The die is cast

Now that Royal Assent has been gained, the European Union (notification of Withdrawal) Act 2016-17 is in force and the only impediment to Britain leaving the EU is for the Prime Minister to write to the EU to trigger Article 50 of the Maastricht Treaty. This is expected in the next two weeks.

The die has been cast and this British action will lead to many repercussions, not all of which are visible today. It is however true that whilst leaving the EU is a very clear demonstration of British sovereignty, it is those repercussions that will determine just how effective and valuable that sovereignty is in today’s world.

Firstly, with regard to the EU, the deal we gain through the next 24 months of negotiations will primarily be a function of what sort of relationship the EU wishes to have with Britain. It may well make economic sense for both sides to have an essentially free trade regime in goods and services, very similar to that which exists currently. However the EU also has political objectives, prime amongst which is that any deal must look and be worse than remaining within the EU and its single market, in order to deter other countries from following the UK out of the exit door. Anti-EU views are gaining ground in France, Italy and Holland, all founding members of the EEC. Some degree of economic loss will be acceptable to the EU in order to achieve these political objectives, and though this may be higher in absolute terms than the loss to Britain, that economic loss would be much smaller as a share of their total economy than for Britain.

Britain’s economic fortunes are thus dependent on the political calculations of the rest of the EU.

Secondly, with regard to the USA, a “special relationship” may or may not exist, but if it does it has always been on US terms. Pre-Trump, the UK was an invaluable bridge between an inherently individualistic US political philosophy and an inherently social European one. – Britain was able to explain and translate each side’s thinking to the other. By leaving the EU this role is hugely diminished, though may still apply to defence matters.

With Trump as President, the picture is more complex. Trump sees Brexit as part of the same changing political tide that saw him elected and Britain’s need for a series of bilateral trade agreements fits very neatly into his philosophy that the US should only negotiate bilaterally in order to maximise its own influence. He clearly enjoys visiting his properties in Scotland and he may wish to be seen rapidly concluding a trade deal with Britain in order to contrast trading relationships with other developed world economies with those of less developed economies such as Mexico and China which he believes have been detrimental to US jobs.

He is though very unpredictable, and would likely seek some painful concessions from Britain, in order to demonstrate that he had “won” the negotiation. Britain would thus be dependent on his capriciousness, both in any trade deal and more widely in global affairs.

Thirdly, China sees itself as a key world power that is happy to make agreements with other countries, but is not very interested in negotiating them. It prefers to set out its terms and wait for others to agree to them. British sovereignty would extend to deciding whether or not to agree to what the Chinese want.

These 3 giant entities (EU, US, China) account for 57% of the global economy and an even greater percentage of UK goods exports – the fate of the British export sector and thus the wider economy is very much in their hands. Britain can only “take” what they wish to “give”. In relation to the size of these economies, Britain, though the 5th / 6th largest economy in the world, has little negotiating power.

Of the other countries who have expressed an interest in early free trade deals with a Britain outside the UK, both Australia and India have indicated that a key objective in any such negotiations would be greater freedom for their citizens to come and work in the UK. This is directly counter to the British government’s policy to substantially reduce immigration. In addition all the nations seeking trade deals are a very long way from Britain and international trading relationships display very strong correlations to geographic proximity.

British sovereignty has been dramatically exercised – the die has been cast – Britain is about to set out on a new independent path for its economic development – its fortunes, however, certainly in the next few years, now depend very heavily on the actions of others. Re-asserting sovereignty may feel liberating now but be economically painful in the future.

 

Jeux avec frontieres

Before the UK joined the EEC in 1973, most Britons knowledge of Europe was from the BBC game show Jeux sans Frontieres (Games without Borders), which showed that Europeans were as prepared as Brits to dress up in silly costumes and attempt bizarre tasks against teams from other countries. It may even have played a part in Britain’s referendum to support EEC membership.

It is now 12 months since David Cameron permitted his government ministers to break from Cabinet responsibility ahead of the second EU referendum. The campaign and decision to leave, followed a few months later by the election of President Trump has transformed the political debate around the world. Since World War 2, the political debate was between those who thought government should seek to do less within society and those who thought government should seek to do more within society. The events of 2016 however show that the debate is now between those who would like national borders to be more difficult to cross (whether by people or goods) and those who want borders to be easier to cross.

Regarding people crossing borders, Mrs May’s immediate conclusion from the referendum was that the British people voted for regaining control of immigration, and the right to live in Britain, and that this was more important any economic benefits from EU membership. Her policy and approach to Brexit since then has clearly been dictated by that conclusion. It is however, notable, that the parts of the country most concerned by immigration are correlated to those parts of the country with the smallest immigrant populations.

For President Trump, it is the twin threats of illegal immigrants from Mexico and radical Islam from some Muslim nations that underpins his desire to establish more effective control of America’s borders. His geographical distribution of support in the election also correlated with low levels of immigrant population.

For Trump, though not for Mrs May, borders are also important for controlling the movement of goods. He argues that the free trade agreements that the US has made in recent years has meant that cheap goods have poured into the US , displacing US-made goods and thus US jobs, particularly in the areas where he drew the greatest support. He seeks to maximise American negotiating leverage by withdrawing from multilateral trade agreements such as the TPP and NAFTA and replacing them with bilateral agreements where the US will (nearly) always be the more powerful party and be more likely to reach agreements that are closer to American interests.

For the UK, voluntarily withdrawing from a trade bloc even larger than the US and seeking new trade agreements with the rest of the world, the general acceptance of free trade is paramount and much rhetoric about the UK being the beacon of free trade in the world (and goods and services crossing borders easily) can be heard from UK Conservative politicians. One early issue that UK politicians have discovered is that many of the countries (eg India and Australia) that would be keen to enter into free trade agreements with the UK, are also seeking greater freedom for their people to enter and stay in the UK.

Unusually for economists, almost all of them agree that free international trade is a good thing for the global economy (though this is not the same thing as being good for everyone in that global economy), and that the last time, the world economy saw a significant increase in protectionism, in the 1930s – this was associated with dramatic declines in trade levels and a global economic depression – ending in World War.

This desire for reinstatement of borders also flies in the face of the reality of technological progress. For people travel across the world is cheaper, more straightforward to plan and a more realistic aspiration that ever before in history. Making that more difficult implies a key loss in economic terms

For goods, bar codes, the standardisation of shipping container and the prevalence and complexity of international supply chains supported by logistical improvements has created huge efficiencies with both higher volumes of trade and lower prices for all. Re-establishing border controls (not only between the US and Mexico but also between the UK and the EU) will raise prices and reduce the global standard of living, even if tariffs remain at negligible levels.

For services, the digitisation of the world means that borders are increasingly irrelevant. More and more retailing is conducted in the ether, a large part of the world satisfies its desire to watch soccer by watching the English Premier League online, even investment bankers outsource research model-building to staff in India.

The current wave of national populism is selling the idea of greater security through control of borders and plays on traditional human tribal urges to discriminate against outsiders. It appears to be going against where technology is taking the human race and the risk must be that to deliver border control will require increasing levels of force, militarisation and regulation that will act to reduce standards of living. It also flies in the face of another great human urge – to welcome and be hospitable to visitors.

 

 

Brexit with Trump

Just six months ago, the probability of victory for each of Brexit and Trump were 30% – and the odds on the double were thus 10-1 against. The world going into 2017 looks a very different and more uncertain place than it did a year ago.

However, Trump’s victory provides the UK with an opportunity to gain a substantially better agreement with the EU than it would have done with a Clinton victory, even though Mrs. Clinton may well have leaned on the EU countries to give the UK a sensible deal.

Trump’s victory has many European governments feeling considerably less secure. With his outspoken admiration of Vladimir Putin and his tendency to see foreign relations as a zero-sum game rather than mutual gains through international agreements, Trump’s view of NATO and European security is very different from his predecessors. For those in Eastern Europe, Putin is today a bigger threat to their borders and US military support less likely to be forthcoming.

One of the few cards that the UK holds in the Brexit negotiations is it deep and unwavering commitment to the military defence of its European allies, and despite the harsh words used against the rest of the EU from those seeking to leave the EU, their military support for the EU has not changed and they have consistently voiced this before, during and since the referendum. That support has now become much more meaningful and valuable, especially to those countries in the former Eastern Europe. 

The desire to punish the UK for its audacity to leave the EU is now (post Trump) more likely to be to seek a strong agreement with a staunch ally who is also a nuclear power. On the Maslovian hierarchy of needs, the basic security of your country is a far more powerful force than the continued existence of a financial passporting system or some controls on the uninhibited movement of people between countries.

In addition, once again, through their votes, the UK and the US have shown the similarity of their thought processes (a clear parallel being  the ascensions of Thatcher and then Reagan), which often baffle European minds.  Maintaining a close and friendly relationship with the UK is likely to be helpful to Europeans in understanding and interpreting the actions of the US. Trump has spent time in the UK (though mostly in Scotland), has openly identified his success with Brexit and did

promise to put the UK at the front of the queue for a trade agreement post-Brexit, following Obama’s threat that it would be at the back of the queue. Though of course this would be strictly on Trump’s terms, and have almost no cost to US jobs – it would enable him to show that there are some trade deals he will do if they are right for the US. The EU-US trade deal, already stymied by European doubts before Trump’s  success is now dead in the water.

Trump’s victory will change the world in many ways, but one of the more surprising ones is likely to be that the UK obtains a better exit agreement from the EU than would have occurred without Trump.

In the down phase of the trade deals cycle

The UK’s referendum decision to leave the EU, leaves it seeking new trade deals not only with the rest of the EU but also with the 50 or so nations with whom the EU has trade deals in place. The new minister for International Trade (Liam Fox) has also indicated that he would be keen to see trade deals with the US, Canada, Australia, New Zealand, India and China. Without trade deals, countries may impose tariffs on imports of goods and stiff regulations on imports of services.

Not only does the UK have very few experienced trade negotiators, since this has long since outsourced to the EU but the UK’s demand to make trade deals comes at a most inopportune time in the trade deals cycle. Recent events indicate the momentum and desire for agreeing trade deals have reversed.

The trade deals cycle began to turned upwards in 1986 when talks for the Uruguay Round within GATT began – with the free market philosophies of Thatcher and Reagan leading the way for countries to reduce the barriers to international trade that were in place. The talks concluded successfully in 1994 with an agreement that reduced global tariffs on goods substantially, so boosting the volume of trade. Other key free trade agreements have been NAFTA which came into force in 1994, the development of the EU Single Market in the 80s and 90s, where Mrs Thatcher did much to drive progress.

As part of that agreement the World Trade Organisation was set up in 1995 to take over GATT’s responsibilities for matters relating to international trade. In 2001 the WTO initiated the Doha Round, at the same time as China was admitted to membership of the WTO. The accession of China to the WTO saw a further dramatic rise in global trade volumes until 2008.

In hindsight this was peak of the trade deal cycle and agreement between nations to reduce trade barriers. No significant progress has been made since then.

The aim of the Doha Round was to further reduce global trade barriers especially within agriculture and services. It had an original deadline for an agreement by 2005, but was plagued by difficulties – negotiations collapsed in Geneva in 2008 and the Global Financial Crisis has meant that since then national governments have been unwilling to make concessions that might harm their citizens.

In recent years, following the collapse of the Doha Round there have been three attempts at major non-global trade agreements. These are between (i) the US and the EU via the TTIP (Transatlantic Trade and Investment Partnership) talks, launched in 2013, (ii) the US and other American and Pacific nations via the TPP (Transpacific Partnership) and (iii) Canada and the EU via the CETA (Comprehensive Economic and Trade Agreement) talks, negotiated between 2009 and 2014.

Of these TTIP talks have got stuck – the original intention to conclude by 2014 has been extended to 2019 but across Europe there is increasing unhappiness at the secrecy of the proposals and the progress of negotiations. The TTP talks produced an agreement but requires ratification from the US – during the campaign Donald Trump has stated his opposition to this and other trade agreements and would not ratify it, and Hillary Clinton, having been a supporter of it when in government has now said that she would not ratify it. The CETA has recently run aground as EU ratification of the Treaty requires each of the 28 member states to ratify it individually and Belgium cannot do so without the agreement of the Walloon parliament, which is currently firmly opposed to doing so, seeing as a further dangerous step towards globalisation.

Trade deals have lost their political support and the momentum of the trade deal cycle is now firmly down. Though the UK and the rest of the EU ought to be able to agree on a post-Brexit trade deal given the economic benefits to both sides, for the UK to conclude many other significant trade deals is likely to be a very long and arduous process.

The UK’s post-Brexit need for free trade deals will prove to be cyclically poorly-timed and a negotiating weakness at a time when countries are growing increasingly suspicious of the benefits of such deals.

 

How do you like your Brexit – hard or soft?

“Brexit means Brexit” has been Theresa May’s equivocal line since the referendum. It has become clear that this actually means that Britain will leave the EU – the manner of that departure, however, remains unclear.

The difference between a “hard” and a “soft” Brexit centres around the relationship with EU single market which allows goods to move around the EU unhindered. A soft Brexit would allow Britain to remain in the single market, whilst a hard Brexit would see it leave both the EU and the single market.

All UK politicians agree, at the very least, that Britain should aspire to “have access to the single market”. This is, however, a meaningless form of words since all countries in the world (with the exception of North Korea) are able to sell their goods to buyers in the EU if they wish – ie they have access to the single market. What is more important is to have “tariff-free access to the single market” – provided a nation is a member of the WTO (World Trade Organisation) then a maximum tariff (or a tax) of 10% can be applied to trade in goods between them. In general, this tariff will be applied to all goods imports unless there is a separate trade agreement between the importing country and the exporting country. There is also considerable bureaucracy involved in proving that the goods meet any national standards or regulations of the importing country.

Being “a member of the single market” means that there are no tariffs and no bureaucracy – if the product meets EU standards then it can be freely sold anywhere inside the EU, and in practice the slightly larger EEA which includes Norway and a few other small countries. The major disadvantage of not being inside the single market is the bureaucracy involved at border points when goods cross in to the EU, which means higher costs for business. This is a particular problem for the border between Northern Ireland and the Republic of Ireland, which is currently completely open.

Being inside the single market is a real prize for business, is the main reason that Mrs Thatcher wanted Britain to be a member of the EU, and has been the UK’s main focus of political activity while a member.

Given the referendum result, the best outcome for Britain is not to be a member of the EU, and thus able to control its own borders (by ending freedom of movement to EU citizens) and write its own laws, but to retain membership of the single market. In fact, this would probably be the best outcome for every EU member and is why the EU negotiators will not agree to it.

Since Article 50 has not yet been triggered and negotiations have not yet started, both sides are talking tough and making clear that they would not be unhappy if nothing is agreed and Britain leaves the EU with no new agreement about trading relations in place. This is assumed by both sides to be that Britain would leave the EU and become a member of the WTO in its own right, rather than as part of the EU. This would be the hardest Brexit – access to the EU but with 10% tariffs applying to all trade (though Britain could unilaterally set a zero tariff on imports if it so wished). In any negotiation, the side least able to accept the situation if the event of no agreement has the weaker hand, so both sides are saying publicly that this would not be a problem for them.

Many in the UK claim that the €90bn trade deficit in goods that Britain has with the rest of the EU, means that the EU would suffer more, in money terms, from no agreement, whilst those in the EU point out that with 47% of Britain’s goods exports going to the EU, while for the EU’s leading exporter, Germany, the UK represents just 7.5% of their exports, the effective impact of tariffs on the British economy would be much greater than on the rest of the EU.

In practice, the obvious solution for both sides is tariff-free access for goods – it is the closest solution to the current situation and any tariffs would be negative for both parties. Provide the negotiations are conducted on a friendly basis, this should be the outcome, and can be construed as a medium-hard Brexit.

In financial services, where the UK has a large trade surplus, the EU operates a “passport” system, if a firm is regulated by an EU country it can apply to have a passport to provide those services in the rest of the EU. British firms are very keen to keep these rights, but if outside the EU they are dependent on the EU agreeing to this. France and Germany are both keen to have the power and the jobs from these financial services in their own countries, and so the price for maintaining these passports will be high. It is likely that the UK would have to offer concessions on the freedom of movement of people to achieve this – this would be a difficult compromise for the British people and politicians to accept.

Britain does not hold too many cards in the negotiations and a hard Brexit looks the most likely outcome.  Provided there is rationality and goodwill on both sides, tariff-free access for trade in goods should result, but an agreement on services, which is of greater importance for Britain will be much tougher to achieve.

A badly-timed referendum

David Cameron never really envisaged losing the referendum, hence he paid no attention to the timing of it should he lose it. However, the state of national politics across many European countries is febrile and within twelve months it is quite conceivable that the four largest countries in the EU will all have different leaders and potentially these new leaders will all be from different parties than rule today. This will have a major effect on the outcome of the exit negotiations.

In Germany the next general election is set for September next year. Ahead of the 2013 election Angela Merkel indicated that she would step down before the next election – this promise has not been repeated since that election but she is yet to confirm that she will stand for re-election next year. She is one of the most experienced and highly regarded politicians globally but her stance over the migrant crisis, being happy to accept over 1 million migrants into Germany over the last year or so, has damaged the standing of her and her CDU party in Germany. Should she decide to stand down, the EU will lose its most powerful politician and Germany’s influence within Europe will decline; should she decide to stand again she might find that her CDU party garners less seats than the centre-left SPD party, her current coalition partner. Recent local and regional elections have been notable for the surge in popularity of AfD, a party that began life on an anti-euro platform but which in recent times has shifted right to become firmly anti-immigrant and anti-Muslim. The proportional voting system in Germany means they are likely to gain seats in the new Parliament and become a meaningful force in German politics

In France, there will be a Presidential election in April. The two-stage process, where the two candidates with the highest number of votes in the first round are the only ones on the ballot for the second round, combined with a large number of potential candidates make for a lot of uncertainty. Currently Marine Le Pen of the Front Nationale, whose major policy is firmly anti-euro and anti-immigration, looks set to gain the most first round votes and be in the final ballot where she would be expected to lose against most others, but it is very unclear who the other candidate might be. From the centre-right of French politics Alain Juppe, a former prime minister and Nicholas Sarkozy the previous President are the two leading candidates, whilst from the left President Hollande is very unpopular and has yet to decide if he will stand again – two members of his government, Manuel Valls and Emmanuel Macron have already announced they are candidates. The current polls indicate that should Hollande stand he would fail to reach the second round, which would be a huge political embarrassment for him.

In Italy, the current prime minister Matteo Renzi has called a referendum on some constitutional changes to reduce the powers of the Upper House and regional governments, that he feels are necessary to deliver structural reforms to the Italian economy. The referendum result is likely to be close – it will be held between November 20 and December 4. He has repeatedly said that he will resign as prime minister and leave politics if his reforms are rejected. On current polling the anti-EU and anti-establishment Five Star Movement is leading though their leader, Beppe Griilo is himself not permitted to be elected to parliament due to a previous conviction

In Spain, there was an election in December 2015 but this produced an inconclusive result and it had not proven possible for any combination of parties to agree on a forming a government with a parliamentary majority. Mariano Rajoy the prime minister before the election has continued in office without sufficient votes in parliament to pursue his policies. Nine months of inter-party talks have failed to resolve the situation and the most likely outcome is another election soon. However current polling indicates that the likely outcome would remain very unclear.

With these four large Eurozone economies facing such political uncertainty, in terms of who will lead and what their policies will be, it seems unlikely that Brexit discussions / negotiations will achieve much forward momentum for some time. For markets, European economic policy will remain dependent on ECB decisions as little progress from fiscal policy or structural reforms can be expected either.

Three into two doesn’t go

By their nature, if referenda are to be used only for matters of the greatest import, a clear answer must be forthcoming and therefore only binary outcomes can be permitted. In fact, though the Brexit referendum voting slip had just Remain or Leave printed on them, the Leave campaign was a coalition of two different perspectives. Michael Gove and Boris Johnson wanted to leave the loss of sovereignty implied by being a member of the EU with its automatic imposition of any Brussels regulations, but did not wish to lose the ability to trade freely with the EU, particularly in financial services where the UK dominates Europe. Many in wealthy parts of the UK voted Leave for this reason. For Nigel Farage on the other hand, the key issue was control of immigration – the EU’s freedom of movement for people in the single market was not acceptable and many in the poorer parts of the UK voted Leave for this reason.

The UK thus finds itself in a situation of intransitive preferences, known as Condorcet’s paradox. This occurs when a society prefers A over B and B over C and C over A. For a single individual this is obviously inconsistent, but in a society of many different points of view, this state of affairs is quite possible.

The referendum shows that the UK prefers Leaving the EU to Remaining in it. However, leaving the EU requires that we have to choose between continuing to be part of the Single Market with its economic benefits and having constraints of the freedom of movement of EU citizens. EU leaders have made it quite clear that this is the price to be paid to be part of the single market.

Thus it is entirely possible that there is majority preference to Remain rather than no longer be part of the single market but have control of immigration, ie Remainers plus many of the richer Leave voters, and a different majority preference to Remain rather than not have control of immigration and continue to have full participation in the single market, ie Remainers plus many of the poorer Leave voters.

Theory shows that for society as a whole such intransitive preferences have no good solution and this is where the UK finds itself today – wanting to Leave but with no plan and the world laughing at it.

Boris Johnson, now in campaigning mode to be the next Prime Minister, proclaims that the UK can have both, but David Cameron has already admitted that the UK must choose. The next Prime Minister will thus have to choose between the interests of business and the City and the poor. As a Conservative the obvious course may be to save the interests of business, but such a course of action will further alienate the poorer sections of the country and boost the support for UKIP and its anti-immigration stance.

There is already speculation that France would be prepared to offer the new prime minister zero tariffs on goods (where the Eurozone has a large surplus with the UK) and controls on immigration from the EU but no passporting rights for UK banks in to the EU. This would be exactly what the Farage wing of Leave would accept, but do great damage to the City and Conservative supporters.

As ever in politics there will likely be a compromise with some damage to the UK’s access to the single market in services in exchange for some flexibility on EU freedom of movement.

The BoJo manoeuvre

It is May 2018 and the Prime Minister is in reflective mood, relaxing in 10 Downing Street with a drink. Fortes fortuna luvat was the phrase that sprang to his mind, or “fortune favours the brave” for those not lucky enough to enjoy his classical education. He was thinking of the book he would later write describing how he had emerged not only as the man who saved both the United Kingdom and the European Union, but, more importantly, how he had succeeded where his long-time rival, Dave, had so conspicuously failed. History, he was confident, would be kind to him.

Perhaps brave was not really the best word to describe the fairly straightforward political calculation that, whatever happened in the referendum, as the most prominent Conservative to stand on the Leave side of the debate, he was the obvious choice for Conservative activists to vote for as the leader to follow Dave. The fact that he didn’t himself really believe that Britain should leave the EU had been hidden away in a distant corner of his brain for the duration of the campaign.

There had definitely been a strong element of fortune though. The 50.3% victory for Leave was clearly affected by the torrential rainstorms that hit the UK in the late afternoon of June 23, 2016. The pensioners had been able to vote to Leave in bright sunshine in the morning, but a combination of storms and England playing in the European football championships in the early evening meant a much lower turnout amongst the younger generations, who polls showed were much more inclined to vote Remain.

Though Dave had initially wanted to stay on as Prime Minister, the backbench Conservative MPs quickly made it very clear that his time was up and he announced his resignation the weekend after the referendum. He felt it inappropriate to invoke Article 50 of the Treaty of Rome and start the clock on the two year timetable that would lead to Britain’s exit from the EU, saying that was a decision that should be taken by his successor.

Boris became Conservative Party leader, and Prime Minister, in September at the Party Conference, but the British public had already begun to experience doubts about the wisdom of its referendum decision in the intervening three months. Stock markets, not only in the UK but also in Europe had fallen sharply and a surprisingly large number of businesses announced their intentions to move their European headquarters to somewhere inside the EU – investment intentions and economic confidence had been hit very hard following the vote.

Not surprisingly the global banks such as J P Morgan, Goldman Sachs and Deutsche Bank clearly had well-developed contingency plans and were quick to announce their intention to move jobs from the City to Frankfurt and Paris from 2017 onwards. However what had taken many by surprise were similar announcements from key global manufacturing companies such as Siemens, Toyota and Pfizer and the withdrawal of EdF from the Hinckley power project, on advice from the French government, had left the UK’s long term energy policy in tatters. The number of announced lost jobs directly attributable to the referendum decision was much greater than even the Remain proponents would have dared to suggest in the campaign.

With Donald Trump, the Republican candidate in the November Presidential election, telling everyone how unhappy he was over the his treatment by the Scots over his dream golf course and saying that the UK had no chance of a trade deal if he was President, the UK economy was moving rapidly into recession amid massive uncertainty.

Given this backdrop, Boris also chose not to invoke Article 50, arguing initially that it made more sense to await the outcomes first of the US elections, and then the French and German elections in 2017 – after all there was no point in beginning negotiations with the EU when the two leading nations would not want to agree anything until their domestic political situations were clarified.

The European nations were also surprised by the drop in confidence in their stock markets as investment intentions declined further. The ECB were at the very edge of what was possible in terms of negative interest rates and QE, and fiscal policy remained constrained by German orthodoxy. What Europe had not expected though was the loss of respect from both the US and China, with many very rude comments about their irrelevance in the world without the UK coming from Trump and leading Chinese politicians. The continuing refugee crisis also tested to the limit the desire to maintain the Schengen area freedoms.

The critical factor had however come from Putin, who sensing Europe’s weakness has invaded and occupied Eastern Ukraine and was openly considering its annexation as he had done with Crimea. With the US consumed by its election it was left to Europe to take the lead in responding and they realised they needed to have the active and committed support of the UK.

Both the UK and Europe thus found themselves staring into an abyss in the months following the first referendum and were very frightened by what they saw.

Europe remembered that the initial vision for the EU had been to end war within Europe, and to that end the full-hearted involvement of the UK was now key. Compared with that even the free movement of labour, so beloved by the former Eastern European nations, could be seen as secondary.

So Boris had found it fairly straightforward, once the new German government had come to power, to seize the opportunity and come to a new reform agreement with the EU, which allowed the UK to control which EU residents could stay in the country, and allowed the UK much greater freedom not to implement bureaucratic EU directives. This dealt clearly and satisfactorily with the issues of immigration and sovereignty that had led many in the UK to vote to leave in the first referendum. The second referendum saw a Remain vote of 65%.

He had achieved a rare unity – the English were pleased with him, the Scots were pleased with him and even the Europeans were pleased with him. His place in history was now assured and, best of all, future historians would be able to compare directly the two referenda and prime ministerial performances, one dismal failure under Dave, one major triumph under himself.

Dips or a Pancake – the UK economy

The UK does not have an official definition of a recession, so the media use the US definition of two consecutive quarters of negative growth in the size of the economy. Measuring the size of the economy is a hugely complex task that takes three to six months to do properly. However the markets and media are only interested in the first estimate that is produced about three weeks after the end of each quarter. Then they only look at the change of that result from the previous quarter – if the answer is less than zero then recessionary conditions are proclaimed, if between zero and one half of one per cent then it is sluggish growth and if above three-quarters of one per cent then Britain is booming. The margin between deep gloom and euphoria is amazingly small – when one adds to this the fact that the average size of error between the first estimate and the final figure is about 0.3%, then it is easy to see why instant newspaper headlines following quarterly GDP data can often turn out to be very misleading.

The first estimate recently published for Q1 2012 UK growth was -0.2%, this followed -0.3% for Q4 2011 and so satisfies the working definition of a recession; worse still because there had been such a poor recovery since the last recession, it can also be called a “double-dip” recession, adding further hyperbole to the headlines. There are at least 11 other EU nations who are also in recession with a few more still to report. For those who follow the detail, the surprise in the data came from construction spending, which had it been in line with expectations would have  brought growth up to +0.1% and prevented the headlines about recession. The National Statistics Office has for some time now had problems in accurately calculating construction spending and keeps changing how they measure it, and when one adds to that the fact that there is normally relatively little construction work done in winter and so substantial seasonal adjustments have to be  made to the data, but that this winter the weather was surprisingly good, then quite frankly nobody will know for some time what the correct numbers might be.

The last 6 quarterly reports have been -0.5%, +0.2%, -0.1%, +0.6%, -0.3%, -0.2% – the most sound conclusion that can be drawn from this is that for eighteen months the economy has been flat and growth has been zero. Within that the public sector has seen slightly negative growth (but only slightly, see here), the private sector has seen slightly positive growth (but not enough to stop unemployment rising) as at home consumers fear for their jobs and in the Eurozone, our largest export market, significant and painful austerity is being imposed. Additionally, loan growth is negative as consumers, companies and banks all seek to reduce their debts and hold more cash, rather than invest for the future.

This “flat as a pancake” picture is likely to continue, but the risks are much more skewed to a worse outcome than they are to a better one. At a zero rate of growth, the economy is very vulnerable to any external shock quickly sending it into recession, and western policymakers have very limited policy options available to mitigate any such shock. Fiscal deficits and debts are already too large and need to be brought lower and so provide no scope for fiscal stimulus, whilst monetary policy has rates close to zero and only further Quantitative Easing as a policy tool which is showing a clear pattern of diminishing returns, each time it gets deployed.

This UK government has only ever had a Plan A, and so is sticking firmly to it, mostly because there are no decent Plan Bs anyway, and has always relied on the rest of the global economy being in a reasonable state. However the pancake is better than the dips.

Is “Europe” more important than democracy or the rule of law?

The desperation of Europe’s leaders to protect their banking systems from the effects of the sovereign debt crisis is leading to startling decisions and actions which call into question their commitment to the principles of democracy and the rule of law.

Last year Merkel and Sarkozy made it clear that Europe required Italy and Greece to install technocratic leaders in order to force through the austerity and structural reform measures that Europe deemed necessary if it was to consider continuing to support these countries through their financial crises. When the previous Greek Prime Minister suggested holding a referendum on adopting austerity measures last November, he was told in no uncertain terms by Germany and France that this was unacceptable. European referenda have a nasty habit of delivering results that the political elites do not like.

Then last week, Wolfgang Schauble proposed that Greece should postpone its general election due in April and extend the life of  its technocratic government. The sub-text was very clearly that Germany feared an inappropriate result that might lead a new Greek government to renegotiate the terms of the E130bn bailout after it had been agreed and Europe had committed substantial sums of money. From the rulings of the German Constitutional Court in recent years, it is quite clear that if anyone tried to push the Germans in similar ways, the reaction regarding the primacy of German sovereignty and democracy would have been extremely forthright. To a great extent these demands resemble the power battles between debtors and creditors in a failed company, where the creditors can take full control of a company’s assets when it cannot meet its obligations, but countries are not companies and voters are not shareholders that are automatically disenfranchised upon bankruptcy.

Perhaps even more worrying is the ECB’s action to ensure that it has greater rights than any other owner of  equivalent securities in the financial markets. By demanding that its Greek government bond holdings be converted into other bonds that will have priority over all other Greek debts, a few weeks ahead of a plan that will see all other Greek government bond holders lose approximately two-thirds of the value of their holdings in a “voluntary” haircut, the ECB is at the very least flouting financial market convention that all holders of a security should be treated equally. At its worst interpretation, in a situation where there will be limited assets to repay the debts, it can be construed as theft.

Worse still is the implication for any other sovereign European bonds that happen to be owned by the ECB. The greater the ECB ownership, the worse-off are all other private holders of other European debt as their rights to repayment now rank below those of the ECB (in credit markets this is known as subordination). Thus the creditworthiness of all European debt in which the ECB has a stake has been even further reduced. This is likely make it more expensive for these issuers (Portugal, Ireland, Italy and Spain) to raise money for a very long time to come. Future sovereign crises are now in danger of setting off vicious cycles of ECB intervention buying sovereign debt in the secondary market leading to private sector investors selling down their positions as they become less creditworthy so worsening the crisis.

To be sure there are no easy choices in solving  the euro sovereign debt crisis, but the longer term costs of some of the solutions that are being called for and implemented may well be far higher than currently understood.

PS – it also appears that Greece’s creditors will take over the national  gold reserves too.