When the global economy turns, Britain will pay the price for the dire state of its Brexit debateby George Magnus / September 26, 2017 / Leave a comment
This week at conference, the Labour Party is fudging decisions on Brexit—refusing a full debate on the subject, while the leadership pretends that we can both leave the European Union and abandon austerity. Next week at its own conference, the Conservative Party will lay bare the sham of the Florence Brexit “truce,” revealing a government strategy that amounts simply to “kicking the can.” It is embarrassing, to say the least, that the main Brexit debate is the one we are having with ourselves, much to the chagrin—if not bemusement—of our EU27 counterparts. Fortunately, the global economy is at least providing a relatively stable backdrop for the UK. But things are changing, and we should not be complacent that this benign state of affairs will continue. As things start to get trickier externally, things will also get feistier at home.
There is some good news. At home, the latest government borrowing figures through August suggest that the Chancellor may have some leeway to ease budgetary policy in his Budget statement on 22nd November. In the world at large, global institutions such as the IMF and OECD think that synchronised global economic growth will hold steady going into 2018, and that the biggest positive surprise remains the EU. The rise of populism—the latest example being Germany’s AfD party taking a 13 per cent share of the vote in Sunday’s German elections—has not interfered with the global expansion. Yet.
Moreover, although the US Federal Reserve is about to start unwinding its asset purchases and both the Bank of England and the European Central Bank have indicated they are leaning towards a partial reversal of easy money policies, none of the major central banks are likely to act inappropriately to tighten financial conditions, bearing in mind low inflation. Even here in the UK, the Monetary Policy Committee’s latest bark about a rise in interest rates may prove to be worse than its bite.
None of this means we can be complacent about the baggage we have brought with us from the financial crisis and before. Global debt is still rising and there are some particular worry-spots, including households’ unsecured debt in the UK, student and auto loans, corporate debt in the US, and above all corporate, real estate and local government debt in China. Worldwide, productivity growth is in a funk. It’s especially poor in the UK, but disappointing across Europe, in the US and also in China and a host of emerging markets. Ten years after the start of the financial crisis, we still can’t be certain why this is or for how long it might continue.
“At the Party conferences delegates will carry on, oblivious to the implications of Brexit”
We can also start to see a new churn going on in the US, China and Europe, which is bound to have repercussions. Until recently, investors and businesses could be fairly confident about the benign impact of US financial and monetary conditions. Now they have to switch focus, because new uncertainties are emanating from the other side of the world in China. This follows a sharp financial crackdown on “excesses” of risk taking and inappropriate financial behaviour in the last few months. The much awaited 19th Congress of the Communist Party will be held next month, and there is considerable uncertainty as to what will happen to economic policy, but the tougher regulatory conditions are expected to endure, leading economic growth lower. By and large, financial markets are not prepared for this.
China, which has previously been seen as a rock of stability with regard to its “about 7 per cent growth” target (even though reality has been rather different from official data) is now passing the baton of confidence to Europe, excluding the UK. The cyclical growth pick-up is younger than in the US and could last longer. Germany’s economy is relatively robust, France has been catching up a bit, and Macron’s labour and other reform proposals may yet help a bit to strengthen the economy and Franco-German leadership in the EU. The ECB’s largesse has bought valuable time for structural reforms to click in Portugal, Spain and even Italy and Greece. Unemployment is falling, and Eurozone growth is running at a little more than 2 per cent. It is by no means an economic nirvana, and major political and economic risks remain but it’s a far cry from where things were two-three years ago.
Europe, which most people regarded until now as the fulcrum of political risk, is (for now at least) slipping behind the US in this respect. Mutual suspicions within the White House, political investigations, twitter attacks by the President on those who oppose his “values,” and a Republican Congress in some disarray, reveal an increasingly dysfunctional Administration. In other ways too, the US is starting to resemble an emerging market: a hollowed out middle class is still being ignored, Washington is weakening an already flimsy social safety net, tribal politics and racial tensions are headline news, and the government can’t seem to structure, let alone pass, credible or relevant economic policies that even business lobbies want.
“As things start to get trickier externally, things will also get feistier at home”
It is small wonder that the US dollar has been in the doldrums. A narrow measure of the trade-weighted US dollar has fallen nearly 10 per cent since last October, while a wider version has fallen nearly 8 per cent since February this year. Even Sterling is up, rising from $1.20 in February to about $1.35 now, though its trend against the Euro is still down. The US equity market still looks buoyant even at current lofty levels, but sentiment can change quickly, as we know. Right now, professional investors can’t see a catalyst, but that’s the thing about political risk: markets aren’t able to price outcomes, and so when things change, they’ll happen abruptly.
As far as the UK is concerned, it is interesting to note that Sterling is a little stronger right now because markets think the Bank of England might raise interest rates later this year. The trouble is that the reason the Bank might do this is because the economy’s deteriorating supply position is embedding higher inflation. Brexit will make this worse. So Sterling will eventually fall back down, whether the Bank does or doesn’t raise rates.
Meanwhile, as I’ve suggested, the global economic backdrop is likely to become more, not less, supportive for Brexit Britain. These issues won’t get an airing at the Party conferences, where delegates will carry on, oblivious to the implications of Brexit and the economy’s capacity to absorb them.