The Brexit talks-about-talks have started badly. What is the chance that there will be no deal at all? Are investors heading for the rapids…?
Come dine with me
On 26 April Theresa hosted dinner at her well-appointed home in Downing Street for Jean-Claude (a louche Belgian gentleman whom she had met on a caravanning holiday in the Low Countries) and his French friend, Michel. Theresa also invited David, her live-in handyman, to make up numbers.
There was much double-kissing on the steps of Number Ten as the guests slipped off into the night in their shiny motors. Theresa thought that it has all gone rather well. The lamb had been succulent and the banoffee pie had had just the right balance of sweetness and astringency. There had been a few somewhat awkward pauses; but when conversation flags David can always be relied upon to jolly things up with one of his Scotsman-Englishman-Irishman jokes.
Imagine Theresa’s consternation when she read in a German newspaper a few days later that Jean-Claude had immediately called his friend Angela on her private mobile to complain that the peas had been frozen – and the wine served was the bottom-shelf plonk from ASDA. Worst of all: he’d told her that the conversation was inane: Theresa was on another planet and David was a bit of a tit.
Theresa, who has described herself as a bloody difficult woman, was not going to take this lying down. She set up a lectern outside her lovely terraced home and invited the world’s media. She told them she is simply not going to put up with any more Eurotrash slagging off her dinner parties. She said: There are some in Brussels who do not want our dinner parties to succeed…
Whereupon Jean-Claude announced that he wasn’t even going to speak English anymore…
Unreasonable demands
In all seriousness, the overture of the Brexit negotiations has got off to a remarkably discordant start.
I had always supposed that the issue of the status of EU citizens in Britain (and conversely that of British citizens in Europe) was a no-brainer. But no, the EU high command has come up for air with an impossible proposal.
The EU is now insisting that all EU citizens in Britain must be guaranteed in perpetuity the same employment and social rights that they enjoy today. It means that we would have to operate two systems of law in the UK – one for indigenous inhabitants and another for more favoured new arrivals (Lithuanians, Romanians, Slovaks – all fine people, no doubt, but who have come here for their own personal advantage). The exit deal would include a provision for the European Court of Justice to continue to oversee legacy laws pertinent to EU citizens[i].
It reminds me of Mughal India where different laws – and of course taxes – were applied to Muslims, Christians and Hindus…It is toxic – an incitement to social unrest. There is simply no way that Mrs May could agree to that.
Budget problems and exit bills
Pity the German taxpayer – for it is they who will bear the consequences of a no-deal scenario. Brexit has big consequences for the EU budget and the Germans finance most of it.
The EU budget currently amounts to €145 billion, which as the European Commission often reminds us, is just one percent of the total GDP of the 28 member states. It’s about equal to Hungary’s GDP and larger than Slovenia’s and Slovakia’s combined[ii].
The UK is the second largest net contributor of the 28 after Germany, and contributes net-net around €12 billion a year – significantly more than France. Poland is the largest recipient, followed by the Czech Republic. Unless the EU can extract that money from the UK as the price for accessing the single market, there is going to be row. Either the budget will have to shrink, as Germany’s deputy finance minister, Jens Spahn, has argued; or Germany and other large countries will have to pay more. The Dutch have already decreed a robust no way, José to the latter.
It seems to me that the current spat about Britain’s exit bill – €50? €60? €100 billion? – is largely a driven by the concerns of the EU high command to avoid a major rumpus about the budget, post-Brexit. I predict that, by late summer, the matter of German contributions will have become a major topic in the German election campaign.
Leading Tory barrister Martin Howe QC has advised the Prime Minister that the EU’s legal argument for the Brexit bill is “completely empty”. I have already argued in these pages that any outstanding pension liabilities in respect of British officials who have worked for the European Commission should simply be transferred to the UK civil service pension scheme. Any further obligations relating to the EU’s future spending from which the UK will not benefit are dubious. There is a growing body of opinion in the government and beyond that Britain should simply refuse to pay.
The Macron factor
I wrote last Monday that the new French President is a Euro-federalist who will push for a European Ministry of Finance and, in the immediate future, a Euro-wide rate of corporation tax. There are many reasons to suppose that he is likely to adopt a highly antithetical position towards the UK. He has called Brexit a crime and has said that Britain “will become Guernsey”. (That may have been a French joke – one never knows).
That said his chief economic advisor has been tasked to emolliate the British press. Jean Pisani-Ferry is Mr Tender to Emmanuel Macron’s Mr Tough. He alone is saying that France needs to build “a new relationship” with Britain. Monsieur Pisani-Ferry has written a paper arguing that it would be folly for the French to antagonise the British. It is not known what his master thinks of it.
What we know is that Monsieur Macron believes that Britain cannot be seen to benefit from Brexit and that he wants to take every opportunity to gemmy business away from the UK – especially financial services. He believes that “third party” firms should be shut out of EU contracts. But as a matter of reciprocity, if BT (LON:BT) were cut out of contracts for the French state it might behove Mrs May to cancel the contracts of the French defence contractor, Thales SA (EPA:HO) with the MOD. In practice, however, such things will not happen overnight.
Remember that Monsieur Macron’s only brief foray into the private sector was his three years in the House of Rothschild. There, he worked exclusively on mergers and acquisitions (M&A). He probably believes the standard economic theory that mergers always work. When the lived experience is that most mega-mergers destroy value – while de-mergers almost always unlock value.
Indeed, one can increasingly see the EU as a bloated conglomerate trying to chide its under-performing Southern subsidiaries with tedious key performance indicators – inducted by means of endless ghastly PowerPoint presentations. Ask the Greeks.
For Monsieur Macron, as for Frau Merkel, Brexit is an unauthorised de-merger to which the Board objects. In practice, President Macron will leave the day-to-day negotiations to the EU Commission team and he is unlikely to intervene directly. But he and Frau Merkel will set the tone of the discussion – a sombre one, I suspect.
The zero option
The only explanation for the European behaviour thus far is that they believe that Mrs May will sign any deal, however pitiful – just as they wore David Cameron down last year and forced him to sign a damp squib. Mrs May is now making it quite clear that, if this continues, she will walk away.
She said on 02 May that “no deal is better than a bad deal”. James Forsyth, a journalist I trust, reported on The Spectator website on 06 May[iii] that the Cabinet Secretary, Sir Jeremy Heywood, had instructed all government departments to prepare for a no-deal scenario. The word is that the British are going to send an unmistakable signal to the EU high command that, if they continue to play hardball, the British will really be prepared to take the zero option – and walk away.
WTO rules OK!
There is a growing consensus amongst right-of-centre economists and politicians – led by that national treasure, Lord Lawson – arguing that trading with the EU under WTO rules would not be such a bad thing after all. It may even (long-term) be advantageous. Peter Lilley (sadly now leaving the green benches) has argued that our net contribution to the EU is almost twice the tariff we would pay on our exports to the EU. Moreover, the Treasury would collect £12.3 billion in tariffs on imports from the EU whereas our exporters would pay only £6.5 billion tariffs [iv].
The tariffs themselves are actually quite modest – the weighted average tariff on manufactured goods under WTO rules is about 3.5 percent. That could easily be offset by exchange rate fluctuations or differential rates of VAT. What is more concerning are the “frictions” associated with additional paperwork (waybills, export licenses etc.) and physical barriers such as warehousing requirements and inspections.
I believe that, relatively rapidly, most of these so-called frictions could be alleviated by technology. Just as you can get a “tag” (microchip) which enables you to drive across the QEII Bridge or on the M6 Toll without having to go online and pay each time, so exporters could fill in all their paperwork online and then charge tags in their trucks which would be automatically scanned as they cross into the EU. But these systems will not be in place on X-Day – 29 March 2019 (the second anniversary of the triggering of Article 50). There will be perturbations.
There is already talk in Northern Ireland that the border between North and South will be an “e-border” – with no necessity to go back to the bad old days of the “hard border” with officious customs men and police patrols. Michel Barnier was in Dublin on Thursday, 11 May. He chanted the mantra that “Brexit will have consequences” – but reassured the Irish that “We shall do all we can to prevent a return to a hard border”.
Have the markets understood?
I now think it is increasingly unlikely that the two sides will have fine-tuned a comprehensive trade deal by 29 March 2019. In the medium term, in five to ten years, economics will trump politics and there will be a fully-fledged trade deal. But right now, a WTO exit in 2019 seems by far the likeliest option – though that will not be a catastrophe.
My concern is that some of the money men might be thrown into a bit of a lather as that scenario looms more likely. Especially after Merkel 4.0 has been returned with renewed scorn for the deserters this September.
The curious thing is that the FX markets seemed to assume the WTO outcome from the start; while the stock markets have responded more idealistically as events have unfolded. There is a significant downside risk however, that, as the zero option approaches over the next 18 months, portfolio managers – especially European ones – may decide to dump British stocks as they anticipate lower trade and therefore growth.
When and if that happens, it could be a buying opportunity – particularly if the British government adopts a Britain first procurement policy in response to increasing protectionism within the EU. That would be good news for the likes of Bombardier (TSE:BBD) who make train carriages in Derby and aircraft in Belfast.
Interestingly, the FTSE-100 has gone nowhere this year while the FTSE-250 is up about 9 percent, each having different correlations with the value of Sterling. Before the crunch moment comes, you might want to be overweight the FTSE-100.
English gentility
The English, slow to anger, are almost unique in that they are brought up to find it amusing when foreigners insult them. If a Frenchman tells them that they have the dress sense of a hedgehog and their highest-end fashion brand is Primark; that the only English contribution to global cuisine is Marmite; that they are a bunch of overweight couch potatoes who are useless in bed; that they have the good taste of an orangutan…All this contumely will just inspire a soft chortle and then the Englishman or woman will politely invite the said Frenchie to partake of more cold baked beans and warm beer…
But if the haughty foreigner tells the Englishman that his one thousand year struggle for a most singular liberty was fought for naught; that the jurisprudence of his people is subservient to a an unelected committee of foreign placemen who all fiddle their expenses; that the citizens of other lands will live under preferential laws in
This royal throne of kings, this sceptred isle/ This earth of majesty, this seat of Mars/ This blessed plot, this earth, this realm, this England…[v]
Well, that’s when the English – along with their Welsh, Scottish and Northern Irish brothers and sisters – start to get angry.
So when Theresa instructs Boris, David and Liam to flounce out, she will do so with the support of the majority of the British public who will see the EU as an unreasonable antagonist. The 48 percent, according to the New Statesman is already down to 25 percent. Only 24 percent of the British people, according to YouGov, believe it is more important to enjoy tariff-free trade with the EU than it is to control immigration.
Before the talks have even started, Britain and the EU are on variant, and diverging, parabolic trajectories. Expect more unhappy dinner parties; and prepare for a market shock.
[i] See: https://www.theguardian.com/politics/2017/apr/21/eu-leader-backs-call-for-separate-deal-on-post-brexit-residency-rights
[ii] See Brian Caplen in The Banker, 09 May 2017, available at: http://www.thebanker.com/Editor-s-Blog/Why-German-taxpayers-are-Europe-s-weak-link?utm_campaign=TB+e-newsletter+9+May&utm_source=emailCampaign&utm_medium=email&utm_content=
[iii] See: https://blogs.spectator.co.uk/2017/05/government-considering-publishing-its-no-deal-brexit-contingency-plan/
[iv] See: http://www.express.co.uk/news/politics/754826/Brexit-news-Tory-MP-Peter-Lilley-no-EU-free-trade-deal-Britain-better-off-WTO
[v] Shakespeare, Richard II, Act II, Scene 1.