Brexit: Why I’m smiling (Part I)

The outcome for 29 March will be either a botched, unenforceable deal that will have to be junked later with much more pain and uncertainty ensuing, or a constructively chaotic no-deal WTO Brexit. Bring it on, says Victor Hill.

Project After goes live…

Plans for a no-deal Brexit are now far advanced in Whitehall – and the Europeans are expecting that outcome too. No doubt a few lily-livered Tory faint-hearts will resign on 29 March (another reason to open the Nyetimber Classic Cuvée). But the Maybot will just continue on autopilot…

I’ll consider the impact of the expected no-deal Brexit on the UK economy very soon. Today, I just want to focus on how the Europeans are bracing themselves for the crisis they themselves have ordained.

Britain is running a trade deficit with Europe of about €100 billion a year. Almost all major industrial sectors are in deficit with only our services sector in surplus. For example, exports of food and drink to the UK amount to €41 billion while the UK exports of agriproducts to the EU are just €17 billion. No doubt climate accounts partly for that but it is also because the British have acquired a taste for French wine and Italian pasta (even though both wine and pasta are produced in the UK – though in insufficient quantity and variety).

While the eurozone faces its third recession in a decade, the British economy is still growing at 1.4 percent – less than last year but ahead of most EU countries. What do the Europeans make of it all?

French fears

About 30,000 French companies export to the UK and over 10 percent of those have operations in the UK. A large slice of France’s €4 billion trade surplus with the UK comes from agribusiness. One quarter of wine and beverage imports to the UK come from France as well as about one fifth of all dairy products consumed. Such agricultural products could attract import duties of between 10 and 30 percent if the two countries begin to trade under WTO rules.

Some prudent French companies have taken precipitate action. The prestigious Maison Louis Latour which exports 1.2 million bottles of Burgundy wine to Britain each year has sent an additional 300,000 bottles this week for fear of delays at the ports after 29 March. Some French businessmen have been criticising the government of President Macron for focussing solely on the rich pickings that Paris can take from the City of London, post-Brexit. (On that, more later.)

In fact, the French parliament recently passed a law involving a €50 million package to finance new border checkpoints, lorry parks and new warehouses at ports and airports. 750 new staff will be recruited to carry out inspections of incoming British goods and foodstuffs.

The French fishing lobby is currently anxious, fearing that if relations between the two countries sour they will no longer be permitted to fish in British territorial waters – which apparently is the source of an astonishing one half of their total catch. Exports of French cars, machinery, electronics and aeronautics could also suffer. Last week the Mouvement des Entreprises de France (the French equivalent of the CBI) sent a delegation to London, saying that the vast majority of French businesses were unready for a no-deal Brexit.

Bon courage, mes amis!

German Angst

An influential economic research centre has warned that 100,000 jobs could be put at risk in Germany if the UK leaves the EU without securing a withdrawal agreement. The study by the Halle Institute for Economic Research found that jobs in the German car industry would be particularly vulnerable to any new tariffs applied on German cars sold into the UK. The Germans sold 770,000 vehicles to the UK in 2017 which equates to at least 15,000 direct jobs and over 100,000 indirect jobs. The study estimates that Wolfsburg, hometown of Volkswagen (ETR:VW), would be hit hardest by any collapse in exports.


Since my piece last week on the poor outlook for the auto industry, new evidence has come my way. Car dealerships in the UK which specialise in luxury German and European brands are overflowing with unsold vehicles. As an exercise in what I call observational economics I encourage readers to go down to their local new vehicle dealerships and check out what I mean.

The German auto manufacturers will be hit hard by the no-deal Brexit at a moment when their sales are already in decline. Their shares look about as attractive as those of German banks.

Italian agony

Italy is drawing up emergency plans to keep trade flowing between the country and the UK – even if that means some kind of bilateral deal that circumvents Brussels. Italy has fallen into a technical recession (two successive quarters of negative growth) at a moment when it has to refinance its national debt to the tune of €400 billion or about 17 percent of GDP. Italian government ten-year bonds are once again yielding around 300 basis points more than their German counterparts. Italian industrial output for December was 5.5 percent lower than in the previous year.

Prime Minister Giuseppe Conte has set up a task force to focus on Brexit – and it is not just a problem of trade. Italy is more dependent on financial services provided by the City of London than Germany or France. There are fears that Italy could have problems placing its debt if ties with the City are restricted. That would send transaction costs and bond yields up further. Moreover, the City provides hedging instruments covering currency, interest rate and insolvency risk for third-party institutions (for example, the Saudi sovereign wealth fund) when they buy Italian bonds.

Until now the European Central Bank (ECB) has been able to gobble up most new Italian government bond issues as part of its programme of quantitative easing (QE). Also Italian banks were given cheap funding by the ECB which they could use to buy their government’s bonds. They now hold about €360 billion of government debt. As of December, however, QE has been terminated. If Italian bonds yields rise further then Italian banks will have to allocate new capital against them – capital which is in short supply.

Much of Northern Italy’s manufacturing sector supplies German automotive players which, in turn, sell into the UK. And the Italian agriproducts sector has a huge market in the UK, which is the country’s third largest market for food after the USA and Germany. This sector is already under pressure, having lost a massive market in Russia due to the NATO sanctions programme. If the UK were to put tariffs on Italian agricultural products while cutting those on lower cost Commonwealth countries like Kenya and South Africa, that would be a grievous blow to Italy’s economy.

Italian youth unemployment has crept up again to nearly 32 percent. In Sicily it is 58 percent. 160,000 young people are leaving the country each year. This poor economic data has increased the sense of vulnerability. No wonder Italy has called upon the European Commission to draw up contingency measures that will ensure light-touch customs clearance for two years after Brexit with continued validity for hauliers’ licenses.

With a downturn in the economy, the budget package which the Italian government agreed with Brussels in November looks increasingly unachievable. Meanwhile, the ratings agencies are circling like vultures. Fitch will deliver its verdict on 22 February and S&P on 26 April. They are both likely to follow Moody’s in rating Italy at one notch above junk.

The EU-27: Ever closer union or ferrets fighting in a sack?

We are constantly being told that the EU-27 speaks with one voice on Brexit and, to the extent that there is just one negotiating team and President of the Commission Juncker and President of the Council Tusk are equally belligerent and anti-British, this is true. But look closely and we find that the European Union is riven with division and disagreement between its member states as never before. These are not cracks, they are fissures!

First off, France and Italy have just ruptured diplomatic relations for the first time since Mussolini declared war on France in 1940. Paris recalled its ambassador to Rome on 07 February. The proximate cause was that Deputy Prime Minister Luigi di Maio met with a particularly voluble anti-Macron leader of the gilets jaunes. (According to French sources one who advocates violence).

In fact, the populist government in Rome has been baiting the government of President Macron for months with a steady flow of barbs. Announcing that the Italian Lega and the Five Star Movement would join forces with the yellow vests in the European elections due on 23 May, Signor di Maio tweeted that “the wind of change has crossed the Alps”.

The underlying tensions are ideological. The Italian populists think that Monsieur Macron is an elitist globalist who wants to use EU power to foist immigrants on Italy. “I hope the French will be able to free themselves of a terrible president” the Italian Deputy PM opined. And last month, Signor di Maio accused France of impoverishing West Africa by keeping it in a colonialist embrace. Then he accused France of sheltering terrorists wanted by Italy. The French were piqued. Last week, Emmanuel Macron described Italian-style populism as a nationalist leprosy.

What this reflects is two fundamentally different visions of what Europe is and what the EU should be. Should it be an embryonic Federation with an army and a diplomatic service which delves deeper into ordinary people’s lives? Or should it be the Europe des Patries (a Europe of free sovereign states) that de Gaulle envisaged? (Europeans have never been asked this question in referendums.) This is a dichotomy that the British should understand by now – only, sadly, Remainer politicians still just don’t get it.

Austria, Hungary and Poland are closely aligned with Italy in this rift. Italians increasingly feel that they are the victims of a malign arrangement which they have no power to change or even influence. The European elections in May will most likely confirm this. Matteo Salvini has described the vote as a straight choice between “the Europe of the elites, banks, finance, immigration and precarious work” and that of “the people – and of labour”. He has pledged to form a Eurosceptic Italian-Polish axis.

On Wednesday (12 February) the Italian prime minister was attacked for his country’s “absurd and inhumane” policies in the European Parliament. Guy Verhofstadt MEP, the arch-priest of European federalism, told Giuseppe Conte that he was a “puppet” of the Five Star Movement and The League. The M5S are demanding an apology: they will not get one.


Secondly, France has now come out (after a sheepish silence) against Frau Merkel’s cloak-and-dagger deal with Russia. In January the two “engines” of European federation signed a treaty of friendship which had the French press up in arms. There were even rumours that President Macron was going to declare that Alsace-Lorraine was joint French-German territory.

But on 07 February, France announced that she was going to back an initiative to bring the Nord Stream 2 gas pipeline project (connecting Russia to Germany through the Baltic) under EU regulations. France rightly warned that the project would make the EU even more dependent on Russian energy supplies. Currently Russia supplies about 27 percent of all the EU’s gas consumption.

The following day there was some kind of accommodation. Berlin is to remain the chief “negotiator” on the project but Gazprom (MSX:GASP), the Russian energy giant, will have to follow EU regulations and will no longer be the sole operator of the pipeline. But the episode speaks volumes about differing strategic priorities between the two principal partners.

Thirdly, our friends the Irish are being threatened by bigger powers. I’ll explain next time why the issue of the Irish border is, from the perspective of Brussels, nothing to do with the peace process – but rather entirely about protecting something called the integrity of the single market (as German MEP Elmar Brok stated this week). That is why, if the soft border persists (devoutly wished by both the British and the Irish), the Europeans are planning to erect a hard border between Ireland and the EU anyway – in defiance of Irish sensibilities. Apparently, the Germans are more concerned about American chlorinated chicken crossing into the EU than they are about peace in Ireland.

Moreover, it is now clear that the EU is plotting to undo the tax regime that has served Ireland so well by securing the domicile of US tech giants such as Apple (NASDAQ:AAPL). At a Bruges Group event in on Wednesday (13 February), Labour MP Kate Hoey (who is from Northern Ireland and has close links with the political class in the Republic) told a packed meeting that she believes that once Brexit is accomplished the Irish will start to reflect seriously about their future. She thinks that the argument for Irexit will become unstoppable within five years.

As I explained in the December edition of the Master Investor Magazine, Europe is bisected by an economic fault line dividing north from south and a cultural fault line which divides east from west. These fault lines are producing some surprising alliances – like Italy-Poland.

Hungary’s Prime Minister, Viktor Orbán, has said that the upcoming European elections are a chance “to bid farewell to liberal democracy”. Unlike Eurosceptics in the UK, European populists do not want to leave the EU, but rather to reform it fundamentally. In that aim they are delusional. The EU architecture, as created by France and Germany, is fundamentally un-reformable. Thus, in my judgment, the EU in its current dispensation will not exist in five years’ time.

The very name “European Union” is a misnomer. The EU is not Europe. Most of the landmass of the continent of Europe resides in Russia and its Slavic sister nations – Belarus and Ukraine. Norway has rebuffed Europe twice in referendums; Iceland is half-way to America. Serbia is wedded to Russia. Makedonia is not even permitted to name itself in accordance with the language that its own inhabitants speak…Britain is on the way out and has always been more at home in the Atlantic Ocean.

If I had my way, the European Union, for the sake of accuracy, would be re-designated by the UN as The Unhappy Alliance of France-Germany and their Unfortunate Satellites…

Wakey, wakey, Britannia!

I’ll consider very shortly (unless I am overtaken by events) just how the UK will be affected by a no-deal Brexit. I’ll apply all the technical objectivity of a trained economist who finds the catastrophist mainstream media (which, as I write, are predicting a shortage of coffins and body bags post-Brexit) puerile to the point of inanity…Though on Wednesday (13 February) career catastrophist Mr Carney reneged. He now thinks that Brexit could be an opportunity…

The fact is that a no-deal Brexit which forced the UK overnight to trade overnight on WTO terms (which would not necessarily entail tariffs, as I shall explain next time) could be a once in a lifetime opportunity to re-dynamise the British economy – just as Thatcherism transformed it in the 1980s. Any new import tariffs will accrue to the Treasury and that money could be used to cut corporation tax and VAT…Once businesses understand how the new regime works they will start investing again.

Transformation can take place very quickly. In the five years since 2014 when the Russians were hit with sanctions, they have managed to transform their agro-economy. From massive net importers of food, they have become self-sufficient. Russians who, like the Brits, were overly fond of Camembert and Brie are now enjoying Russian-made dairy products.

A no-deal Brexit will be a shock as exporters struggle to get up to speed with new procedures… But tough nations take shocks – my parents’ generation went through far worse. Within three months things would settle down to the new normal. There is also the little matter that there will be some extraordinary buying opportunities come the probable no-deal Brexit. But you’ll have to wait until next week to find out what they are.