David Fuller and Eoin Treacy's Comment of the Day
Category - General

    UK Tories Lash Out at EU $63 Billion Brexit Bill

    Here is the opening of this provocative article from Bloomberg:

    U.K. lawmakers in Prime Minister Theresa May’s Conservative party hit back at claims from Austrian Chancellor Christian Kern that Britain will be charged 60 billion euros ($63 billion) to leave the European Union as tensions surge ahead of Brexit talks.

    In a Bloomberg interview on Thursday, Kern became the first EU leader to put a value on the size of the U.K.’s Brexit bill. While May’s office was muted in its public comments, Kern’s warning that there would be “no free lunch” for the U.K. sparked a furious response from senior members of Parliament.

    “This figure is a nonsense that’s been conjured up by EU officials who are behaving like children,” former cabinet minister Iain Duncan Smith said in an interview. "For the Austrian chancellor to even refer to it is quite absurd. As for saying there’s going to be no free lunch for Britain, we paid so much into the EU budget over the years, we pretty much bought the damned restaurant."

    Haggling over the Brexit bill looks like it will mark a testy start to the negotiations once May invokes Article 50 of the Lisbon Treaty, something she has said she’ll do before the end of March. Britain’s Trade Secretary Liam Fox has called the very idea of a charge “absurd” and the government in London is adamant it won’t pay for any EU projects signed after November.

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    Email of the day

    On gold, interest rates and inflation:

    David, Eoin or you have made the point a number of times that a key point in tracing the rising direction of gold was when rates of inflation were ahead of interest rates. Do you have a chart which gives a picture of this phenomena? Best regards,

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    The Commercial Realities of Brexit

    My thanks to a subscriber for this very informative report by Daniel Foe for Asia Research.  This is so interesting that I was torn with choices in finding a brief sample to show readers: 

    The other significant area that Theresa May mentioned was a desire to maintain security ties.

    The current EU Commissioner for Security is British and was appointed in August 2016. Despite the UK’s lead in this field by EU standards, he was described by the chairman of the EU Parliament’s foreign affairs committee as “a type of junior commissioner”. As if that was not clear enough, Gianni Pittella, leader of the European Parliament centre-left socialists and democrats, said, “it is a little, technical portfolio”, adding that there should be “no prize, no award” for voting to leave the EU. https://www.ft.com/content/bc9bb68a-589e-11e6-8d05-4eaa66292c32

    Britain is the EU’s largest military power, and for a number of years Britain alone has been reaching its target in terms of defence spending (Britain is estimated to have spent about 2.1% of its GDP in 2016 against a target of 2.0%). However most of the countries in the EU, especially the large ones, are falling well short of the target. For Germany in 2016, the expected expenditure is only 1.2% (ironically, perhaps, Greece’s is 2.6%, but given that they are largely funded by German money,  perhaps Germany is a little closer to their benchmark than they are given credit for!). http://www.nato.int/nato_static_fl2014/assets/pdf/pdf_2016_07/20160704_160704-pr2016-116.pdf

    Thus, in dollar terms, Germany would need to spend an additional USD 27.7 billion in 2016 alone to reach their defence spending target. This has been a source of significant irritation to the US, and mentioned by all of the candidates in the recent US elections, but Donald Trump appears more likely to make waves over this matter, despite his view of the obsolescence of NATO. Thus the UK leaving the EU will draw further unwelcome attention to this deficit. http://money.cnn.com/2016/04/15/news/nato-spending-countries/

    Whilst much comment has been directed at the UK–EU relationship, little comment has been directed at the EU27’s internal relationships post-Brexit.

    The matter of the UK’s nett contribution to the EU budget, which was €8.5 billion in 2015, will highlight this area, as the deficit will need to be made up by the rest of the cash-strapped EU27 or there will be the prospect of services needing to be cut.

    Like any relationship that breaks down, the discussion of the future relationship can degenerate into bickering and irrational behaviour as the parties struggle to focus on the best outcome for the new reality. Helpfully, Theresa May has taken a powerful overview of the requirements and levers that both sides have. https://www.theguardian.com/politics/2017/jan/30/uk-eu-economic-cold-war-italian-minister-mario-giro

    Britain, as the second largest importer of EU goods in the world, will have significant leverage over the setting of tariffs for manufactured goods and will be able to use this in settling the overall trade agreement, but it is always possible that an emotionally blinded EU—especially where Juncker, Head of the European Parliament holds some sway—could make an emotional decision rather than one guided by getting the best solution for all concerned.

    Theresa May hinted that, if an acceptable deal is not reached, she could turn the UK into a regional tax haven in order to retain business in the UK: a sort of ‘supersized Singapore’ in Europe.

    You will be able to hear pronouncements about progress from various sources. Elections in France, the Netherlands, and Germany this year may change the way talks evolve, but we believe that the issues discussed above represent the key underpinnings. https://www.bloomberg.com/politics/articles/2017-01-26/france-s-neighbors-sound-alarm-over-election-catastrophe-risk

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    British Airways Poised to Join Long-Haul Narrow-Body Craze

    This article by Benjamin Katz for Bloomberg may be of interest to subscribers. Here is a section:

    Walsh spoke a day after Norwegian Air presented details of flights from five locations in Britain and Ireland to three low- fee airfields in New York state, Rhode Island and Connecticut, to be served by Boeing Co.’s 737 Max 8 model from June with one- way fares starting at 69 pounds or 69 euros ($86/$73).

    While the Boeing jets will be operating close to the limits of their range, Norwegian Air has also ordered 30 A321neoLRs with which it could connect dozens of smaller cities either side of the Atlantic in the medium term.

    Aer Lingus already operates long-haul flights with a fleet of Boeing 757s, the only narrow-body model to see regular use on non-stop Europe-U.S. services, but which ceased production in 2004. The seven A321s on order will serve as replacements while also adding new routes. The Irish unit began serving Hartford from Dublin last year and IAG has said that several other smaller U.S. airports are keen to attract flights with competitive fees.

    Walsh said on a conference call with analysts that the introductory fares offered this week by Norwegian Air aren’t sustainable. “Norwegian has a very small margin of profitability and the fares that they’ve launched are clearly just designed to get some headline media coverage,” he said.


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    Italexit is not a solution for Italy's problems

    Thanks to a subscriber for this article by Lorenzo Codogno and Giampaolo Galli which may be of interest. Here is a section from the conclusion:

    The euro is irrevocable. It was designed as Hotel California: “you can check out any time you like, but you can never leave!” However, we know that it would be wrong to take it for granted. Italexit could still happen as the unwilling and messy result of an unbearable deterioration in public finances and economic performance, combined with misguided political will and financial market turmoil. It would be a huge mistake. Much better, and less costly, would be to address the underlying problems, allowing Italy to survive and thrive within the euro by enhancing potential growth and economic resilience. 

    It would be wrong to conclude that Italexit, or exit from the monetary union by any other Member State, is going to be an easy process that can be evaluated with a straight cost-benefit analysis and smoothly managed in an orderly way. While Roger Bootle, one of the advocates of the return to national currencies, came to somewhat different conclusions, he acknowledged that the exit merely being the reverse of the construction process does not make it easy: “it would be the equivalent of unscrambling an omelette”.

    In the case of Italexit, redenomination and default would become very likely and would cause a number of side effects and negative spillovers into the economy. Exit without redenomination would lead the debt-to-GDP ratio to reach 190%, assuming 30% devaluation, making default even more likely. Hence, Italexit would not address the issues its proponents claim it would address, while producing significant financial instability. Just mentioning it as a viable solution as part of a political platform would imply risks of making it a self-fulfilling prophecy. The economic, social, and political consequences would be enormous and last for a number of years.

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    The second stage of disruption

    This article by Alex Pollak for Loftus Peak appeared in Australia’s Livewire letter and may be of interest to subscribers. Here is a section:

    But it’s what inside that counts. Autos and components are a significant part of consumer discretionary, as are media, retail and staples including food. A major component of Industrials is transport – road, rail, marine, airline, construction material and heavy trucks.

    Virtually all the automakers have electric and self-driving models in the works. But, as we have noted before, the more successful they are with these, the more the potential for write-offs in their internal combustion engine business – which is basically the whole business.

    Banking disruption has started but hasn’t hit the mainstream – yet.

    But fund managers typically invest looking to the existing make-up of the global economy, through the GIC’s sectors, which are composed of the companies in those industries. So the fund manager will have investment in oil, automakers, energy and transport, at time when those sectors are heading for massive disruption. In essence, the fund manager is investing by looking backwards!
    This is a poor long-term strategy, and one which has already begun to cause drag in portfolios which are underweight ‘technology’ shares (because they form a small part of the index, at the expense of sectors like basic materials and utilities, which are large now but are de-weighting as disruption takes hold.)

    We are at a particular point in the economic history where disruptive companies are moving into industries which were previously considered inviolable, companies which couldn’t be damaged because demand for the underlying physical good was thought to stretch out to the horizon. In fact, the demand may still be there, but the way it is delivered, because of technological change, is affecting virtually all industries.

    It's why we invest in disruption, and the reason our returns have been solid.


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    Unpayable Debts and an Existential EU Financial Crisis; Are Eurozone Central Banks Still Solvent?

    Vast liabilities are being switched quietly from private banks and investment funds onto the shoulders of taxpayers across southern Europe. It is a variant of the tragic episode in Greece, but this time on a far larger scale, and with systemic global implications.

    There has been no democratic decision by any parliament to take on these fiscal debts, rapidly approaching €1 trillion. They are the unintended side-effect of quantitative easing by the European Central Bank, which has degenerated into a conduit for capital flight from the Club Med bloc to Germany, Luxembourg, and The Netherlands.

    This 'socialisation of risk' is happening by stealth, a mechanical effect of the ECB's Target 2 payments system. If a political upset in France or Italy triggers an existential euro crisis over coming months, citizens from both the eurozone's debtor and creditor countries will discover to their horror what has been done to them.

    Such a tail-risk is real. As I write this piece, four out of five stories running on the news thread of France's financial daily Les Echos are about euro break-up scenarios. I cannot recall such open debate of this character in the Continental press at any time in the history of the euro project.

    As always, the debt markets are the barometer of stress. Yields on two-year German debt fell to an all-time low of minus 0.92pc on Wednesday, a sign that something very strange is happening. "Alarm bells are starting to ring again. Our flow data is picking up serious capital flight into German safe-haven assets. It feels like the build-up to the eurozone crisis in 2011," said Simon Derrick from BNY Mellon.

    The Target2 system is designed to adjust accounts automatically between the branches of the ECB's family of central banks, self-correcting with each ebbs and flow. In reality it has become a cloak for chronic one-way capital outflows.

    Private investors sell their holdings of Italian or Portuguese sovereign debt to the ECB at a profit, and rotate the proceeds into mutual funds Germany or Luxembourg. "What it basically shows is that monetary union is slowly disintegrating despite the best efforts of Mario Draghi," said a former ECB governor.

    The Banca d'Italia alone now owes a record €364bn to the ECB - 22pc of GDP - and the figure keeps rising. Mediobanca estimates that €220bn has left Italy since the ECB first launched QE. The outflows match the pace of ECB bond purchases almost euro for euro.

    Professor Marcello Minenna from Milan's Bocconi University said the implicit shift in private risk to the public sector - largely unreported in the Italian media - exposes the Italian central bank to insolvency if the euro breaks up or if Italy is forced out of monetary union. "Frankly, these sums are becoming unpayable," he said.

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    We Must Leave the EU Quickly; It is Falling Apart Faster Than I Thought

    Hand over a €60 billion ransom or we won’t even start to discuss a trade deal: that, if Jean-Claude Juncker is to be believed, will be the European Union’s opening gambit ahead of Brexit.

    Bring it on, I say: the best way to expose a very weak adversary who is pretending to be very strong is to call their bluff. Yet it may never even get to that. At this rate, what is left of the EU could soon be begging us for a trade deal, not the other way around.

    The reality is that the EU is edging ever-closer to the abyss: it is at its weakest, most vulnerable since its creation, and it is now touch and go whether it survives 2017 or whether it is swept away in a catastrophic populist revolt.

    Trouble is not only brewing in France, where Marine Le Pen keeps gaining ground, but also in the Netherlands, in Greece, in Italy and in eastern Europe.

    Even if the dissidents fail, for now, the EU will soon be crippled by Britain’s departure, robbing it of its financial centre and billions of pounds a year in net contributions.

    The EU’s modus operandi has always been to buy support with German and British money, especially in poorer regions and in France’s agricultural heartlands: when the cash runs out, or is replaced by some euro-tax, tensions will flare up again.

    We keep worrying about how Brexit will affect Britain. But the real question is how Brexit will debilitate Brussels, shift the balance of power and ideology on the continent, with smaller, more pro-market nations losing their British champion, and trigger a new dash to yet more unpopular centralising treaties, fuelling more rage and anger. Yet the Eurocrats in Brussels and some Remainers in Britain keep on talking as if nothing has changed, as if the UK were leaving some powerful, eternal, economically successful superpower. The status quo is gone, forever, and what is left could be smashed further in just three months’ time.

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