Two months after Britain’s shock referendum result, and what has happened? Not a lot. Though you wouldn’t think it from reading the running commentary. So was Project Fear the hoax that the Leave campaigners always said? Probably not.
The few days after the result seemed to fulfil Project Fear more quickly than even Remain campaigners suggested. The pound fell sharply and many stock indices tumbled too. There was much talk of this or that investment being stopped, or this or that institution or business being under threat. Remain supporters have kept up the pace of alarmist talk ever since, to judge by my Facebook feed.
But Brexit campaigners have a point when they poke fun at this. When it comes to cold, hard economic statistics it is very hard to see much, or any, adverse impact. The stock markets have fully recovered. Retail sales, employment and prices all looked pretty healthy in July. The government still finds it laughably easy to raise money on the bond markets; the Bank of England’s currency reserves went up. Only that fall in the currency has persisted. And no doubt that reflects weaknesses in the economy before the vote – given the scale of the ongoing current account deficit. The various indicators that have taken a plunge represent sentiment rather than hard fact, and may have been contaminated by the sheer shock of it all, as might the gloomy reports from the Bank of England and the Institute for Fiscal Studies.
On only one thing can Brexiteers be disappointed. The remaining EU has sailed on just as smoothly as the UK, with the Euro strengthening significantly against the pound. This defies predictions of imminent panic and collapse gleefully made by (some) Brexit campaigners. No other country seems at all inclined to follow Britain’s lead to the exit. Even as the emerging kerfuffle on Italian banks is as good evidence as you might ask for about problems with EU rules and democratic mandates.
There is, of course, one possible explanation for this insouciance: denial. Maybe people think that exit is so hard, and will have such obviously dire consequences, that it will never happen. Speculation about the invocation of Clause 50 for formal exit pushes it further and further into the future. If so it shows remarkably little insight amongst the market makers. Any process by which the referendum result is reversed will be very messy, and entail a lot of collateral damage.
Personally I think people are putting too much faith in the markets’ ability to see trouble ahead. The signs that the 2008 crash was in the works were obvious more than a year beforehand, when the interbank markets froze. Strong enough, as I don’t tire to point out, for me to move my pension portfolio from shares into index-linked gilts and cash. The more perceptive would have seen the trouble coming a year before even that, when US property prices started to slide, threatening the foundations of the whole financial edifice. And yet the markets did not reflect the mounting danger at all.
And at the other end of the scale, when it comes to the multitude of small decisions taken by consumers and businesses that drive the short term statistics, there is also a sort of built-in inertia. Short term decisions quickly overwhelm intangible longer term worries. People don’t know what to do, so they carry on as normal.
There are two ways in which the Project Fear may yet turn out to be on the money. One is a slow decline that accumulates: slower growth turns to a shallow recession that persists. That would be perfectly consistent with current statistics. The other way would be like the 2008 crash: a delayed reaction leading to a sudden crash. Both of these follow my metaphor of the economy being holed below the waterline in my post in the week after the result. The ship is in mortal danger despite no damage visible above water.
Why might trouble happen? It comes back to the basic weakness of the British economy (which, it must be said, EU membership was doing little to help) – a substantial trade and current account deficit. Britons as a whole are spending more than they are earning, and have been for many years. That has been OK because plenty of foreigners have been prepared to lend us money, or to invest in British businesses or property. Also British multinationals may be selling off foreign assets and bringing the proceeds home. Brexit is putting that investment flow at risk.
What happens if the country can’t get enough currency to pay for imports? Demand for Sterling falls, and the currency sinks. That might attract investors (British assets look a bargain) or scare them (with the risk of further depreciation). Currency reserves, private and national, start to be drawn down. That will affect living standards. Then either the trade balance corrects (buy fewer imports and sell more exports), or things start getting nasty with a financial crisis as the stability of banks and the entire payments system comes into question – which is what happened in 2008, for different reasons. These changes tend not to happen smoothly.
The problem is that the financial system is very complex, with all sorts of buffers and hidden dependencies, which makes it non-linear. Responses are not proportionate to the changes to the system. Past performance is a poor guide to future dangers. There might be a lot of short-term factors stabilising things, but that could be undermining resilience. The country could be building up vulnerability to the next financial crisis, just as the Labour government of the naughties created vulnerability to the banking crisis of 2008.
Or perhaps the Brexiteers are right. The financial system will adapt to the new realities calmly and the British economy is fundamentally stronger than the pessimists say. The economy will sail serenely on and gather strength to boot.
The thing is that it is just too early to tell. It could be many months, or even years, before any crisis caused by Brexit emerges. I will be watching for signs of trouble. But, to be honest, I haven’t seen them yet. It’s all a phoney war.
The issue of “triggering Article 50” is set to become the “new Brexit debate” among the Brexit Bunch, foremost, of course, within the Tory party. My view has always been that it is not going to happen until the French Presidential elections are out the way (May 2017) and Le Pen (who will expend every ounce of energy praising Brexit to the skies and demanding the French be allowed their referendum as well) has failed to gain entry to the Elysee. By then, however, the German federal elections will be on the horizon (September) and I cannot believe Merkel is going to have the slightest interest in beginning formal negotiations (given just how important the UK market is to so many branches of German industry) until she knows her position as Chancellor is fully secured for another four years. My view is therefore, Article 50 as soon as possible post the German federal elections (October 2017) and withdrawal (at least in terms of the major issues (trade relations/SEM access etc.) by late-2019 (followed quickly by a UK General Election, either as a follow-up to one called this autumn (with Labour more divided than at any time since 1985) or, if she can brave it out, the first under Prime Minister May). This is, of course, going to be contested with all possible strength by the Brexit die-hards who want out as soon as can possibly be achieved and, as with the referendum campaign, will be more than willing to stoke up every feeling of fear, xenophobia, lowest level nationalism going in order to achieve their aims. (There is already speculation that Farage will be re-emerging from his ‘resignation’ – the third one in recent years (rendering him a complete joke in the eyes of any except his most worshipful adherents!) Their call will be for simply repealing the 1972 Act of Accession (to the then EEC) and getting out, settlement on SEM terms yea or neigh (which really WILL be guaranteed to ‘shake things up’ in ways which had been expected from ‘Brexit’ (the actual contents of which, it is now abundantly clear, none of its leading advocates had the faintest glimmer of an idea as to what it would mean in practice in the event (which they ALL held as unlikely until the early morning hours of 24th June) of their winning.
One thing which can be forecast with absolute certainty is that the 52% voted for uncertainty and “hoping something would turn up” for at least five-ten years when they placed their cross in June.
“What happens if the country can’t get enough currency to pay for imports? Demand for Sterling falls, and the currency sinks. That might attract investors (British assets look a bargain) or scare them (with the risk of further depreciation). Currency reserves, private and national, start to be drawn down. That will affect living standards.”
This is the way the argument is presented to us all the time of course. But, to really understand what is going on we need to look at the picture on a world-wide scale.
There are a few countries like the UK and the USA who have a policy of relatively free trade and don’t much mind whether there current accounts are in the black or in the red. There are also more than a few countries like: China, Japan (though not so much now), Denmark, Germany, Singapore, Switzerland for whom it is almost a matter of national pride that they should supply the rest of the world with more goods and services than they receive in return. Maybe we should all be very grateful to them for that?
We know that the world as whole must have balanced trade. Until such time as we start trading with the Klingon empire? So for every every dollar or euro that Germany is in surplus there is another dollar or euro in deficit somewhere else in the world.
The surplus countries simply have to recycle their surpluses if they want to keep things the way they are. There is no possibility of there being any real problem of getting the currency required until such time as countries like Germany say “OK guys that’s enough. We aren’t going to supply you guys with quite so much German beer and quite so many BMWs any longer. We are going to buy Nissans from your UK factories and we are going to import more of your real ales”.
Would that be a big problem?
Yes, an old problem Peter. In this week’s Economist (an article about Mundell-Fleming) it mentions Keynes’s scheme to tax persistent export surpluses – vetoed by the US for the same reason that Germany would veto any such scheme in the Euro zone.
Although my own economics is largely Keynesian I wouldn’t agree with his argument that there needs to be a tax on export surpluses -providing we have fully floating non-convertible currencies. This rules out the eurozone as a viable option until such time as the EZ becomes a fiscal union too. So, to that extent, my understanding, of what should be, isn’t in contravention of Mundell -Fleming.
Then the determined net exporters of the world have a problem they can’t veto. If they want to run continuous surpluses they have to recycle them by buying bonds in their customers’ currencies. Otherwise their own currencies rise and their customers’ currencies fall. Meaning they won’t be able to afford those exports any longer.
They effectively get caught in a bind from which it is difficult to escape. If Germany balanced its trade the standard of living of its own population would rise. They would be making things for themselves rather than others. But the political opposition from the vested interests of German capitalism would be enormous. The solution is simple enough. They have to learn to become much less deficit averse than they are. The Americans managed it !
But from conversation with German friends I am much less optimistic about them. They make good engineers but crap economists!
The Economist article points out that Keynes had a strong prejudice towards fixed exchange rates, as a promoter of trade. That is historical – there was little experience of free floating rates (apart from Canada, which is why so many of the floating rate theorists came from that country, including Mundell).
As for the Germans, I guess history provides a clue. As you suggest, corporate vested interests are very powerful (having coopted trade unions to a large extent). Perhaps we should focus attention on how they use their financial surplus. Dodgy financial investments with the government bailing them out when they go so was one of the factors behind the Greece and Spain debacles.
Perhaps we should focus attention on how they use their financial surplus.
They don’t do anything with them.
The common (mis)perception is that a Government’s surplus/deficit is the same as a company’s profit /loss. But a company’s profit can be re-invested and/or paid out as a dividend to be spent in the economy.
But, a surplus can’t be spent otherwise it wouldn’t be a surplus. It can be lent out by the surplus country buying the bonds of the deficit countries. That’s fine if the currencies are different. The surplus countries use their surplus dollars and pounds to buy up Treasury bonds in the USA and UK. They have a simple choice. Either spend those pounds and dollars on goods and services from the UK and USA or buy bonds. They don’t have any leverage on either government as a result. Probably the UK govt would rather they bought goods and services in any case.
The problem arises when the currencies are the same as in the EZ. The surplus countries don’t want to buy goods and services, at least not in sufficient quantities, from the EZ deficit countries and at the same time they don’t want to lend them back the surplus euros. Something has to give. And the people of Greece, Spain, Ireland, Finland, Italy etc know what that means in practice.
There is always another side to a surplus. It represents an excess which has to go somewhere. It tends to get parked in foreign assets – hence China owns vast amounts of US debt. In Germany’s case their banks contributed to the financial bubble in deficit countries like Spain and Greece. Serve them right if they got burnt when the bubble burst – except the government largely bailed them out leaving the tax payer holding the assets, and making it an issue of German taxpayers against the world. If Germans don’t want to spend their surplus on buying imports they mustn’t expect to invest it in risk-free financial assets.
We seem to be approaching a measure of agreement. You are quite right that it was German banks who were doing the lending. Only a part of that would have been directly to the deficit countries’ governments. Most of it , as in Spain and Ireland. ended up in the speculative property market. The fiscal position of the govts of Spain and Ireland was quite good, in term set by the neoliberal rules of the SGP, It wasn’t even that bad in Greece.
So when it all when wrong in 2008 the pressure was on governments to bail out their banks. The Governments of the less affluent peripheral region, had then to be bailed out by the ECB and the wealthier members of the EU. So what was originally a private debt problem became a public debt problem. The general narrative since is that the problem was caused by too much public borrowing.
The same has happened in the UK. The Brown government has been criticised for not running a surplus in the ‘good times’.
But the ‘good times’in the UK were fueled by too much private debt. If public debt had been reduced, private debt would have had to be even higher to maintain the same level of economic activity.
Yes. Martin Wolf of the FT said that a current account deficit was a much surer prediction of trouble in the Euro zone than a budget deficit, which makes all the focus on budget deficits misplaced.
Well there is a clear relationship between budget deficits and current account deficits. If a country has a current account deficit then someone in that country has to finance it by borrowing.
The problem for the EZ countries is that they can’t do anything to reduce their CAD. No devaluations. Tariffs are out. If their population wants to save then their tax revenue declines and the rules of arithmetic puts the Govt is deficit which isn’t allowed by the SGP rules!