7 March 2016

Should we stay or should we go?

So the 23rd of June is the date for the Brexit referendum

So the 23rd of June is the date for the Brexit referendum. The Prime Minister, David Cameron, has concluded a deal with the EU that, although not a “game-changer” in terms of Treaty revisions, it is certainly non-trivial in that the concessions go a long way to protecting the UK’s financial services industry. There are also important concessions in ensuring that the UK is not on the hook for any future Eurozone bail-outs. As such, it would be premature to play down the significance of the Prime Minister’s deal as it may well mark the peak in the process of EU political and economic integration. Over the last 50 years, EU leaders and policy-makers have used periodic crises to strengthen the integration process but now the situation is less clear. It is interesting to observe that other EU countries are now looking to seek UK-style opt-outs and special treatment. This threatens to fracture any “progress” in terms of further EU integration. As it is, the tortuous negotiations recently involving the Prime Minister and 27 other heads of state show how cumbersome and bureaucratic reaching any sort of deal can become. 

The debate in the run-up to the Brexit referendum is certainly hotting up. The “in” camp argue that being outside of the EU would threaten the economy resulting in damage to trade, investment and jobs. It would be the proverbial “leap in the dark” so best to stay in the EU, the argument goes, and work to ensure progress towards a reformed EU. The “out” camp insist that far from being apocalyptic, leaving the EU would take back political and economic control of the country and free it from excessive EU regulation and the primacy of EU law. The “out” camp argue that the Eurozone has hardly been an economic success story and since the inception of monetary union the main economic features have been a double digit unemployment rate, anaemic economic growth and fiscal austerity. Even prior to the onset of monetary union, many academic economists, especially from the US, argued that the Eurozone was not an “optimal currency area” and was entirely unsuited to a “one-size-fits-all” interest rate policy.

The surge in capital flows from the “north” to the “south” at the inception of monetary union sowed the seeds of the eventual Eurozone banking crisis and exposed the imbalances between the core and periphery.

The surge in capital flows from the “north” to the “south” at the inception of monetary union sowed the seeds of the eventual Eurozone banking crisis and exposed the imbalances between the core and periphery. The end-result was a bail-out of the French and German banks who had lent to the periphery and financed an unsustainable debt bubble in countries like Greece. For every reckless borrower, there is also a reckless lender. These increasingly periodic debt and banking crises, which compelled the European Central Bank to adopt Quantitative Easing, and negative interest rates has created a division between the core and periphery and between creditor and debtors. In addition, many economists have pointed out the design flaws in monetary union which increasingly looks eerily reminiscent of how the 1930’s Gold Standard operated.  

Germany, as the leading creditor and surplus economy, continues to pursue a policy of balanced budgets but is not helping to facilitate the adjustment process for debtor and deficit economies. The upshot is that Germany now has a current account surplus that amounts to 7% of GDP, three times the size of China and a major imbalance in the global economy. The periphery has had to endure so-called “internal devaluations” which have crimped domestic demand and deflated the economy. This is not a recipe for a healthy economic system.

It also has to be said that a key feature of the global economy over the last 10 to 15 years has been a shift in the centre of economic gravity from west to east. Beijing is where it’s at, not Brussels. The challenge for the EU is to transform itself into a much more vibrant economic system that can keep pace with China. Emerging markets now account for 60% of global GDP and have contributed to a significant part of global economic growth in recent years. Is the EU capable of serious reform or, as the migrant crisis makes clear, does the EU start to crumble? 

The rise of anti-euro political parties throughout the EU threatens to radicalise the political landscape especially bearing in mind the French and German elections in 2017. But as of now all eyes are on the Brexit referendum.

The opinion polls and bookies’ odds appear to favour the “in” vote. UK voters, as much as they are uncomfortable with the EU, may decide to stick with the status quo. The interesting issue is that an “in” vote does not necessarily let the EU off the hook. Without reform the EU may wither on the vine and just become increasingly irrelevant in a changing global economy.

Neil MacKinnon is global macro strategist at VTB Capital in London. He is a founding supporter of the Vote Leave campaign and a co-author of Business for Britain’s Campaign or Go economic assessment.

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