We haven’t written much about Brexit…largely because, for the life of me, I have been unable to embrace, with any conviction, a view as to whether the Europeans will dodge this bullet, as they have dodged so many in the past, or whether chaos will finally ensue. Then, if chaos ensues, I’m equally clueless about what the contours of the chaos will be; what a hard Brexit will look like. I am baffled. And while it is demonstrably true that cluelessness and bloviation are not mutually exclusive, I, perhaps more thin-skinned than most of the chattering class, have been waiting for some sort of an epiphany before I wrote on the topic.
But birds gotta fly, fish gotta swim and us members in good standing of the commentariat gotta prattle on. Since I’m not convinced I’m going to get any smarter and since this is likely to be one of the seminal economic events of 2019. I’m diving in. Might be ugly. Hide the children.
Let me begin by noting that at Dechert, we have a lot of people steeped in the complexities of this issue and international trade more broadly, and they have had a lot to say about the topic, erudite, thoughtful and balanced; certainly none of which characterizes my commentaries.
Perhaps because my day job is CRE securitization and there is a certain geographic insularity to that, I haven’t been hyperventilating over Brexit, but I’m beginning to think I should. Maybe it’s Y2K and Europe dodges the bullet and something largely amiable and workable results. Maybe Brexit pumps up the flow of invested dollars into the US market and maybe it drags a few bankers back to New York from London (not a bad thing). In that case I’ll go back to sleep. But maybe, on the other hand, it all goes casters up. This could be one of those bad things where a bad thing somewhere reverberates in the everywhere. Contagion, anyone? It will be more than a UK and European Union problem. As an aside, I struggle to imagine all the banks and bankers of London going to Paris following a hard Brexit. Paris was once worth a mass (apologies to Henry IV), but can they actually move the entire edifice of financial London across the Channel? Seems not doable. The effort will only exacerbate the post-Brexit chaos. (Note to my English friends, before you decide to go: they still speak French there…no really!)
Let’s start with something we can all agree on. It’s an unseemly mess, isn’t it? Go online to see Theresa May begging, Theresa May threatening, Theresa May dancing! (I’m not convinced that English politicians should ever dance…ever!) And that was all just at the recent Tory Party Conferences! In the UK, the government is a mess, even by our standards, and there’s no consensus whatsoever on Brexit. Go or stay, the recriminations when whatever is going to happen happens, are likely to be destabilizing. The French are being quintessentially prickly, worried that a deal will sacrifice their dignity and gloire to the avidity of Perfidious Albion. The Germans seem deeply conflicted and apparently have forgotten how to lead. And now Mrs. Merkel is out. A power vacuum in the heart of Europe is not a promising development for Brexit, or frankly, for anything else. Brussels is doing a poor imitation of Alex Haig in the Reagan White House, trying to act like it’s in charge, that only Brussels matters. But regrettably, for the process and the gnomes of Brussels and for those with visions of a European state dancing in their heads, there are 28 pesky sovereigns here and the increasing cacophony of their views on almost every critical issue affecting the European Union are deafening and impairing clear thinking about Brexit. For Poland, Hungary and the Czech Republic the key issue is keeping Brussels out of their shorts on political and social change. Italy is horribly self-absorbed (see below). Spain is mired in political crisis. Macron is loved by two less people than supported the unlamented President Hollande at the end and populist parties are on the rise across the continent. How does that speak with a single voice? A chat with a hydra seems likely to produce only dismal outcomes.
And look, these countries haven’t liked each other for the last couple of millennia and all the smiles of modern politicians are insufficient to mask the underlying frission of animosity and suspicion that roils even the most technical discussions inside the Union. And let’s be clear, this is not just economics, this is not just technical. This is a highly emotive issue for both sides (all sides?) and many across Europe are truly spiritually committed to the sanctity of the Union. The European Union is legitimately afraid that an easy exit here might usher in the deluge with existential problems already roiling both the eastern and southern fringes of the Union.
This would all be great theater, if it didn’t matter so much. Not to be small, and entirely as an aside, isn’t all this sturm und drang a bit of a relief from staring at the Washington clown car every day? “Look our American cousins, we can be stupid and boneheaded and ugly and duplicitous as you.” That at least makes me (in a Schadenfreude sort of way) feel a little better.
Stepping back a bit and grasping for perspective, my take is that Brexit is most importantly understood as the current episode in the slow motion collapse of the entire European Union experiment. This dissolution began with the birth of the modern EU with the Maastricht Treaty of 1992. The European Union is like an unstable isotope which will inevitably degrade into its component parts. Its half-life is already behind us. Several years ago when the financial crisis brought a severe recession to Europe, the Euro tanked and interest rates spiked, the Union suffered a body blow. Mr. Draghi made his famous “whatever it takes” speech which seemed to shore the edifice up, but don’t try to pretend that damage wasn’t done. This type of damage is cumulative. With Brexit, a body blow is again in the offing. The pace of dissolution is accelerating. I fear that looking back, Brexit will just be another scene in this multi-act tragedy written by some Ibsen wannabe where everyone is either dead or miserable (or both) at the end.
This is hardly gobsmackingly innovative thinking on my part. The collapse of the European experiment has been two years away for the past ten years and, frankly, the over-under now is not a hard pick. Harking back to Econ101, a polity which doesn’t have control over its monetary policy while pretending to control its own fiscal policy is doomed. It works until it doesn’t. The gold standard worked until it didn’t. Those countries that elected to dollar-denominate their money supply worked until they didn’t. In the crucible of economic, political or social stress (frankly, they are almost always coincident), all these systems shatter. Given the political cauldron that is Europe, where increasingly desperate Pan-Europeans are only trying to pretend they still like each other and share a comprehensive set of common values, the end indeed seems neigh.
Italy might be the next chapter, although at the rate it’s going, it might even beat Brexit to the punch, as it were. In any event, political tumult there will be another step leading toward the inevitable restructure of the European experiment. Let’s play it out. Italy’s weirdly left/right coalition, is not going to not spend money nor balance its budget and there is not much Brussels can do about it. Remember that Germany and France once thumbed their noses at Brussel deficit caps and nothing happened to them, so they are a tad short of cred on threatening Italy or anybody else. (Sidebar: for a fun-filled excursion on the consequences of the fusion of the looney and jackbooted left and looney and jackbooted right, read Friedrich Hayek’s The Road to Serfdom, not a great read; but hey, he as an Austrian economist writing in English. What do you expect? Danielle Steel? But it is a truly scary book and still regrettably perhaps more relevant today than at any time in the past 70 years.)
Italy’s woes and Brexit together are an astonishingly bad duet. Each problem distracts from any coherent and focused effort to solve the other. Brexit could, as we outlined above, be an existential threat to the European experiment and now, Italy. The policy prescriptions of the current Italian government with certainty will trigger a series of bad things tomorrow and they apparently really don’t care today. Living in the moment is a virtue, right? Watch the dominoes fall. Interest rates spike. Italian banks (which hold zero capital against sovereign debt) tank as their capital cushion vanishes. A rapid deterioration of the Italian economy follows. Contagion is inevitable as European banks holding Italian debt are stressed. Investors run away from the sovereign debt of other countries who might have the Italian disease (and there are many of them), causing more contagion across the European banking sector. The virulent failure of the banks causes a rapid decent of Europe’s economy, which re-enters a significant recession with very few tools in the toolbox of the European Central Bank or the European Union left around to address the new rescission. The result is more populism, more centrifugal forces unleased resulting in a compelling need to regain sovereign control of monetary policy. Rinse, wash and repeat until the center will not hold.
I actually don’t think the European Union will ever give up the ghost; it’ll just too important a concept, a dream if you will, for Europe (at least while memories of the great 20th century war (1914 & 1945) are still rather fresh). It will, however, be transmogrified into an ersatz version, a mockup of the real thing, which those who hold a vision of a single European Union will be appalled to confront. Sovereign currencies are likely to return or some forms of synthetic or parallel sovereign currencies will proliferate which will allow individual countries to reflate. The range of political choices permitted by European Union is likely to get stretched by the continued growth of illiberal democracies in the east and perhaps even more populist-tinged governments across old Europe as well. The Four Freedoms will be a ragtag bunch; the ECB will be hobbled. No common supervision of the banks will be achieved and Brussels will become increasingly irrelevant. It will be a very different place. Perhaps it will be more akin to the original customs union of its birth? Maybe free trade can be salvaged. But I see an inevitable waning of the tide of increased unification or even federalization of the continent.
In any event, Perfidious Albion may suffer a rough patch whether they go or whether the Europeans succeed in stitching this Frankenstein’s monster back together. While we should never forget two things—never get into a land war in Southeast Asia and never underestimate the ability of Europeans to kick the can down the road—the risks here are very real. All it would take is a little mistake, a bit of political overshoot or a miscalculation and the already vulnerable edifice which is the EU will fall off its high wire. The vocabulary and trappings of the European Union may remain, and almost certainly will, but the relationship between a post hard Brexit UK and the rest of Europe won’t look all that different from the relationship between each of the current members of the Union and each of the others. Brexit for all!
Hope you enjoyed Halloween, when we only pretend to be scared.