Nothing much has changed since September, except that more of the same means we continue to sleepwalk towards a crisis.
The Brexit debate is polarised in the UK between those who are trying to derail the process – The Remainers; and those that believe that Brexit must go ahead in order to fulfil the obligations of the referendum. In Europe, Chancellor Angela Merkel is taking the intransigent line that there can be no discussion until Article 50 is triggered and, we are told, is instructing officials to avoid any “backdoor contacts”. This political stance can only be driven by political considerations. The Chancellor, who has shown herself over many years to be intelligent and pragmatic, can hardly think that this non-cooperative stance is conducive to enhancing a complex negotiation that is supposed to be completed within two years. As there are no rules or precedents for how the negotiations should be conducted, it is quite bizarre to have the leading party in the negotiation saying they are not even going to discuss the process. This means that when Article 50 is triggered, a lot of time will be wasted on working out how the process of negotiations should even start.
All this means that the whole process is going to be more fraught than necessary and will, therefore, be likely to cause more unnecessary economic disruption as businesses will postpone difficult decisions on capital expenditure etc. The major loser in this situation will be the European economy. With Merkel leading on the intransigent line, the bandwagon is really summed up by the Finnish Prime Minister’s statement that the EU were united in opposing the UK’s efforts to find loopholes in to Block’s sacred four freedoms – “the movement of goods, capital, services and people.” It is clear that for the time being, the European Commission President Juncker is going to aim for a hard exit i.e. there will be no negotiation. As I have said, the confusion will be damaging to the economy and in the end the stance will not be sustainable, bearing in mind the UK is the second biggest economy in a trading block where even Turkey is included in the Customs Union, but as far as I am aware there is no question of allowing them the free movement of people.
While all this negotiation manoeuvring on the EU side is going on, the UK Prime Minister’s negotiating position is being undermined by the Remainers, in both the House of Lords and the House of Commons, demanding to know in advance of any negotiation what Britain’s negotiating position is and apparently demanding also to be involved in the process. Clearly an absurd position for anyone who understands anything about complex negotiations, but then one has to conclude that the Remainers are not actually interested in a good outcome to the negotiations; worrying that our legislators are prepared to sacrifice economic interests for European Utopia.
The other crisis which is looming is a repeat of the 2007/8 financial whirlwind – this time created by excessive and unsustainable government deficits, along with corporate borrowing and the near zero interest rate regime that is undermining the structure of the world’s financial systems. Starting with the US, the ratio of debt to corporate earnings is approaching the highest on record. This leverage is promoted by Central Banks buying commercial paper which is encouraging mis-allocation of capital, particularly in America where the funding is being used in the most unproductive fashion of companies buying back their own share capital. More importantly, we are also witnessing a bizarre recovery in debt issuance from Argentina to Mexico. Institutional funds are being forced to ignore the risks of debt issued by these areas as they search for yield. In Europe we have seen for some time Government deficits being financed by the European Central Bank and the Bank of England. The latest and most novel borrower is Saudi Arabia with an eye-watering $17.5 Bn. issuance to finance its domestic liquidity problems caused by the fall in oil prices.
The historically high issuance of debt, with unprecedented low rates of interest, at some point will turn into a huge capital destruction catastrophe as it’s impossible to believe that at some point interest rates won’t rise. Even if, as a theoretical exercise, you predict that interest rates don’t rise, one is still faced with an impending crisis as most of the debt cannot be repaid as it is not being put to any productive purpose and the assets behind it are being dissipated by running deficits.
For the last twenty years, we have been living in a period during which a generation has forgotten that debt has to be paid down and debt destruction, often discussed and experienced in the last century, has been forgotten about. This forgetfulness came to the fore recently when Prime Minister May‘s suggestion that the Bank of England’s “generosity” to the debt market was possibly not the best policy, was met by an almost universal expression of outrage from the Bank and its supporters in the financial community.
Damon de Laszlo
20th October 2016