Au revoir, Auf Wiedersehen, Hasta la vista, Arrivederci – see you tomorrow!

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Au revoir, Auf Wiedersehen, Hasta la vista, Arrivederci – see you tomorrow!
Master Investor Magazine

Master Investor Magazine 58

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Goodbye, EU. To be honest, we never loved the idea of a German-run bureaucracy telling us what to do. Even if Europe gave us cathedrals, opera, romantic love and fine wine. But we still love Europe – and will always trade with her, says Victor Hill.

A bullet dodged

The UK’s withdrawal from the European Union today comes at a very delicate moment in the evolution of the global economy. Neither the benefits nor costs of Brexit will become apparent until well after the end of the transition period, when a truly new dispensation heaves into view next year. The 11 months remaining of 2020 will thus be a time of great uncertainty – as well as of opportunity.

Last summer, the global economy came perilously near to falling into recession as China slowed, German manufacturing plummeted and world trade stalled. The Federal Reserve changed course and jettisoned the contraction of its balance sheet, cutting rates three times; and the ECB abandoned its attempt to halt QE. What’s more, the full-on US-China trade war was averted. Market exuberance, if not entirely irrational, continues (tempered right now, mind you, by the threat of a global pandemic).

But Mr Johnson will seek to forge a new partnership with the EU surrounded by systemic risks. The global debt burden continues to increase, supercharged by Chinese Leninist capitalism. An IMF economist told an audience in Davos earlier this month that global debt had reached a record $188 trillion. That doesn’t even include structured debt (e.g. collateralised loan obligations). But any attempt by the priestly caste of central bankers to tighten monetary policy risks killing the patient. “Normal” interest rates will not return for some time (with consequences I have discussed in these pages before).

The overwhelming consensus in Europe and beyond is for a fiscal stimulus to bolster loose monetary policy. That is very timely for Project Johnson, which will seek to expand the economy via further deficit finance (i.e. borrowing) which hip economists now think cool. The budget on March 11 will pre-figure a spending splurge (see below).

Mr Varadkar thinks that the UK is a small nation that will be whipped into subservience by a much larger bloc. He is not a sophisticated analyst. If it as all about relative population size then China would have thrashed the US in the trade war.

The UK-EU negotiations will take place against a stage-set wherein the European nomenklatura are desperate to stimulate the eurozone economy for fear of another banking and sovereign debt crisis. They know that, having run out of ammunition, there is nothing the ECB could do to stave off a recession next time round.

Moreover, the key symbolic battle – the principle that a state can leave the EU – has already been won by the UK.

Finance or fish?

The un-sackable, eternally insouciant Monsieur Barnier resumes his role tomorrow as Chief Obstacle. Over the last month he has sounded even more intransigent than we fondly remembered him in Mrs May’s time. You might have thought a civilised win-win arrangement between two entities which start out in total regulatory alignment would not be too tortuous – but that would be to underestimate French elitist bloody-mindedness.

The EU happily trades with Thailand and South Africa (and Canada, for that matter) without dictating to them how many hours their workers work. But when the EU trades with Britain, apparently, it requires the right to determine our labour laws, personal taxation and industrial strategy. Otherwise, they might expose themselves to social dumping. Why do you think the hard-working Portuguese lost their once formidable textile industry?

The fact is that the EU – as embodied by Barnier – will do everything possible to prevent les rosbifs from gaining any kind of competitive advantage. That is precisely why the final Brexit will be a much harder one than the original outcome most likely back in the balmy summer of 2016. I assumed, in my Brexit youth back then, that the UK would remain within the single market and the customs union. Now I would regard that as anathema. You cannot be half-in and half-out.

The EU evidently wants the UK to maintain a level playing field in terms of state aid (NB Flybe), tax, social legislation and environmental regulations as part of the final deal in exchange for zero tariffs and quotas. But Mr Javid has asserted that “We will not be rule-takers”. In response, the European Commission has urged the UK to clarify divergence plans as soon as possible. The closer the alignment, the more straightforward the trade deal.

Next week – probably after the cabinet reshuffle, expected as early as Monday – Mr Johnson will pronounce on the matter. He is likely to say that Britain will be prepared to accept border checks rather than allow Britain to be a rule-taker and to submit to the will of European judges. Sovereignty trumps frictionless trade.

One very early clash will be over fisheries. Mr Varadkar and others have suggested that if the UK conceded on fisheries early on, effectively allowing the existing dispensation to continue, then the EU will grant UK banks equivalencestatus, and thus passports, assuring the future role of the City of London in European finance. It has been reported that the major banks are already lobbying the government to sweeten the Brexit pill by axing the bank levy and the bank surcharge at a cost of £4 billion.

I am at one with my friend, the Scottish Tory MP John Lamont, on this. He has been a champion of the fishermen (they are overwhelmingly, if not exclusively, male) of St. Abbs – one of the few remaining traditional fishing communities in the UK. Such communities were abundant before 1972. Any concessions to Europe on fishing rights will go down badly in Scotland where the only political dichotomy now is between the SNP separatists and the Tory unionists. I predict fireworks in March when Boris proclaims that the UK’s coastal waters are a sovereign exclusion zone – and large zones designated as marine national parks. Let the Europeans wail.

Monsieur Barnier has never been elected to anything (unlike Mr Johnson). He is not even accountable to the European Parliament. Phil Hogan, the new Irish EU Commissioner for Trade, could probably sort out the impasse within weeks. Watch this space.

Whether Germany will be able to maintain its £45 billion trade surplus with the UK is the real question Frau von der Leyen should ask. This comes at a moment when the Trump administration is squaring up for a punitive trade war with Europe. The US will not resolve its egregious trade deficit without reducing that with Europe. Trump II will have learned Trump I’s lessons from China – and will have nothing to lose. The outlook is not good for French wine and German cars.

Add to that the rise of populist politics (there will be ructions in Italy this year) and the massive structural disruption across the automotive industry. I’m told the lights are on all night these days in the Berlaymont.

Expect a celebration budget

Mr Javid will come over as excessively merry on 11 March. Taxes will be trimmed, mostly to the advantage of lower income households – the personal allowance will be raised again above inflation. Rabbits will be pulled from silk top hats. The mood will brighten even as Remainers enter a winter of discontent.

Master Investor Magazine

Master Investor Magazine 58

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Fiscal stimulus is the new economic orthodoxy – austerity, RIP. Even libertarian economist Ken Rogoff thinks Britain should spend, spend, spend…So long as it is mostly on infrastructure. The markets will respond positively – an 80 percent debt-to-GDP ratio looks modest by comparison with the neighbours, these days.

The infrastructure agenda

During the May years of Brexit stasis all of the major government investment decisions were effectively put on hold. Mr Johnson’s infrastructure in-tray is heaving.

First there is 5G. This is a priority for Mr Johnson because providing high-speed broadband to rural areas, especially in the North, would boost productivity and shore up his support base in the red-seats-now-turned-blue. The decision announced on Tuesday (28 January) that Huawei will be allowed to remain a supplier of 5G equipment, but would be restricted to peripheral activities, was a fudge – though probably a necessary one. The fact is that, if Huawei is not allowed in at all, or if its existing equipment were to be ripped out, then the 5G project would take much longer and would be much more expensive. And where are the substitutes? The 35 percent “limit” is perplexing, however. 35 percent of what, exactly? And who will decide when that limit has been reached?

The second big decision is on HS2 – the fast train from London to Birmingham and thence, ultimately, to Manchester and Leeds. Every time the consultants run the numbers the estimated costs increase and the anticipated benefits erode. From a cost-benefit point of view the project looks dire; and support for it on the Tory backbenches in in free fall. HS2 will scythe through true-blue Buckinghamshire, a county which will derive zero benefit from the project. And many Northern Tory MPs see the project as a London-centric one which will suck resources southwards.

The thing to understand about HS2 is that it was never really about speed, as the French trains à grande vitesse are. If you are connected to the internet and have a comfortable seat, then the marginal utility of getting to Birmingham 20 minutes quicker doesn’t count for much. It was always more about capacity. On Thursday (30 January) the Financial Times reported that Chancellor Javid was backing the project. I suspect there will be another Huawei-style compromise on this one.

Then there is the role of nuclear power in the UK’s energy mix. Hinkley Point C, powered by a pressurised water reactor, is already well underway down in Somerset where EDF (EPA:EDF) is the chief contactor and operator, and the state-owned China National Nuclear Corporation (CNNC) is the major investor. (Let’s hope CNNC and Huawei are not in cahoots, giving Beijing the ability to flick a switch and plunge the UK into darkness. Actually, British intelligence is painfully aware of this – more on that soon).

Hinkley Point C will have the unenviable reputation of being the most expensive nuclear power station in the world; and it will produce amongst the world’s most expensive electricity – at £92.50 per megawatt hour – roughly twice the price of EDF’s power output in France. EDF is likely to pitch shortly to build a new super reactor alongside Sizewell B on the Suffolk coast. That is likely to create much steam.

And let’s not forget the third runway at Heathrow airport. Famously, when Mayor of London, Mr Johnson declared that he would lie down in front of a bulldozer to thwart this project. In the hysteria of the “climate crisis” any expansion of aircraft capacity will be seen as a backward step. But the fact is that London Heathrow is the only major airport with just two runways – Schiphol has five. The airport is running at 100 percent capacity 24/7/365. A light dusting of winter snow: and paralysis results. There is nothing environmentally friendly about all those aircraft “stacking” over the Home Counties.

The reality is that the Johnson government, just like the Cameron-Osborne one, is a true believer in the efficacy of large-scale government infrastructure projects to pump-prime the economy. That is admirable; except that more sceptical economists know that grands projets are always late, always over-run their budgets and rarely deliver returns on investment of those in the private sector.

A US-UK trade deal?

January has raised some real issues in US-UK relations. At Davos, Steve Mnuchin, the US Treasury Secretary, made clear that the UK will face retaliatory trade sanctions – possibly on cars – if it persists with plans for a digital tax on the US tech giants. The Americans have already succeeded in forcing the French to delay the introduction of their proposed digital tax until “the end of the year”. They expect to arm-twist the UK in similar fashion.

Meanwhile, the OECD is formulating a common approach to taxing the tech titans. This would affect a wide range of companies beyond just the FAANGs. This is therefore an inopportune moment for the Johnson government unilaterally to impose a tax that many regard as discriminatory and unworkable – even if it was in the Conservative Party manifesto.

Worse still, Mr Johnson’s government has ruled out concessions to the US in agriculture, pharmaceuticals and access to the NHS before any talks have even begun. After the decision on Huawei, with shrill warnings coming from Washington, the Americans may conclude that there is nothing to discuss at all.

Philip Marey, Rabobank’s senior US strategist, predicts that the US will enter recession in the second half of this year. That risk could be exacerbated if a left-wing Democratic presidential contender fares well in the polls. And if Mr Trump leaves the stage, there will be no deal at all.

Big Ben strikes zero bongs

At 23:00 hours this evening the United Kingdom will formally leave the European Union after 47 years. I don’t know about you, but I shall hopefully be in bed – though I might pop into the village pub early evening to check the pulse. But forget champagne. Champagne should be enjoyed, in my book, either at luncheon or as an aperitif before dinner, not quaffed late at night. And what is wrong with our excellent English fizz?

Go for it, Boris! This year will be even more challenging than last. But we are behind you.


Comments (1)

  • John Davis says:

    We are behind you? What we are is Rees-Mogg’s unaceptable vassal state. Pay, no say. Rule takers not rule makers. A state in decline, facing a breakup of its union. A supplicant to the USA and China, just as Russia hoped. A country soon to have a foreign border through its own territory, imposing sanctions on itself. A world laughing stock, led by a self-serving serial liar and an unelected bureaucrat who used to live in Russia. Now seeking to suppress press freedom and legal rights while promoting bankrupting vanity projects pursued for personal glorification. The promises of removing red tape, unfettered SM access and frictionless trade abandoned as history is rewritten and the lies are quietly erased. A population manipulated by a secretive, but publicly funded, ERG group, with higher prices, bankruptcies, job losses and future austerity guaranteed. Just to keep the Tory party together, enrich a few pockets and pander to a fanatical minority by manufacturing a phony war against a pretend enemy, all helped by a rightwing press. Racism and xenophobia have become mainstream and the hard right are enjoying a resurgence which has all the hallmarks of a move towards fascism. Johnson has already attempted to close down democracy and is intent on preventing the courts from stopping him again. Utter moral degeneracy at the heart of government, but you don’t seem to have noticed.

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