Not only is a no-deal/WTO Brexit now the most likely outcome, but paradoxically it is the only outcome which will deliver the certainty craved by big business. Adapt the brace position, says Victor Hill: this could be a bumpy landing…
Two-and-a-half minutes to midnight
It was never going to be straightforward to extricate ourselves from a straightjacket tailored and tightened over 45 years by a supranational agency controlled by a clerical elite determined to perpetuate itself – and implemented by a pitiful political class in the UK which believed, deep-down, that the British nation was a spent force and had better come quietly…
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Mrs May started out encouragingly: the agenda that she set out at Lancaster House (17 January 2017) was reasonable and, in a more rational world, would have been eminently attainable. However, as time went by she was captured by the ultra-Remainer civil service who played Europe’s game of persuading the British people that they could never escape the Customs Union without deleterious consequences – not least for the peace process in Northern Ireland.
The Irish border issue, as I have said before, is a trope. Not only that, we now know that it is an entirely mendacious one – since, as the Germans explained last week, it is nothing to do with the peace process but more about maintaining the integrity of the single market. Even though, qualitatively, there is nothing different between the UK-Irish border and the UK-French border.
I admit that there are only about six ferry routes between the UK and France – so it is much easier to police; whereas there are innumerable crossing points between Northern Ireland and the Irish Republic. If truck drivers can submit digital customs declarations at Calais to keep the French happy – then why can they not at Dundalk?
The problem with the May-Barnier Withdrawal Agreement was not only the so-called Irish Backstop – which is, in any case, in defiance of the 1998 Belfast Agreement which pledged that the status of Northern Ireland could never be changed without the express consent of the people of Northern Ireland (and which therefore makes it open to judicial challenge)[i]. The Withdrawal Agreement would also have tied the UK to the Customs Union and the Single Market (at least in terms of the regulation of goods) indefinitely – despite the payment of a £39 billion danegeld – and would have thrown away all the advantages of exiting the EU.
The Withdrawal Agreement was rejected by the House of Commons on 14 January by a majority of 230. The chances of the EU agreeing to substantial modifications before 29 March seem vanishingly small.
Trade policy by AI
An AI robot would probably note that Remainers accuse Leavers of desiring protectionism while endorsing the most protectionist arrangement in the history of international trade. It might also advise that this is a fraught topic which has been in play for about 500 years. (Most of the pubs on the coast of my native Kent are called The Smugglers’ Arms – and with good reason: import tariffs have always been a big deal.)
Now just suppose the UK were to declare a Unilateral Declaration of Independence on 29 March (which is, in my view, what the British people voted for on 23 June 2016). The Mother of Parliaments would thereby arrogate to itself the right to determine the United Kingdom’s terms of trade with all other nations entirely in accordance with its own perceived interests – which is what all nations have done in the modern period. (Until the advent of the EU, that is.)
This is not necessarily a Trumpian drive to extinguish our substantial trade deficit with Europe – though that is a factor. Liberal economists tend to think that imports are the price you pay for exports – so a rough trade balance is desirable. (There are apparently few liberal economists in Germany, where a trade surplus is a national objective.) All things being equal, unilateral tariff reductions are mutually beneficial. But things never are equal – especially in the European Union, where tariffs are imposed on all external parties except those which have negotiated FTAs.
When you trade, so economists tell us, you can buy better goods than you make at home cheaper from abroad, and you can sell goods that your overseas customers find attractive because they are cheaper than the substitutes they find at home. That’s basically the theory of comparative advantage.
But, in reality, tariffs on goods, which have generally fallen in recent decades, are no longer the main impediment to trade – especially to an economy which is predominantly reliant on services. Hong Kong imposes no import taxes at all but has FTAs with China, New Zealand, Chile and the EFTA countries (Iceland, Norway, Switzerland and Liechtenstein). Singapore has FTAs with China, Australia, India, Japan, Korea, EFTA, Turkey and the USA.
Australia, in the great tradition of the Anglosphere, has constructed its modern prosperity on the principle of Free Trade. That was partly as a result of the country’s need to restructure its economy after the shock of the UK joining the EU in 1973. It is now enjoying its 28th consecutive year of positive economic growth. Today, about 70 percent of Australia’s trade is conducted under bilateral FTAs (though not with the EU). As I reported last April, Asia’s hungry markets just cannot get enough of Australian agro-products.
On 17 February Porsche warned UK customers they might have to pay 10 percent extra for cars delivered to the UK in the event of a no-deal Brexit. The German luxury automotive manufacturer wants buyers to sign a clause agreeing to a potential tariff. Porsche’s owner Volkswagen (ETR:VOW) declined to say if some of its other brands, including Audi, Lamborghini, Skoda, Bugatti, Seat, and Ducati might follow suit. A 10 percent surcharge would see the cost of a Porsche 911 rising from £93,110 to £102,421[ii]. Would that really make a difference to the people who buy brand new Porsches? A 10 percent appreciation of the pound would wipe out the prospective tariff.
At the end of the day, if importing goods from the EU tariff-free is economically beneficial, then so is importing goods tariff-free from the rest of the world.
The EU is good for UK manufacturing. Really?
Cadbury, having been taken over by Kraft Heinz (NASDAQ:KHC) in 2010, moved chocolate production to Poland 2011 with an EU grant. The manufacture of the Ford (NYSE:F) Transit was relocated to Turkey 2013 with an EU loan. Jaguar Land Rover (JLR) has recently agreed to build a new plant in Slovakia with €130 million of EU support. JLR’s ultimate owner Tata Group has run down the Port Talbot steel works and disadvantaged workers’ pension rights. Peugeot (EPA:UG) also closed its Ryton plant and moved production to Slovakia with EU subsidies.
The British Army’s new Ajax fighting vehicle is to be built in Spain using Swedish steel at the request of the EU. Indesit’s (BIT:IND) white goods plant in Bodelwyddan, Wales has been relocated with EU support to the Netherlands. Hoover (part of Techtronic Industries (HK:0669013440)) moved its Merthyr factory out of UK to the Czech Republic with EU backing.
Numerous British airports including Heathrow are ultimately owned by Spain’s Ferrovial (BME:FER) – just as Scottish Power is owned by a Spain’s Iberdrola (BME:IBE) because Spanish tax laws favour companies that acquire abroad. Most London buses are run by Spanish and German companies. The Hinkley Point C nuclear power plant is to be built by France’s EDF (EPA:EDF), majority owned by the French government, using cheap Chinese steel that has failed in similar nuclear installations. This French-Chinese plant will produce the most expensive electricity in British history.
Swindon was once a major producer of rail locomotives and rolling stock. Now, Bombardier (TSE:BBD) in Derby is the only UK-based manufacturer of rolling stock. Yet the UK government, under EU rules, has consistently been obliged to place orders with EU producers such as Alstom (EPA:ELO). That great British auto icon, the Mini (acquired when BMW (ETR:BMW) bought Rover Group in 1994) is now built in Holland and Austria. I could go on.
Nissan’s decision not to build the X-Trail in Sunderland (03 February) and Honda’s decision to close its Swindon factory and its plant in Turkey in 2021 (18 February) were both announced within the envelope of maximum Brexit uncertainty. This has much more to do with challenges to the auto industry globally which I explained two weeks ago – plus the rise of Japanese economic nationalism and Mr Abe’s aim to replicate President Trump’s campaign to bring manufacturing industry home. (I’ll have more to say about that soon).
None of this seems to figure at all in the Labour Party deliberations. Instead, Labour now bleats the mantra of customs union good – free trade bad, even though this means that Britain can never pursue its own industrial strategy. It’s time that the UK government had the power and gumption to protect – in the most fundamental meaning of that word (which does not necessarily mean imposing tariffs) – indigenous industries instead of continuously selling out to foreign competition.
We’re as ready as we ever shall be
Talk of catastrophe is overdone. The most catastrophic effects of a no-deal/WTO Brexit have already been averted. These would have included a rupture in the multitrillion-dollar derivatives market and the grounding of planes. But neither of those is going to happen.
The EU and the UK are in fact cooperating on planning for no-deal/WTO in one key area – finance. Both sides would stand to lose big-time from a market meltdown. Agreements already in place will enable UK and EU regulators to supervise one another’s markets. There is a mechanism to avoid a sudden seizure in the multitrillion-dollar derivatives industry by ensuring that EU banks can continue settling trades at clearing houses in London.
Another agreement allows investment funds in the EU to continue to delegate trading to staff in London. But the financial sector is still pressing for further action so that there is no disruption in the over-the-counter (OTC) market in swaps and other contracts which are traded directly between buyers and sellers.
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In the case of a no-deal Brexit, while the UK has said data will still be able to flow, Europe has given no similar reassurance. The ICO (the UK data regulator) is advising companies to make sure they have appropriate safeguards in place.
Of course, the main concern is about frictions around importing and exporting goods – from automotive components to aircraft wings to haloumi cheese. Everyone has heard of Article 50 (of the Lisbon Treaty) but few people know what Article 24 (GATT XXIV) is. This provides that countries which wish to lower trade barriers bilaterally can do so, in certain circumstances, without adhering to the general WTO principle that all members should have access to the same trading terms. It also provides for countries which do not have free trade agreements in place to implement interim measures for up to 10 years.
So, in theory, the UK and EU could happily continue trading goods without tariffs on March 30 even without an FTA (let alone a miserable Withdrawal Agreement). Mrs May and Monsieur Barnier don’t really want you to know about this because they want their ghastly deal for political reasons on both sides. But you are sure to hear more about this very soon.
Some analysts are predicting that sterling could plunge as much as 20 percent in a no-deal scenario – but I suspect that a lot of that fall is already priced into a pound that is undervalued on almost all metrics. Equally, the stock market is likely to over-react – as it always does – though not excessively, in my best guess.
The market could well take the view that the UK could now restart constructive negotiations; but from hereon in, as one WTO entity dealing with another (and both with identical regulatory systems). From that point onwards, with Brexit a fait accompli, the European Commission/Council would come under increasing pressure from Berlin and Paris to regularise trading arrangements.
For the speculators amongst my readers, there could be a massive buying opportunity from early March onwards. I particularly favour UK domestically-focussed stocks, especially housebuilders and construction companies – some of which may benefit from a turbo-powered Project After spending blitz. (Hopefully, someone other than Mr Hammond will initiate that.)
They’re trying t’ make me go to rehab – but I say: No, no, no….
You’d have to be an Amy Winehouse fan to appreciate Herr Juncker’s finer points. He is a bureaucrat’s bureaucrat – indirect, wily, slippery, and impossible to pin down…
But the real point always was that one was not negotiating with a commercial counterpart at all. Businessmen can do deals with one another because they both have something the other wants: the issue is the price, and the terms. Britain, by leaving the EU, is offering something that Europe does notwant; and the EU feels justified in doing all they can to frustrate Britain’s aspirations.
But it is even worse than that. Businessmen are driven by the pursuit of profit; Brussels is driven by the pursuit of power and by the teleological, quasi-religious ideal of ever-closer union – which is regarded as a good in and of itself. Any concession made to the UK amounts to surrender of that power; and then there might be a queue of states wanting specialist treatment and concessions thereafter.
If you analyse this from the perspective of game theory, it is clear that there was never likely to be a deal – except one which was highly inimical to Britain’s interests. Mrs May set out on her mission by repeating the very reasonable mantra that no deal is better than a bad deal. But, as history will judge, she finally pursued a bad deal for fear of no deal at all. By thus giving credence to the catastrophists, she opened the door for all those forces which wished to reverse Brexit to oppose her anyway. So, we had the theatre of the absurd in which a largely pro-Remain Labour Party opposed Mrs May’s marshmallow-soft Brexit because they wanted something softer…Only to precipitate the hardest Brexit possible…
No-deal is not a cliff edge – it’s a ditch. And we’re all going into that ditch together – the Remainers screaming loudest, the Moggites with bumptious glee…The only thing businesses and investors can do is to make a virtue of necessity – and make it work. The way to do that is to support a coherent trade policy of our own making, which hopefully (eventually) would have cross-party support and the confidence of all nations of the United Kingdom.
Carpe diem. Seize the day!
Afterword
I intend that this will be my last pronouncement on Brexit until after 29 March. I feel I have said everything I needed to say on the matter over the last three years and more. I’ll be focussing on technology in this column over the next month or more. But if you are coming to the Master Investor Show in London on 06 April I’ll be sharing my views live on where we then will be – and the outlook for investors. It’s not too late to register for free – but please hurry, as we are expecting record attendance this year…
I hope my small contribution to this historic debate has been useful. But in the aeons of media time since the wee hours of 24 June 2016 when the course of our lives changed forever, as did those of our ancestors in the 1790s, I have often recalled Charles Dickens’s majestic opening to his soaring narrative about the intertwined inhabitants of London and Paris during the French revolution[iii]:
It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness…
[i]Martin Howe QC has also argued that the Irish Backstop also contravenes the Act of Union of 1800.
[iii]A Tale of Two Cities (1859).