Brexit moves from ‘Snakes and Ladders’ to cricket

The Brexit debate had appeared to be a simple game of Snakes & Ladders till now.  The Leave campaign landed on the ladders that led to its goal of No Deal, whilst the throw of the dice left Remain on the snakes, tumbling down towards irrelevance.

Yet today, at the very last minute, there are signs that we might instead now be starting to play the far more complex English game of cricket where captaincy is all-important, as one famous Australian cricketer has remarked:

“Captaincy is 90% luck and 10% skill. But don’t try it without that 10%”.

The Brexiters should certainly have won by now, if we were playing Snakes & Ladders.  They landed on a ladder early in the game when premier May set 29 March 2019 as Brexit Day.  By default, this meant the UK would then leave the EU without a deal – unless a Withdrawal and Transition Agreement could be finalised before then.

No Deal is, of course, the Brexiter dream as the leading Brexit economist, Prof Patrick Minford, argued in May when suggesting its result would be:

“Plus £651 billion ($875bn) for the UK versus minus £507bn for the EU: it could not be more open and shut who least wants a breakdown.“

As I noted in The pH Report at the time:

“Even if May can somehow achieve a deal with the DUP (the Democratic Unionists on whom she depends for her Commons majority), she would still have to agree it with the Leave enthusiasts in the Conservative Party. They are convinced that the real cost of Brexit will be borne by the EU27…. 

It therefore seems unlikely May can find a deal that is acceptable to the Leavers, given their belief that a “hard Brexit” represents the best negotiating strategy for the UK.

Today, it is clear that the DUP and the Tory Leavers will indeed vote against May’s Deal next week.

So by now, the Leavers should be celebrating.  But they aren’t.  Somehow leading Leavers such as Boris Johnson, David Davis and Dominic Raab all managed to land on their own personal snakes by resigning from the Cabinet at critical moments.

THE LEAVERS HAVE FAILED TO PRESS HOME THEIR ADVANTAGE

In life, as in cricket, one has to seize the advantage when it comes your way.  This is where the 10% of skill is all important, as it tells you when to grasp the moment.  Clearly Leave, led by the former Foreign Secretary Boris Johnson, has so far failed to hit the all important ball to the boundary and secure victory.

In cricketing terms, Remain may therefore have just managed to avoid an innings defeat, giving them the chance to go into bat again.  Skillful captaincy will then be all-important.  The next few weeks will therefore be the most critical period for the UK economy in recent history as competing visions of the future battle it out:

  • Prof Minford told the UK Treasury Committee in October that the UK auto industry needs to disappear: “You are going to have to run it down … in the same way we ran down the coal industry and steel industry. These things happen.”
  • Yet it is not clear that UK’s industrial heartlands who gave Leave its majority share this vision.  They, after all, were told at the time that Brexit would simply mean giving the National Health Service “the £350m the EU takes every week

3 Scenarios therefore seem possible over the next few weeks.

SCENARIO 1 – MAY LOSES NEXT WEEK’S VOTE, AND LOSES A NEW VOTE IN JANUARY
A week is a long time in politics, but it seems relatively safe to say that May is unlikely to win next week’s Commons vote on her Withdrawal Agreement. Her aides, however, have been busy playing up the likely size of her defeat, suggesting she could lose by 100+ votes.  And so, politics being politics, they will likely spin this as a success if she now loses by “only” 50 votes.

In turn, this would probably enable her to defeat a motion of No Confidence, and then bring a slightly modified version of the Agreement back for a new vote in January.  At that stage, it would be too late for any new deal to be agreed with the EU27.  So if she then loses this second vote, the Brexiters will win by default.  No Deal would become almost inevitable on 29 March.

SCENARIO 2 – MAY WINS A NEW VOTE IN JANUARY
UK politics is tribal, as I have been told many times over the past 2 years by leading MPs from all parties.  As such, it is very, very difficult for a Tory MP to vote to bring down their government.  So if May does “only” lose by less than 50 votes next week, then it is also possible that the Christmas break would provide time for reflection and give her a small majority in a second vote.

This, of course, would still mean the UK exiting the EU on 29 March.  But in cricketing terms, it would essentially be a draw – where neither side could claim victory, due to the Irish “backstop” (originally a cricket term).  In today’s Brexit version, it means that the UK would be bound to the EU unless and until the 27 agreed that the nightmare of a hard Irish border had disappeared.

SCENARIO 3 – MAY LOSES THE VOTE(S) BY A LARGE MARGIN AND THERE IS A NEW REFERENDUM

Scenario 1 is clearly the most likely outcome.  But the current row over the legal advice being given to the government gives Remain the chance to build a solid opening stand in the battle for a new People’s Vote.

It is a complex legal area, as the timeline from the House of Commons Library confirms, which is why skilful tactics by the Remain captain, Sir Keir Starmer, will continue to be critical:

  • Remain go in to bat this week to secure the detailed legal advice given to the government
  • By resisting this move, May risks alienating the moderate Tory MPs that she needs for her survival
  • If they vote against her on the issue of Parliamentary privilege, they might feel emboldened to do so again
  • But this would still represent an extraordinary development as it has only happened twice before in recent history
    • After premier Eden was forced to resign after the humiliation of the Suez crisis in 1956
    • After the disastrous Norwegian campaign in May 1940, when Churchill replaced Chamberlain

In the background, however, is the key fact that an overwhelming majority of MPs voted to Remain.  It is therefore not impossible that they could force a new referendum – particularly as the first was only “advisory”.  Remain would then have to campaign positively on the issue of peace and prosperity – as I argued here in May 2016.

But then, at least, the British people would have a real chance to decide on the future they wanted for themselves and their children.

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.

Airbus warns of “dawning reality” there may be no Brexit deal

Suddenly, businesses across Europe are waking up to the realisation that the UK is currently on course to leave the European Union (EU) on 29 March next year, without a deal on trade and customs.  As Katherine Bennett, the UK boss of aerospace giant, Airbus, warned on Friday:

“This is not project fear, this is dawning reality.”

As the BBC reported on Friday: “Airbus has warned it could leave the UK if it exits the European Union single market and customs union without a transition deal…It also said the current planned transition period, due to end in December 2020, was too short for it to make changes to its supply chain.  As a result, it would “refrain from extending” its UK supplier base. It said it currently had more than 4,000 suppliers in the UK.”

BMW, which makes the iconic Mini and Rolls Royce, added:

“Clarity is needed by the end of the summer.”

Similarly Tom Crotty, group director at INEOS, the giant petrochemicals group, said several companies were putting investment decisions on hold because of Brexit uncertainty:

“The government is relatively paralysed … it is not good for the country.

THE RANGE OF TOPICS COVERED BY THE BREXIT NEGOTIATIONS IS VERY LARGE

This is why my IeC colleagues and I have now launched Ready for Brexit on the 2nd anniversary of the UK’s referendum to leave the EU.  We are particularly concerned that many small and medium-sized businesses (SMEs) – the backbone of the European economy – are failing to plan ahead for Brexit’s potential impact.

As our Brexit Directory above shows, Brexit creates a wide range of challenges and opportunities:

  • Customs & Tariffs:  Export/Import Registration, Labelling, Testing, VAT
  • Finance:  Payment Terms, Tax & VAT, Transfer Pricing
  • Legal:  Contracts, Free Trade Agreements, Intellectual Property
  • Services & Employment:  Banking, Insurance, Investment, Property
  • Supply Chain:  Documentation, Regulation, Transport

And yet, today, nobody knows on what terms the UK might be trading with the other EU 27 countries after 29 March.  Or indeed, all the other countries where UK trade is currently ruled by EU agreements.

The EU is a rules-based organisation, and the legal position is very clear:

  • The UK has notified the EU of its intention to leave by 29 March
  • Negotiations are underway over a possible Withdrawal Agreement, which would set new terms for UK trade with the EU 27 after this date
  • The proposed Transition Agreement, which would extend the deadline for leaving until 31 December 2020, will only apply if this Withdrawal Agreement is finalised in the next few months

Ready for Brexit will keep its subscribers updated on developments as they occur, as well as providing news and insight on key areas of business concern.

A NUMBER OF VERY DIFFERENT OPTIONS EXIST FOR FUTURE UK-EU TRADE ARRANGEMENTS

The UK has been in the EU for 45 years.  Unsurprisingly, as the slide above confirms, the negotiations are proving extremely complex.  Both sides have their own objectives and “red lines”, and compromise is proving difficult.

The negotiators not only have to deal with all the trade issues covered in the Ready for Brexit Directory, but also critical political questions such as the trading relationship between N Ireland and Ireland after Brexit.  That, in turn, is complicated by the fact that the UK government depends on Democratic Unionist Party (DUP) votes for its majority, and the DUP is opposed to any “special deal” on customs for the Irish border.

BUSINESSES NEED TO RECOGNISE THERE MAY BE “NO DEAL” AFTER 29 MARCH
I have taken part in trade negotiations, and negotiated major contracts around the world.  So I entirely understand why Brexit secretary David Davis has insisted:

“The best option is leaving with a good deal but you’ve got to be able to walk away from the table.”

Similarly, International Trade Secretary Liam Fox is right to warn that:

“The prime minister has always said no deal is better than a bad deal. It is essential as we enter the next phase of the negotiations that the EU understands that and believes it… I think our negotiating partners would not be wise if they thought our PM was bluffing.”

The issue is simply that many businesses, and particularly SMEs, have so far ignored all these warnings.

According to a poll on the Ready for Brexit website, only a quarter have so far begun to plan for Brexit.  Half are thinking about it, and almost a quarter don’t believe it is necessary.  This is why we have produced our easy-to-use Brexlist™ checklist, highlighting key areas for focus.

“NOTHING IS AGREED UNTIL EVERYTHING IS AGREED”
As the UK and EU negotiators have said many times over the past 2 years, “nothing is agreed until everything is agreed“.  These 7 words should be written above every business’s boardroom table:

  • They remind us that it may prove impossible to agree a Withdrawal Agreement between the UK and EU27
  • And without a Withdrawal Agreement, there will be no Transition Agreement

Instead, the UK would then simply leave the EU in 278 days time on World Trade Organisation terms.

If you don’t know what WTO terms would mean for your business, you might want to visit Ready for Brexit and begin to use its Brexlist checklist *.

 

 Ready for Brexit offers users a free one-month trial including access to the Brexlist. After this there is an annual fee of £195 to access the platform.  Discounts are available for companies who want to help SMEs in their supply chains to prepare for Brexit, and for trade associations who would like to offer the service to their members.

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Brexit disaster looms as UK government power struggle erupts

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“.

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Political risk and interest rates rise in US, UK and Japan, as debt and dysfunctionality grow

Debt Jul17

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.

IMF growthUnfortunately, 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.

May, Trump, AbeIn 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.

 

Metastable markets at risk from impact of US, UK political stalemate

UK election Jun17We 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.”