Was Brexit Fear a Giant Hoax Or Is This the Calm Before the Next Storm?
Comment of the Day

June 30 2016

Commentary by David Fuller

Was Brexit Fear a Giant Hoax Or Is This the Calm Before the Next Storm?

Yet it should be dawning on European politicians by now that the economic fates of the UK and the eurozone are entwined, that if we go over a cliff, so do they and just as hard, and therefore that their bargaining position is not as strong as they think. They cannot dictate terms.

Few seem to grasp this, much like the wishful thinking in September 2008 when so many supposed that Lehman posed little danger to them. Britain has "collapsed politically, monetarily, constitutionally and economically,” said Dutch premier Mark Rutte, almost seeming to enjoy the flourish of his own words. Our great ally William the Silent would not have been so frivolous.

Morgan Stanley says they need to wake up. It warns that the eurozone will suffer almost as much damage as Britain in a 'high stress scenario', and so do others. Danske Bank says the UK and the eurozone will both crash into recession later this year. 

If so - and that is not yet clear - it is hard to see how the eurozone could withstand such a shock, given the levels of unemployment and the debt-deflation dynamics of southern Europe, and given the intesity of political revolt in Italy and France.

Contrary to the supposition of Mr Rutte, the fall in sterling is a blessing for the British economy, and a headache for the eurozone. The exchange rate is acting as a shock-absorber, just as it did in 1931, 1992, and 2008,  all bigger falls, and all benign.

Devaluation strikes no fear in a chronic deflationary world where almost every major country is trying to push down its currency to break out of the trap, and largely failing to do so. It would facetious to suggest that Britain has pulled off this trick. Crumbling investor confidence is never a good thing. But the UK has stolen a march of sorts, carrying out a beggar-thy-neighbour devaluation by accident.

The pound needs to fall further. It is still too strong for a country with a current account deficit running consistently above 5pc of GDP. The International Monetary Fund said just before Brexit that sterling was 12pc to 18pc overvalued, and may have to fall more than this to force a lasting realignment of the British economy. 

This cure has hardly begun. As of today, sterling is 5pc below its trading range for the last month against the euro and the Chinese yuan. It is weaker against the US dollar but the dollar is on steroids, much to the horror of the US Treasury.

The more sterling falls, the greater the net stimulus for the British economy. The reverse holds for the eurozone. It is a further deflationary shock at a time when Europe is already in deflation, when inflation expectations are in free-fall and bond yields are collapsing below zero, and when the ECB is running out of options.

There are two dangers for the world economy. One is that China is exporting deflation with alarming intensity. Morgan Stanley estimates that China's trade-weighted devaluation is running at an annual rate of 11pc, and factory gate deflation adds another 2pc. This is a tsunami coming from the epicentre of global overcapacity.

The other danger is that British and European politicians fail to understand what is coming straight at them from Asia. Britain's Brexiteers must come up with a coherent policy on trade very fast, and the EU must come off their ideological high-horse and face the reality that they have absolutely no margin for economic error. 

US Secretary of State John Kerry warned in stark terms on his post-Brexit swoop into Europe that nobody should lose their head, or go off half-cocked, or "start ginning up scatter-brained or revengeful premises." 

Nobody seemed to heed his words at the EU's imperial summit in Brussels, an exercise in righteous anger but not much else. The markets may yet speak in harsher language.

David Fuller's view

Markets are now assuming that Brexit negotiations will be stretched out over at least two years.  Moreover, that Britain and Europe may be able to form a new agreement which gives the UK financial community “passporting” rights and also control of its own ‘Australian style’ immigration policy. Britain will always allow in plenty of immigrants but select them on the basis of what is best for the country, selected not only from the EU but also from the other 93% of the global population.      

Meanwhile, plenty of uncertainty remains.  Policy agreements which gave the UK much more autonomy in terms of governance within the EU would largely satisfy both the Remain and Brexit sides of this decisive debate.  Of course there is no certainty that the EU would agree to this, and it would lead to similar demands from many other of the 28 countries, but this would be democracy in action.  It could also save the EU from a catastrophic breakup. 

Uncertainty within Europe is unlikely to go away anytime soon. Nevertheless, devolution of real powers to EU countries would have a favourable outcome.   

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