By Victor Hill, first published on Master Investor
The Road to No Deal
While Europe and the world have been monopolised by the Covid-19 pandemic, the UK-EU trade talks have been stumbling on via Zoom. The outcome of these talks will determine the nature of the UK's relationship – commercial and political – after 31 December. The problem is that the Europeans have not changed their negotiating stance even as the world has changed around them. Their objective, as clearly stated by EU Chief Negotiator, Michel Barnier, has been to impose terms on Britain that would make us regret we ever left the EU in the first place.
Essentially, the EU wishes to ensure that Britain cannot out-compete its European neighbours (the so-called level playing field); British waters must remain open to European fishermen; and the European Court of Justice (ECJ) must continue to hold sway in the UK. A Canada-style – nor even a Japan-style – free trade agreement (FTA) is apparently not available because of Britain's geographical proximity to the trading bloc. (That was always an odd stance in a digital age when physical proximity counts for less).
Over the last week or two the mood music of the talks has become much more sombre. Monsieur Barnier told a German radio channel that the British do not understand that Brexit has consequences. Britain's Chief Negotiator, Sir David Frost, hit back, saying the EU-27 needed to relax Monsieur Barnier's negotiating mandate. His letter was described by France's former Europe Minister, Nathalie Loiseau, as "aggressive". Even Bank of England Governor Andrew Bailey warned British banks to prepare for no-deal on Wednesday 3rd June.
The Price of No Deal Has Fallen
Those who find no-deal anathema have always claimed that no-deal would result in intolerable delays at the Channel ports. (Readers will recall the parliamentary shenanigans of last October when the anti-Brexiteers briefly seized control on this basis.) That concern is less justified at a time when both international trade and travel have collapsed. The prospect of trucks stacking on the M20 doesn't play anymore.
Anyone who claims that there will be an immediate spike in food prices should note the EU's tariffs on foodstuffs coming from outside the EU such as the 104 percent tariff on sugar, 50 percent on New Zealand lamb, 70 percent on chicken breasts and 20 percent on orange juice and bananas. True, supply chains in the strategically important automotive and aerospace industries could be disrupted – but these sectors have already been disrupted by the pandemic. Their prospects will depend on the structure of the economic recovery. The idea that Nissan cars produced in Sunderland will become unsaleable in Europe because of a WTO 10 percent tariff is cock-eyed.
Moreover, the idea that we shall be able to de-regulate after 01 January 2021 just as the world is – hopefully – coming out of recession, is appealing. We might even be able to do something about the nearly €100 billion trade deficit we ran with Europe last year. Undoubtedly, Britain faces a tough climb to get out of our particular coronavirus hole. But at least we are not wedded to a currency union that is fundamentally flawed.
The Status of EU Law Has Changed Fundamentally
The real significance of this obscure and technical German court ruling is that it subordinates EU law to German law. Steven Barrett, an eminent barrister, wrote on The Spectator website last week:
What matters about the German court's action is simply that, for the first time ever in the history of the EU, a national court has refused to submit to the European Court of Justice…When the UK voted to leave the EU it was always theoretically possible for Parliament to do so by passing an Act of Parliament. But the idea of doing so was unthinkable at the time; the UK began its process of leaving, not under our law, but under EU law. What the German court has done is the constitutional equivalent of us unilaterally leaving.
The ECJ has, over the years, acquired a habit of arrogating powers to itself that in fact have no basis in the texts of the successive treaties that have consolidated the EU's powers over its member-states. In the same way, the ECB, in the opinion of the crimson-robed German jurists (all disciples of sound money), has strayed from the realms of monetary policy into economic management without any legal authority to do so. The German court ruled categorically that it is "not bound" by any rulings of the ECJ.
Germans are not alone in thinking this ruling timely. The Polish Prime Minister, Mateusz Morawiecki, of the Eurosceptic Law and Justice Party, described the judgment as "the most beautiful in EU history". Meanwhile, EU Commission President Ursula von der Leyen vowed infringement proceedings against Germany. How can Monsieur Barnier demand that the UK remain subject to EU law and regulations when, according to the German constitutional court, even its own member-states are not subject to those laws save to the extent that they consent? Never was there a more propitious moment to make a clean break from the entire edifice of EU law which now itself looks in cracked from base-stone to pedestal.
EU Competition Law Has Been Suspended
As I wrote in the Special Report that I co-authored with James Faulkner in April, the instinctive reaction of the larger EU states during the emergency has been Sauve qui peut – Every man for himself. In this environment it would be absurd for the British to subordinate their interests indefinitely to the sway of European institutions.
The EU's Financial Standing Has Collapsed
The arrangement does not pool the legacy debts of all member states in a joint fund – as Alexander Hamilton achieved in the early years of the United States when the former 13 colonies pooled their finances (1790). It is linked to the EU Commission's seven year budget cycle. The EU will not be issuing Eurobonds – which would most likely be ruled illegal in Germany. Instead, the new Recovery Fund will supply €500 billion of grants – not loans –spread over four years and beginning in March 2021. There will also be cheap loans advanced on strict conditions to selected borrowers. Claudio Borghi, the Lega chairman of the Italian parliamentary budget committee, described the Recovery Fund as "a gimmick". The package is described as "temporary". But, once the pandemic has passed, do we really think that the EU will return to the status quo ante? The French certainly regard the fund as a first step on the path towards a true fiscal union. A political crisis in Italy has been averted – for now, but for how much longer?
The Commission itself foresees that Italy's debt-to-GDP ratio will rise from 135 percent at the beginning of this year to nearly 160 percent by the end of 2020. Some economists think that this underestimates the impact of the pandemic and lockdown in an economy which has not been growing at all. Portugal's debt-to-GDP ratio may end up at 160 percent and Greece's at 220 percent. These are all impossible numbers. Later this month the ECB will announce its latest round of QE – possibly another €500 billion. This may have to be undertaken without the participation of the German Bundesbank (see above). Europe stands on the cusp of deflation – the slump in oil prices brought the headline inflation rate down to just 0.1 percent in May. One sympathises with Madame Lagarde.
"We Are Fish"
This is not just about chlorinated chicken – which is a marginal issue and one that could be addressed by appropriate labelling. (American farmers treat chicken carcasses in chlorine because chicken there is overwhelmingly battery-farmed, which renders the birds more prone to disease). It's about whether British farmers should be forced to compete with cheap American imports because of differing welfare and ecological standards. The counter-argument is that the Americans will buy our lamb (even though they don't even buy New Zealand's wonderful lamb).
Personally, I don't think we can square this circle in a politically acceptable way. Any trade deal with America would have to create a "dual-tariff" regime whereby cheap American food imports or hormone-fed beef etc. would carry tariffs so as to equalise their retail prices with British products. (And I know which ones I shall choose). The really important trade deals will be with the CANZUK countries (Canada, New Zealand and Australia). We shall not go hungry or thirsty with them on board.
How Things Will Play Out
Some devout Brexiteers nonetheless crave a deal by September. They fear that if there is none forthcoming that will play into the hands of the Rejoiners who always wish to make a crisis out of a drama, there being a slew of unresolved issues. Further, a future Labour government – the probability of which has risen in recent months – might seek to conclude a deal on unfavourable terms. But if the Brexiteers are apprehensive, the Rejoiners are dizzy as the ground shifts under their feet. The arguments around Remain-Rejoin have been undermined. Monsieur Barnier's catch-phrase in the days of Mrs May used to be "The clock is ticking" – while actually running down the clock. Now he accuses us of doing the very same.
I'm not alone in hearing secret harmonies. Just as the pandemic and the lockdown have made us all more inclined to self-sufficiency – baking our own bread and growing our own veg – so the idea that nations need to make more of what they consume at home is one whose time has come. National resilience, if you will. Globalisation is in retreat. If it has to be no-deal – then bring it on.
What are the markets telling us? Zoom (NADAQ:ZM) now has a market capitalisation greater than that of the world's seven leading airlines put together. If you subscribe to the Efficient Markets Hypothesis – that the market summarises all available information accurately and that all actual stock prices are true at any given moment – this valuation suggests that the world has fundamentally changed. We shall continue to work from home, commute less, and shall travel less overseas for business and holidays. There will be huge consequences to this shift for investors, which I shall explore soon…
The NASDAQ has hit an intraday trading all-time high as I'm writing this (Thursday). Did I mention that I don't believe in the efficient whatever it-was…?