A hard Brexit please

This week the government made clear its decision regarding the sort of Brexit it will be seeking. The red lines of control of immigration and withdrawal from the European Court of Justice’s jurisdiction represent the “taking back control” that the Leave campaign promised.

The other 27 countries in the EU have made abundantly clear that the price of Britain denying freedom of movement is that it cannot continue to be inside the single market –  the working definition of a hard Brexit. Thus some sort of agreement on how trade will be conducted between Britain and the EU will be required.

There appear to be two key areas to be negotiated before Britain actually leaves – (i) a transitional trade agreement pending a more permanent agreement which might take many years to conclude and (ii) an agreement on the financial services sector and the current passporting system.

It is interesting to note that the red lines regarding “taking back control” do not include the subject of the UK’s net contributions to the EU budget and it seems that Britain may be prepared to pay (financially) for a transitional trade agreement and agreement over continued financial services passporting. Whether this would be acceptable to the EU countries is not clear – the current payment from the UK of £18bn per year (which would presumably be the maximum that Britain would be prepared to pay), does not go very far when spread around 27 countries.

Whilst now is the time of maximum pessimism about Brexit negotiations -before formal talks have even begun and with each side setting out their red lines – Britain has lost goodwill in Europe over the last week following policy ideas announced at the Conservative Party ‘s regarding foreign-born workers.

Both Merkel and Hollande have made clear that it is important for them that Britain should be not be seen as having won anything by deciding to leave the EU, and though it is quite possible neither will be around to have much influence over the negotiations, their fellow-countrymen are unlikely to have very different ideas.

With important votes and elections in Italy, Spain, France, Netherlands and Germany over the next 12 months, little progress should be expected in the Brexit talks in that time period. This will prove negative to the world’s view of Britain – the pound has continued its post-referendum decline this week, and gilt yields have risen in anticipation of the higher inflation this is likely to create in the British economy.

International investors will at best defer further investment into the country and at worst begin making adjustments to their factory and office locations to reflect a Britain outside the single market. Any good news regarding the benefits of new trade agreements with other non-EU countries will have to await the outcome of talks to agree our relationship with the EU.

By announcing when it expects Article 50 to be triggered and its red lines, Britain has now entered a period of massive vulnerability for its economy. Maintaining the goodwill of the other EU countries should now be a key objective of foreign policy.

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.

Dear Diary – possible reflections of some of those at the G8 meeting

The G8 meeting achieved nothing, despite the sense of crisis in the markets. The communiqué was bland and meant different things to different people. Below are what the leaders may well have really thought  about the summit.

Barack.  Re-election chances continue to drop – only 6 months to go. Have to say that Angela has some backbone, kept going with the German Nein all weekend long despite all of us ganging upon her to open her wallet. Played at being best buddies with Francois, the new boy in our club – it keeps David and Angela on their toes. Anyway he and I do have a lot in common, the rich should be paying a whole lot more towards getting us out of this mess, and it shouldn’t be the ordinary Joe who takes the hits all the time. Europe really worries me though – if it all blows up this summer, it could send our economy back into recession just about election time and I’ll be a very young ex-President.

Angela.  Re-election chances continue to drop – only 16 months to go. Well, that goes down as one of the most miserable weekends of my life. I know I’m still at the top of Barack’s European speed-dial, but it was horrible to watch him buttering up Francois. At heart though neither of them believe in balanced budgets and sound money like I do; they just want the money and public expenditure to keep on flowing and keep their supporters sweet. I am now only really left with David as a true right-of-centre ally in Europe; at least he is backing our drive for a political union as the best option to save the monetary union. Even so, he joined in with the others that Germany must spend lots of money we don’t have and let the ECB print and cause inflation – I was totally alone on this but stood my ground.

I thought it was a pretty smart idea to take 3 hours off from our discussions to watch the Champions League Final – it would be 3 hours not having to defend sound economic principles and a chance for Germans to show the football world how good we are (again) – but it didn’t work out. Bayern lost (on penalties – Germans never do that) and the symbolism was so awful – a team of foreign imports on huge salaries from the part of London inhabited by investment bankers, managed to overcome the bulk of the German national team, who were so strong, courageous and disciplined, and from Munich, the most successful centre of the German export industry. Worst of all that photo of us all watching the game has gone viral thanks to Twitter.

David. Re-election chances starting to drop – though still have 36 months to go. Politics is a rum old game. Who would have thought that a British Conservative Prime Minister would be telling the nations of Europe that their best (and only) hope was to move toward a full-on political union led by Germany? Yet George keeps on telling me that really is the best hope for our economy until the next election. Maybe, but it would be terrible for Britain’s influence with the US and China if Europe was truly one country with an elected President. I really can’t see it happening though, but I just don’t know if that is a good or a bad thing. That photo should do me the world of good with all the ordinary footy supporters in the country though – not many Posh Boys really like association football. Like Angela I had to be grovel a bit to Francois.

Francois. Chances in the parliamentary elections in 4 weeks definitely on the up. Life is amazing right now. Two weeks I was M. Normal, a French Socialist leader that had never had responsibility for anything in my life except for other Socialists, and now the President of the United States of America is telling me and the others what wonderfully interesting ideas I have. Also quite a nice feeling for Angela and David to have to be extra nice to me right now – I shall make good use of that back home in the next few weeks ahead of the elections.

Mario. Politicians are so transparent, always worrying about their election prospects.

Vladimir. Why are these guys so afraid of elections? Everyone’s beating up on Angela. I reckon she needs a good friend like me, and then just maybe we can get Germany to see Russia as their best European ally, instead of always looking westward.

Democracy – the antidote to Eurozone austerity

Over the last twelve months of Eurozone crisis, the politicians in Europe have in the main been talking to each other rather than their electorates. In fact the conversations have involved Northern Europeans (mostly from Germany) telling Southern Europeans to slash government spending and find ways to collect more tax revenues and the Southern Europeans promising very solemnly that they have always intended to and will do so just as soon as they receive some extra money from the Northern Europeans. The voters have never been asked their opinion either in the North as to whether they want to commit funds to support those in the South, or in the South as to whether they want to go through with the austerity measures their politicians have agreed to. Over the next 18 months there are important votes in France, Greece, Holland and Germany, when the politicians will be courting votes and saying things that are odds with current policy settings.

It is said that in the French presidential elections, in the first round the French vote with their hearts and in the second round with their heads. Well, 30% of the electorate voted for the extreme left or the extreme right in the first round; both reject entirely the idea of deeper European integration and the economic policy of austerity. Further, the centrepiece of Francois Hollande’s platform is the rewriting of the fiscal compact set out in the new treaty to pursue a much more aggressive growth strategy and greater powers to the ECB to lend directly to countries. In this he is on a collision course with Angela Merkel and impact is likely to occur very soon after the May 6 run-off election. The received wisdom is that he will not seek dramatic change to what has already been agreed, and will be satisfied with language that has an aspiration for greater growth without meaningful measures – this would probably the best he would get from Merkel and Germany. The key though is that a clear majority of the French electorate rejected the current policies of austerity.

May 6 is also the date of the Greek general election. The technocrat Papademos who was put into power as the head of a coalition government of the 4 major parties in order to agree the terms and conditions of the Greek bailout, has completed his job and is stepping back to allow normal politics to resume. Northern Europe insisted that all 4 parties in the coalition individually signed up to the terms and conditions of the bailout, in order to prevent any backsliding after the agreement, but there are already problems. Recent polls indicate that 67% of Greeks want to stay in the euro but don’t want the austerity, which can be interpreted as wishful thinking, economic ignorance or that their politicians are allowing them to believe that such a choice exists. It is not clear that those 4 parties would command 50% of the seats in the new parliament, even if they could be persuaded. Already Venizelos, the head of the Socialist party has been floating the idea of Greece going back to the drachma as an alternative to austerity.

The Dutch too are struggling despite being seen as part of the Northern European bloc. The coalition government fell over the weekend because the far right party refused to accept the austerity measures necessary for the Netherlands to get their budget deficit in line with the Eurozone targets. An election now looks likely in Holland.

Once these elections are settled, attention will begin to shift to Germany’s election in September 2013. Here though the politics is reversed, what is popular with the Germans is the notion that the rest of Europe should engage in the austerity necessary to get their public finances in order as Germany has had to earlier this century, so that no further calls on the German purse are made from bankrupt Eurozone nations.

Exposure to the votes of their peoples is going to cause politicians to say and do things that make continued agreement on austerity and bailouts increasingly hard to do.

Elections and political transitions in 2012 – January 2012

This year brings elections or organised transitions in political leadership in Russia, the US, China and France. Such periods can lead to unpredictability in economic policy ahead of these transitions as current leaders seek to avoid bad news in order either to win the election or to go out on a high. Similarly the period immediately after an election or leadership transition is usually one where the leader has most political capital and will generally seek to execute his or her most vital or most cherished policies. These may not necessarily be those policies which are most appropriate in an economic sense but are the most appropriate in a political sense. With so many transitions in such important nations this year, the scope for good politics to triumph over good economics is very large.

The US election is now underway with the Republican primaries firing the starting gun. The two parties are ideologically further apart than at any time in living memory (the phrase “class warfare” is being used a lot), and the Democrat President is unable to get the Republican Congress to agree to anything he wants to do. This year policy is in limbo, US politicians are unlikely to agree on doing anything  with regard to economic policy – this is understood and to some extent accepted by the markets, but action must be taken in 2013 to start reducing the fiscal deficit and the candidates are unlikely to reveal to the electorate just how bad things will need to be in terms of spending cuts or tax increases. In addition, upcoming elections require all candidates to stand up very strongly for American interests in any international dispute – in trade matters this can easily spill over into protectionist policies to “safeguard American jobs”.

In China, a new generation of leaders will come to power just before the US election – at the top level there will be no shocks but there is much manoeuvring still going on for the next level down, who will form the leadership team in five years time. Chinese officials will struggle to allow or tolerate “bad” economic news, and any further weakness of the type seen in recent months may well generate another dramatic stimulus response of the sort seen in early 2009. In foreign and trade policy also, it will be important for the Chinese to be seen to be stoutly defending their interests to safeguard Chinese jobs.

France is the most interesting story with its May Presidential elections. First it means that Sarkozy cannot allow anyone to leave the euro before the elections, because all his efforts over the last two years to “save the euro” would have visibly failed – therefore more summits and buying of time with new initiatives is very likely. However were he to remain President (unlikely from the current opinion polls), he would never have to face the French voters again – he could afford to try to be a European statesman and actually may be prepared to adopt a more German solution to the euro crisis, even at the expense of traditional French interests. By contrast markets might get a nasty shock were his main challenger Francois Hollande to win the Presidency. He is a fairly unreconstructed socialist, and would have few political soulmates in Europe, and has already declared that the current policies of austerity and institutional change to force countries into more restrictive fiscal policies are unacceptable to him. It is difficult to see Angela Merkel willing to give much of the ground that Hollande would require in order for France and Germany to continue to lead the efforts to save the euro. Either way the French election looks likely to be absolutely pivotal in determining which way the euro crisis gets resolved.

Amidst all this, the UK looks to be a rather stable place. The coalition looks set to soldier on – the Liberals cannot afford to leave since the ensuing election would see them almost wiped out, whilst Cameron benefits from pursuing the economic policies that he believes is necessary but seeing the blame laid on the Liberals. The economic policy of steady austerity has been set for the next few years and no change will be considered until much closer to the planned 2015 election. For Cameron, current economic policy is both economically and politically appropriate and he stands in a place that many of his fellow world leaders would wish to be.