Brexit: la bombe surprise

When is a deal a betrayal? And if there’s a deal, why is UK business frantically preparing for no-deal? And if there is to be no-deal – will that be a catastrophe? Victor Hill thinks investors should hold on tight and focus on three key things.

A choice between vassalage and chaos?

It was at about 16:00 on Tuesday (13 November) that the news flashed up on our screens that a Brexit deal had been struck between the UK government negotiating team and the EU. Mrs May emerged from a marathon five-hour cabinet meeting on Wednesday evening to announce that the cabinet was on-side. Brussels announced there would be an exceptional summit on 25 November.

Then, on Thursday morning, the first cabinet resignation: significantly that of Dominic Raab, the Brexit Secretary, the man who was supposed to have negotiated the deal. (It turned out he did not). Mr Raab was quickly followed out of cabinet by Work and Pensions Secretary Esther McVey. As I write, a further five junior ministers have resigned. Mrs May’s statement to the House of Commons Thursday lunchtime was met with hostility from all sides.

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On Wednesday evening no one outside of Mrs May’s close inner circle had actually read the agreement – so the pundits could only speculate on its contents. What we did know was that the deal, if ratified, would entail that the UK would remain inside the EU Customs Union, not just for the transition period up to December 2020, but indefinitely until such time as a Canada-style trade agreement was concluded between the two sides. And even then, the “backstop” would determine that the UK could only leave the Customs Union with the consent of the EU…

Until such point, Britain would have to conform to all EU rules while having no say whatsoever on their formulation. The draft agreement became available for the likes of us to download on Thursday. It is 587 pages of turgid, legalistic prose. Good luck if you intend to read it.

On the plus side (for Brexiteers), it looked like freedom of movement was to end and that the UK would disentangle itself from the Common Agricultural Policy, the Common Fisheries Policies and the European budgetary cycle (all after the transition period). It was unclear whether Britain’s fishermen would fish in British waters without the competition of their European counterparts. On the minus side, during the transition period (or periods), the ECJ will retain jurisdiction over UK laws.

At the annual Mansion House speech on Monday (12 November) the Prime Minister had alerted us that a Brexit deal was imminent – though she hedged her bets by saying that the government was also preparing for no-deal. That day The Rev. Johnson declaimed from his pulpit in the Daily Telegraph that Mr May was leading us to vassalage and that the cabinet should mutiny. (In the same article he also said that a mutiny would make no difference). Mr Rees-Mogg looked more sombre than usual and insinuated that his faction would seek to unseat the Prime Minister. On Thursday he finally submitted a letter to 1922 Committee Chairman Sir Graham Brady advising his loss of confidence in the PM.

Mr Redwood wrote in his diary on Wednesday:

This is a bad deal. The government should drop it now. Parliament is unlikely to pass the necessary legislation for it. I will vote against were they to try. If we can’t get a good future partnership before we pay them any extra money, why would we get one once we have signed away the cash?

My task today is not to take sides amongst the Tory factions – the Brexit Ultras, the Brexit Pragmatists and the Tory Remoaners. I want to ask how investors can make sense of the vortex of rumour, speculation, gossip, media-noise and fake news. To answer that question I’d like to step back from the proto-deal itself and re-affirm three propositions.

The first is that the European Union itself is in deep trouble – economically, politically and philosophically – much more so that most Europeans realise. In fact, the actions of hyper-federalist like President Macron are only making things worse. The second is that, over the medium to long-term, Britain’s decision to leave the European Union will be justified (history may even judge that a botched deal was still worthwhile). The third is that, even if there is no-deal –because Mrs May’s deal is rejected by Parliament – there will be turbulence; but the UK economy will ride it out.

Proposition (1): It is Europe that is dysfunctional, not the UK

There are two major fault lines within the EU, of which one within the 18-state Eurozone itself. The Eurozone rift runs North-South: it reflects the disparity between the surplus countries, such as Germany and the Netherlands, and the deficit countries which aboard the Mediterranean. Then there is an even deeper cultural fissure which runs East-West. The Western EU states are liberal and relatively amenable to mass immigration; the Eastern EU states are socially conservative, like Catholic Poland, and find the prospect of the obligatory imposition of migrant quotas unacceptable.

I observed the two-minute silence last Sunday at a 13th century church in Kent. There was so much symbolism, however, in what was going on in Paris, over 300 kilometres away as a crow flies. There, President Macron, who was hosting more than 60 heads of state and government, used the occasion to deliver a speech warning of the dangers of nationalism. He said: “Patriotism is the exact opposite of nationalism”.

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This was not a thoughtful reflection on the peace that has prevailed in Europe since 1945. It was a pointed jab at such states as Hungary, Poland and now Italy which have decided to assert their own interests at the expense of the European ideal. It was also a slap for Mr Trump – a self-proclaimed nationalist – who sat beside him looking peeved. (Mr Trump later tweeted that the French would be speaking German today if it were not for American military assistance in two world wars. He also observed that there is no country more nationalist than France). On the same day the French Finance Minister, Bruno Le Maire, told a German newspaper that Europe should become an empire.

Last week President Macron announced that Europe needed to build its own army in order to protect Europe against the US, China and Russia. That prompted a tirade from Mr Trump, whose bromance with Emmanuel Macro is clearly over. On 13 November Frau Merkel unequivocally called, in support of President Macron, for the establishment of a European Army in a speech to the European Parliament in Strasbourg. She said that an EU army would counter unreliable allies. (I think she was referring to America and Britain).

As if to underline the East-West split in Europe, the Poles were celebrating the 100th anniversary of the re-establishment of their nation. At an Independence Day event in Warsaw, Polish President Duda addressed the multitude. Polish soldiers stood side-by-side with members of the National-Radical Camp (ONR), which is vociferously opposed to Muslim immigration, and representatives of Forza Nuova, an Italian right-wing movement.

Monsieur Macron’s attempt to re-configure the Western security alliance, supported by the out-going and increasingly enfeebled German Chancellor, makes him a much more dangerous figure than Mr Trump. It is now clear that the Franco-German alliance is now trying to impose itself on every aspect of government policy within the European Union.

This is an aggressive act; but it is also defensive. For the European mandarins now believe that the Italians could now bring the Euro crashing down…

The Doom Loop is a noose around Italy’s neck

On Monday (12 November) the stand-off between Rome and Brussels over Italy’s 2019 budget claimed its first casualty. The major Italian banks had to unite to support an emergency bond issue by Banca Carige (BIT-CRG). The relentless rise in Italian government bond yields triggered by the concerns of the financial markets over the budget battle had impacted the bank’s capital base – just as I foresaw in September.

Monday’s intervention averted a bank failure and the contagion that would have ensued. The event reminds us, however, that the Doom Loop (a phrase coined by the World Bank) between the finances of the Italian state and those of Italy’s banks persists. Italy’s banks now own 20 percent of all outstanding Italian sovereign debt, a holding which makes up 10 percent of their asset base.

The Italian government needs to roll over €288 billion in debt during 2019, as well as sell issuing and additional €50 billion in net new issues. With foreigners having reduced their holdings of Italian government bonds from 50 percent of the total outstanding in 2009 to 34 percent today (the lowest since 1999) and with the ECB set to halt new asset purchases after next month, Rome had been relying on Italian banks to provide that finance. If Italian banks are less willing to buy government bonds, that will push up government bond yields even higher, further deepening the doom loop.

Jim Mellon told a private audience of investors in Manchester last Friday (09 November) at which I was present that it was more than likely than ever that Italy would leave the Eurozone. It’s not as if the Eurozone economy is looking robust. Bank of France industrial sentiment index fell to 103 in October, from 104 in September. Italian industrial production fell by 0.2 percent month-on-month in September.

A number of German politicians now back President Macron’s plans for a European Army and a common Eurozone budget. British Remainers should face up to the fact that, if the British people understood that, they would still want out. A German commentator recently told the BBC R4 Today programme that Brexit was about number 25 on Germany’s list of headaches. That made me smile.

Proposition (2): We leaving the EU with good reason

There was a swim-suited belle in Love Island a few months back who said that she just couldn’t get her head around Brexit. She’s not the only one. How will you explain Brexit to your children after we leave? Of course, there were many reasons, but here’s the main one…

The EU offered freedom of movement for the citizens of all its member states – from Bulgaria, where the average wage is €4 an hour, to Denmark where the average wage is €44 an hour. So anyone from a poor country could decamp to a rich country and live the dream.

Except that they couldn’t. A Bulgarian arriving in wealthy Denmark, France or Germany could waltz in – but would rarely get a job. In these countries the labour market is much more inflexible than in the UK: the laws on hiring and firing are much more restrictive. Even in unskilled trades they would have to provide material evidence that they were qualified to do the job – meaning that they would have to do a two-year training course in France to become a French plumber. (And they would have to pass a language test). They would not get benefits because they had not paid into the system. Not so in Britain.

Because Britain, since the Thatcher supply-side reforms of the 1980s, had a dynamically mobile labour market such that the Bulgarian could get a job on Day One. I was served by a Neapolitan waiter at a restaurant in St. Pancras some months ago who had arrived on Eurostar that afternoon. That is simply unimaginable in France or Germany. Furthermore, my young Neapolitan friend was immediately entitled to state benefits (including Working Tax Credit) which would have seemed extraordinarily generous in Southern Italy.

There are many more reasons why there was always going to be a parting of the ways – but this one, in and of itself, is justification enough. People talk about free trade as if it is all about the abolition of tariffs. In fact, non-tariff barriers – which still exist within the EU, especially in services, are a much bigger deal than tariffs.

I have been banging on for more than three years in these pages now to the effect that unrestricted low-skilled immigration drives down wages of the indigenous working classes in this country – forcing them into welfare and often into despair. And, at last, a serious think tank has conclusively established that I was right.

Economists for Free Trade (EFT), a 16-strong group of experts including Patrick Minford, Professor of Economics at Cardiff University and Roger Bootle, Chairman of Capital Economics, argues in a recent report that Britain’s poorest families are at least £300 a year worse off as a result of unskilled immigration. This, as we know, accelerated rapidly after the accession of 11 poorer Eastern European and Mediterranean countries to the EU in May 2003. The most deprived regions of the UK – where most of these unskilled immigrants settled – suffered disproportionately because the strain on public services (doctors’ surgeries, schools, public transport and the rest) was most acute there. The EFT report calculates that it costs the UK £3.5 billion to support unskilled immigrants every year.

On 13 November the ONS revealed that over the last 12 months, wages excluding bonuses rose by 3.2 percent – the fastest rate of increase since the end of 2008 when the financial crisis struck. That was just under one percent above inflation. UK unemployment also went up very slightly for the first time this year, rising by 21,000 in the same period to 1.38 million as more people became available for work. Clearly, the UK labour market is tightening – at last.

But, most tellingly, we can now see that the rise in wages is directly correlated to the supply of low-skilled EU workers. Also on Monday the CIPD reported that firms seeking staff are being hit by labour shortages, with a reversal in the number of migrants in UK workplaces.
As Brexit approaches, the CIPD claims that the shortage of both EU and non-EU migrants shows that foreign workers regard the UK as a less favourable destination. That is partly due to the weaker pound and the improvement in the European economies over the last year. Research among over 1,000 employers suggested that vacancies are becoming harder to fill. This squeeze is leading employers to increase pay rates, according to the CIPD.

According to the latest official data, the number of non-UK-born workers in the UK decreased by 58,000 between April to June last year and the same period this year. This compares with an increase of 263,000 for the same period between 2016 and 2017.

I conclude that people on low wages – the very people who were most disadvantaged by globalism – are already benefitting from Brexit. Just as US steel workers are already benefitting from Mr Trump’s tariffs on foreign steel.

Proposition (3): Whichever scenario, the UK will land on its feet

Brexit could boost the UK economy by as much as £135 billion a year, according to another EFT report. They argue that it is time to abandon the gloomy forecasts of Project Fear and embrace Project Prosperity – the mounting evidence that quitting the protectionist EU will improve Britain’s prospects.

The surge in national output – worth about £5,000 a year to the average UK household – could also be accompanied by an 8 per cent fall in prices – which would add an average of £40 a week to poorer households. Moreover, there will be savings in benefits currently paid to unskilled EU immigrants.

In From Project Fear to Project Prosperity, Professor Minford says that the benefits of quitting the EU will only be realised by a combination of global free trade for Britain – outside the single market and the customs union – plus opening up the UK economy to the positive effects of full competition. He will probably now prefer no-deal in favour of Mrs May’s deal.

Meanwhile the UK economy is holding up. Growth in Q3 was a creditable 0.6 percent. In Italy it was zero.

Will Mrs May’s deal get through parliament?

I am not appraising the deal here but I can speculate on its chances of enactment. They are exceedingly small.

Within an hour of its publication late afternoon on 13 November, both Mr Johnson and Mr Rees-Mogg had vowed to vote it down. Mr Duncan Smith opined that the government was about to crumble. Most Westminster commentators and parliamentary arithmeticians judged that the deal would inevitably be defeated in the House of Commons.

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At PMQs on Wednesday, Labour MPs queued up to excoriate the Prime Minister – even though the deal closely resembles the package that they apparently wanted, namely a customs union, albeit a temporary one. No doubt it would suit Corbynite Labour to plunge the country into chaos – that is how extremists normally get elected. So we can surmise that, with all but a few outliers – Kate Hoey and Frank Field, perhaps – Labour will go into the division lobbies with the Tory Ultras. What a weird site that will be.

The SNP (35 MPs in the House of Commons) has decreed that if Northern Ireland should be allowed to remain in the Single Market then so should Scotland. They will certainly vote against the deal. Meanwhile, the 13 Scottish Tory MPs have warned that unless Scottish fishermen recover control of their waters, they will oppose the deal. (Regular readers will remember that I campaigned in the Tory interest in beautiful Roxburghshire in Scotland during last year’s general election. I know for sure that men such as John Lamont MP are unyielding on this). In addition, the DUP – whose 10 MPs are supposedly in informal coalition with the Tories – have already rejected the deal.

We all know that there is no way that – even if Mrs May is deposed – Britain will be able to go back to Europe, like Oliver Twist, and ask for more. Barnier & Co. will just tell us to go jump. So Labour will actually be voting for no-deal. That will mean severe frictions for supply chains – especially in our aerospace and automotive sectors. I’ll explain soon why the no-deal scenario is actually quite survivable – and may even throw up some unexpected opportunities.

Sterling rose to its highest level against the Euro for more than one year on Tuesday afternoon – only to crash at one point by two percent against the US Dollar on Thursday morning. UK bank shares were hammered on Thursday on the London market.

Assertions that the withdrawal agreement must be ratified by all EU-27 national parliaments turned out to be untrue – it must be ratified only by the European Parliament. French media has already been muttering that the deal is too conciliatory to les Anglais.

Well-run businesses, like Premier Foods (LON:PFD) and Rolls-Royce (LON:RR) have announced that they are planning for no-deal. In the unlikely event that this deal goes through, the negotiations on Britain’s future trading arrangements with the EU will not even begin until the second half of next year. These could last well beyond the formal transition period which ends in December 2020 – and there is scope in the agreement to extend the transition period by another three years.

I voted Leave with my eyes open – I have always argued that we could not just shred 45 years of complex regulations overnight. Britain will emerge as a truly sovereign state (unless Brexit is reversed by a spurious people’s vote unlikely in my view) sometime in 2022-24 – by which time the UK will have had a general election. If you are bored stiff by Brexit today, I regret to advise that the torture will continue for quite some time to come…

I wrote in early October that we were at the point of maximum uncertainty. I was wrong. Things are more uncertain now than ever. On Friday morning the government is on the point of implosion (Mr Gove has rejected the post of Brexit Secretary – but will he resign?), Mrs May faces a vote of no-confidence and the only deal in town is about to be asphyxiated by an alliance of Ultras and opportunists…

And yet, and yet…As I wrote in the summer of 2016, this is just something we have to get through in order to grow up into what we could become – like adolescence. Acne and all.