax payments to the south – whilst southern-based 5 Star want more money to go in their direction
President Trump has also undermined the Brexit position. He initially promised a “very big and exciting” US-UK trade deal post Brexit. But since then the US has supported a protectionist move by Boeing to effectively shut-down the vital Bombardier aircraft factory in Belfast, N Ireland, despite May’s personal appeals to him. And last week, it joined Australia, New Zealand, Argentina and Brazil in objecting to the EU-UK agreement on agricultural quotas post-Brexit.
I have taken part in trade talks and have also negotiated major contracts around the world. So I know from experience the UK could never have achieved new deals within the 2 years promised by leading Brexiteers.
Today, it is also increasingly clear that May’s government doesn’t have the votes in Parliament to agree any financial deal that would be acceptable in Brussels. So whilst large parts of UK industry still assume Brexit will mean “business as usual”, European companies are being more realistic. In a most unusual move, the head of the Federation of German Industries spelt out the likely end result last week:
“The British government is lacking a clear concept despite talking a lot. German companies with a presence in Britain and Northern Ireland must now make provisions for the serious case of a very hard exit. Anything else would be naive…The unbundling of one of Germany’s closest allies is unavoidably connected with high economic losses. A disorderly exit by the British from the EU without any follow up controls would bring with it considerable upheaval for all participants. (German companies feel) not only that the sword of Damocles of insecurity is hovering over them, but even more so that they are exposed to the danger of massive devaluation.”
UK, European and global companies are already drawing up their budgets for 2018 – 2020. They cannot wait until Brexit day on 29 March 2019 before making their plans. And so, as it becomes increasingly obvious that the UK-EU talks are headed for stalemate, and that ideas of a lengthy transition period are simply a dream, they will make their own plans on the assumption that the UK will head over the Brexit cliff in 18 months time.
Nobody knows what will happen next. But prudent companies, investors and individuals have to face the fact that Brexit, as I warned after the vote, is likely to be “a disaster for the UK, Europe and the world“.
The post Brexit disaster looms as UK government power struggle erupts appeared first on Chemicals & The Economy.
It was almost exactly 10 years ago that then Citibank boss, Chuck Prince, unintentionally highlighted the approach of the subprime crisis with his comment that:
‘We are not scared. We are not panicked. We are not rattled. Our team has been through this before.’ We are ’still dancing’.”
On Friday JP Morgan’s CEO, Jamie Dimon, provided a new and more considered warning:
“Since the Great Recession, which is now 8 years old, we’ve been growing at 1.5% – 2% in spite of stupidity and political gridlock….We have become one of the most bureaucratic, confusing, litigious societies on the planet. It’s almost an embarrassment being an American citizen traveling around the world and listening to the stupid s— we have to deal with in this country. And at one point we all have to get our act together or we won’t do what we’re supposed to [do] for the average Americans.”
The chart above, from OECD data, highlights one key result of the dysfunctionality that Dimon describes:
Central bank stimulus has proved to be a complete failure, as it cannot compensate for today’s “demographic deficit”
UK debt as a percentage of GDP has more than doubled from 51% in 2007 to 123% last year
US debt has risen from an already high 77% in 2007 to 128% last year
Japanese debt has risen from an insane 175% in 2007 to an impossible-to-repay 240%
Debt is essentially just a way of bringing forward demand from the future. If I can borrow money today, I don’t have to wait till tomorrow to buy what I need. But, I do then have to pay back the debt – I can’t borrow forever. So high levels of debt inevitably create major headwinds for future growth.
Unfortunately, central banks and their admirers thought this simple rule didn’t apply to them. They imagined they could print as much money as they liked – and then, magically, all the debt would disappear through a mix of economic growth and inflation. But as the second chart shows, they were completely wrong:
In April 2011, the IMF forecast global GDP in 2016 would be 4.7%
In April 2013, they were still convinced it would be 4.5%
Even in April 2015, they were confident it would be 3.8%
But in reality, it was just 3.1%
And meanwhile inflation, which was supposed to help the debt to disappear in real terms, has also failed to take off. US inflation last month was just 1.6%, and is probably now heading lower as oil prices continue to decline.
In turn, this dysfunctionality in economic policy is creating political and social risk:
The UK has a minority government, which now has to implement the Brexit decision. This represents the biggest economic, social and political challenge that the UK has faced since World War 2. But as the former head of the UK civil service warned yesterday:
“The EU has clear negotiating guidelines, while it appears that cabinet members haven’t yet finished negotiating with each other, never mind the EU”. He calls on ministers to “start being honest about the complexity of the challenge. There is no chance all the details will be hammered out in 20 months. We will need a long transition phase and the time needed does not diminish by pretending that this phase is just about ‘implementing’ agreed policies as they will not all be agreed.”
The US faces similar challenges as President Trump aims to take the country in a completely new direction. As of Friday, 6 months after the Inauguration, there are still no nominations for 370 of the 564 key Administration positions that require Senate confirmation. And last week, his Secretary of State, Rex Tillerson, highlighted some of the challenges he faces when contrasting his role as ExxonMobil CEO with his new position:
“You own it, you make the decision, and I had a very different organization around me… We had very long-standing, disciplined processes and decision-making — I mean, highly structured — that allows you to accomplish a lot, to accomplish a lot in a very efficient way. [The US government is] not a highly disciplined organization. Decision-making is fragmented, and sometimes people don’t want to take decisions. Coordination is difficult through the interagency [process]…and in all honesty, we have a president that doesn’t come from the political world either.”
Then there is Japan, where Premier Abe came to power claiming he would be able to counter the demographic challenges by boosting growth and inflation. Yet as I noted a year ago, his $1.8tn of stimulus has had no impact on household spending – and consumer spending is 60% of Japanese GDP. In fact, 2016 data shows spending down 2% at ¥2.9 million versus 2012, and GDP growth just 1%, whilst inflation at only 0.4% is far below the 2% target.
As in the UK and US, political risk is now rising. Abe lost the key Tokyo election earlier this month after various scandals. Voter support is below 30%, and two-thirds of voters “now back no party at all” – confirming the growing dysfunctionality in Japanese politics.
WOULD YOU LEND TO A FRIEND WHO RUNS UP DEBT WITH NO CLEAR PLAN TO PAY IT BACK?
So what is going to happen to all the debt built up in these 3 major countries? There are already worrying signs that some investors are starting to pull back from UK, US and Japanese government bond markets. Over the past year, almost unnoticed, major moves have taken place in benchmark 10-year rates:
UK rates have nearly trebled from 0.5% to 1.3% today
US rates have risen from 1.4% to 2.3% today;
Japanese rates have risen from -0.3% to +0.1% today.
What would happen if these upward moves continue, and perhaps accelerate? Will investors start to agree with William White, former chief economist of the central bankers’ bank (Bank for International Settlements), that:
“To put it in a nutshell, if it’s a debt problem we face and a problem of insolvency, it cannot be solved by central banks through simply printing the money. We can deal with illiquidity problems, but the central banks can’t deal with insolvency problems”.
White was one of the few to warn of the subprime crisis, and it seems highly likely he is right to warn again today.
We are living in very uncertain times, where the only certainty is that there is no “business as usual” option for the future. One sign of this is that the extraordinary has become ordinary :
□ The FBI appear convinced Russia’s government targeted last year’s US elections: US President Trump and his former FBI head have since accused the other of lying about the issue
□ UK premier Theresa May has just lost an election she had expected to win by a landslide, and is now engaged in a probably futile attempt to remain in power
We have not seen political chaos on this scale since the 1970s. Yet unlike the 1970s, markets continue to bury their heads in the sand, in the mistaken belief that the central banks will always be able to ensure that prices never fall.
The problem is two-fold:
□ Most investors and company executives grew up during the BabyBoomer-led economic SuperCycle. They have never known a world where growth disappointed, and where political stalemate led to major economic crises
□ Central bank policies have made the underlying situation worse, not better. They have artificially boosted the value of financial assets (stocks, houses and commodities) whilst creating vast amounts of debt that can never be repaid
Even worse is that a generational divide has opened up in both the US and UK, as most assets are owned by older people. Younger people instead find themselves burdened by high levels of student debt, and facing a future where weekly earnings are no longer rising in inflation-adjusted terms.
KEY AREAS OF TRUMP’S AGENDA HAVE FAILED TO MOVE FORWARD
It was clear when President Trump came to power that we had reached the end of “business as usual“. He immediately set about creating major disruption in global trade patterns:
□ He cancelled the TransPacific Partnership which would have linked 11 Pacific countries with the USA
□ He also notified Congress of his intention to renegotiate the North American Free Trade Agreement
□ More recently, he announced his intention to withdraw from the Paris Climate Change Agreement, COP-21
Unsurprisingly, push-back is now developing against these dramatic changes. On COP-21, powerful opponents such as Michael Bloomberg have begun to co-ordinate moves by several key states, cities and companies to instead “do everything that America would have done if it stayed committed” to the Agreement.
Trump’s other major policy move – the lifting of restrictions on the development of fossil fuels – is also seeing push-back, this time from the markets. Oil prices are already back to pre-election levels, and are likely to go much lower as new US production comes online.
Trump’s position is also weakened by his failure to recruit a large team of highly skilled people, capable of promoting his agenda with all the relevant stakeholders. So far, he has only nominated 83 people to fill the 558 key positions in his Administration that require Senate confirmation. In the Dept of Commerce, only 7 of the 21 key positions have been nominated; in Energy, only 3 out of 22; in Treasury, only 10 out of 28.
As a result, the US now seems likely to face political stalemate. Trump clearly has a mandate to push through his changes. But every day that passes makes it less likely that his key policy objectives – healthcare/tax reform and infrastructure spending – can be implemented.
The problem is simple – every new President has only a short “window of opportunity” to implement his policies, as their post-election momentum soon starts to disappear. By Labor Day (4 September), legislators are refocusing on next year’s mid-term elections. Their ability to make the compromises necessary for major legislation soon disappears, once the “losers” from any change make their voices heard.
MAY’S ELECTION FAILURE CREATES AN OPENING FOR CORBYN
Last Thursday’s election result confirmed my analysis back in October that:
“In the UK, where most pundits regard the populist Labour Party leader, Jeremy Corbyn, as unelectable due to his radical socialist and pacifist agenda, it would only take a breakdown in the Brexit negotiations for his chances of gaining power to rapidly improve.”
The breakdown duly occurred with May’s decision to adopt a “hard Brexit”. May, like Trump, relied on a small group of advisers and failed to recruit the team needed to push through her ambitious agenda of total EU withdrawal. The result, as I noted last month, was that the “UK risked crashing out of EU after election without a trade deal“.
This stance created fertile ground for Corbyn as he mobilised large numbers of young people to vote for the first time. They quickly realised that their future was at stake, given that the Brexit negotiations are due to start on June 19.
May will clearly try to hang on – but she is unlikely to succeed for very long. Corbyn’s move to propose giving EU citizens full rights after Brexit could easily be the straw that brings May down, as leading Tories such as Ken Clarke and others would no doubt vote with him.
As in the US, political stalemate is likely to develop. Brexiteers no longer have a mandate for a “hard Brexit”, where the UK would leave the EU without access to the Single Market and Customs Union. But neither can Remainers easily reverse the formal EU exit process, which will see the UK leave the EU by March 2019.
MARKETS ARE IN A METASTABLE STATE
Markets cannot continue to ignore these developments for much longer. They are in what scientists would call a metastable state. The detail of the next move is uncertain – and the only certainty is that the status quo is untenable:
□ There is no going back to the SuperCycle: the Western world faces a demand deficit due to its ageing population
□ Equally, there is no obvious and easy route forward, until policymakers focus on the “impact of the 100-year life”
As a result, markets will soon be forced to rediscover the negative impact of political stalemate. Probably Winston Churchill’s famous comment after the Allies’ victory at El Alamein in 1942 best describes the position:
“Now this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.”
Yesterday, senior EU negotiators warned that “the chances of Britain crashing out of the EU without a new (trade) deal were now “over 50%””. Clearly, therefore, the UK’s preparations are not going well.
Instead of building trust, the UK’s Brexit Secretary, David Davis, seems to think that threats – such as promising “the row of the summer” – are the best way to open discussions.
I have taken part in major trade and contract negotiations around the world. Based on this experience, I believe his strategy is very unlikely to succeed. It risks instead leading to a populist-style “Battle with Brussels”, which the UK will lose. The UK will then crash out of the EU – with no deal on trade – long before the March 2019 deadline.
PREMIER MAY IS IGNORING HER OWN WARNING LAST YEAR
My key concern is that premier Theresa May seems to be ignoring her own warning before last June’s referendum:
“The EU is a single market of more than 500m people, representing an economy of almost £11tn ($14bn) and a quarter of the world’s GDP. 44% of our goods and services exports go to the EU, compared to 5% to India and China. We have a trade surplus in services with the rest of the EU of £17bn. And the trading relationship is more inter-related than even these figures suggest. Our exporters rely on inputs from EU companies more than firms from anywhere else: 9% of the ‘value added’ of UK exports comes from inputs from within the EU, compared to 2.7% from the United States and 1.3% from China….“(my emphasis)
I am not alone in my fears. UK industry is becoming very worried about what may happen. Paul Drechsler, President of the Confederation of British Industry (CBI), spelt out the key issue last week – the need to maintain access to the Single Market and Customs Union. He described the journey of a computer chip made today in Cardiff’s tech hub:
“The chip is bought by a company in Germany. The metals inside it are sourced from South Africa and Turkey, using free trade agreements the UK has through its EU membership. Some of the plastics inside it are processed in Poland and Spain. Engineers from France, Croatia and Hungary worked alongside Brits in Cardiff to design it. When finished, it is packaged by a worker from Bangor, Wales and delivered to the port by a driver from Slovakia.
“The chip has been made to European standards, its design protected by a Europewide trademark. It was insured with a financial package covered by EU passporting and, when incorporated into a machine and put in the shop, it will meet Europewide levels of consumer protection.
“In other words, for that chip, and the British company that makes it, to remain as competitive as today we need: three new trade deals, free movement of EU citizens, three new sets of internationally approved regulatory and copyright standards and an agreement on EU financial services passporting.”(my emphasis)
A hard Brexit, without access to the Single Market or Customs Union, will not just impact the UK. As the CBI example confirms, today’s complex and extended supply chains mean that companies across the EU27, and around the world, will find their trade disrupted.
RULES AND REGULATIONS ARE AS IMPORTANT AS TARIFF BARRIERS TO MOST COMPANIES
Many in the UK chemicals industry – the UK’s largest manufacturing export earner – are also very worried. Its largest customer, the car industry, is totally dependent on global supply chains and just-in-time delivery, as the chart shows. Going back to a pre-Single Market world of tariffs, customs barriers, endless form-filling and border delays will lead to major uncertainty and loss of business.
And, of course, tariff barriers – although important – are not the only issue. The future role of the European Court of Justice, and the rules and regulations under which products are sold, are even more critical, as a new survey by the British Coatings Federation confirms:
“Over three quarters of our members said that a separate UK chemical regulatory system would be bad for business. Maintaining regulatory equivalence with key EU regulations (REACH, CLP and BPR) through continued relations with institutions such as the European Chemicals Agency is essential to ensure we have a strong UK manufacturing base that can import chemical raw materials from Europe, and export finished goods such as paints, coatings printing inks and wallpaper without being at a competitive disadvantage.”
BREXIT RISKS ARE BEING IGNORED IN THE UK ELECTION CAMPAIGN
Given the criticality of these issues for the economy, they should be the major topic of the current election campaign. But instead May’s election manifesto simply promises:
“As we leave the European Union, we will no longer be members of the single market or customs union but we will seek a deep and special partnership including a comprehensive free trade and customs agreement.”
She seems to expect the Brexit negotiations to follow the pattern of the Treaty of Lisbon in 2014:
Then the UK appeared to “opt out” of key domestic and legal policies to pacify the Eurosceptic tabloid media
Behind the scenes, however, it negotiated a special Protocol 36
After signing the Treaty, the UK immediately “opted back in” to many of the policies via Protocol 36
But it is very hard to see how this can happen with Brexit, as EU Commission President Juncker warned last month.
I am therefore not optimistic about the outcome of the talks. I correctly warned – over a year ago – that Brexit was likely. Having followed developments since then, I find it hard to believe the EU 27 will allow May a back-door re-entry via a new Protocol 36-type deal, after a “hard Brexit”. This seems a totally unrealistic objective.
I hope I am wrong. But if I am right, the current UK government strategy means there is no “business as usual” option for the vast majority of UK companies – or for many EU 27 and non-European businesses. I fear, as I have warned since March 2016, “Brexit will hit UK, Eurozone and global economies“.
The UK goes to the polls on 8 June in a surprise General Election. And premier Theresa May has clearly decided to base her campaign on a ”Who governs Britain?” platform, as she highlighted when launching her campaign last week:
“Britain’s negotiating position in Europe has been misrepresented in the continental press, the European Commission’s stance has hardened and threats against Britain have been issued by European politicians and officials. All of these acts have been deliberately timed to affect the result of the general election that will take place on June 8….there are some in Brussels who do not want these talks to succeed. Who do not want Britain to prosper.”
In reality, of course, all that has happened is that Brussels is behaving exactly at Theresa May herself forecast, when campaigning a year ago for the UK to Remain in the EU:
“In a stand-off between Britain and the EU, 44% of our exports is more important to us than 8% of the EU’s exports is to them….The reality is that we do not know on what terms we would win access to the single market…It is not clear why other EU member states would give Britain a better deal than they themselves enjoy. ”
May’s rhetoric will no doubt give her a large majority, given the weakness of the Labour opposition. She has also promised to be “a bloody difficult woman” during the Brexit negotiations that follow the election. But what is good for an election win, may not be such good news for London house prices. These are at all-time record levels in terms of the critical price/earnings ratio, and were already heading into an inevitable downturn as the City AM chart shows:
Massive over-building at the top end of the market means there are now 59k high-end apartments under construction in London, yet annual sales of new-build flats are just 6k
Sales have also been hit by the hike in purchase tax (stamp duty) to 10% above £925k ($1.2m) and 12% on purchases over £1.5m
The UK’s 2 million ‘buy-to-let’ landlords, most of whom are in London, have also been hit by a combination of a higher tax take on their income and tighter borrowing criteria for mortgages
China’s capital controls means its buyers have had to pull back, as it becomes more difficult to move money overseas. They have been the largest buyers of residential property in central London
Now this downturn could well become a perfect storm, as May’s “battle with Brussels” risks an exodus of highly-paid finance and other professionals from London. As the BBC reports: “More than one million people work in the financial services sector in the UK and it pays over £70bn a year in taxes to the government, 11.5% of all receipts.”
FINANCIAL SERVICES ARE PREPARING TO LEAVE LONDON
The CEOs of the world’s 2 largest investment banks have already warned of difficult times ahead.
JP Morgan CEO, Jamie Dimon, has warned: “The clustering of financials in London is hugely efficient for all of Europe. Now you’re going to have a declustering which creates huge duplicate costs which is expensive to clients, but we have no choice.”
Goldman Sachs CEO, Lloyd Blankfein, has highlighted the risks caused by uncertainty over the terms of the UK’s exit: ”Without knowing how things will turn out we have to plan for a number of contingencies,” Mr Blankfein said about possible job losses. “If there is no period of time to implement whatever changes are brought about in a negotiation, we may have to do things prematurely and we may have to do a range of things as a precaution and take steps.”
Unsurprisingly, buyers are starting to sit on their hands and waiting to see what happens, as The Guardian reports:
“London estate agents have begun to offer free cars worth £18,000, stamp duty subsidies of £150,000, plus free iPads and Sonos sound systems to kickstart sales in the capital’s increasingly moribund property market. The once super-hot central London market has turned into a “burnt-out core.”
How much will prices fall, and how long will it take for prices to bottom? These are now set to become the key questions at London dinner-parties. Logic suggests prices will need to fall at least 50% to bring them back to more affordable levels. And the pain is likely to stretch out over years, as leading buying agent, Henry Pryor, has warned:
“In my 28 years in the property business, we have done this twice before, and each time it takes around five to seven years before things recover.”
We must all hope that May will use her potential landslide election win to quickly reverse her recent rhetoric, and return to the common sense positions she staked out before the Referendum. It is not too late for her to agree to remain in the Single Market, the Customs Union and accept the jurisdiction of the European Court of Justice.
Without such a move, London home owners will face a perfect storm as the financial services industry “de-clusters” to Frankfurt, Paris, Brussels, Dublin and Amsterdam next year.