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Independence and its consequences

Britain left the EU on the last day of January and is an independent nation once more. The new Johnson government is confident that Britain will do well outside the EU. Free trade will be embraced, and a no-deal outcome, now dubbed an Australian trade relationship, holds no fears for the British government.

This article summarises the political and economic consequences of this historic moment. The fly in the ointment is there is no sign that Britain’s government understands the importance of sound money, which will be crucial in the event a global economic and financial credit crisis materialises.

Independence and trade negotiations

Having given independence to all its colonies, now it’s Britain’s turn. On 1 February the UK became politically independent and entered an eleven-month transition period while trade terms with the EU and other trading nations are negotiated, with the objective of entering 2021 with freedom to trade without tariffs with as many nations as possible. If Britain succeeds in its initial objectives these trade agreements will include not only the EU but also America, Japan, South Korea, Canada, Australia, New Zealand, the other trans-Pacific Partnership nations and a host of sub-Saharan African nations in the Commonwealth. It amounts to about two-thirds of the world measured by nominal GDP, of which only 21% is with the EU.

Additionally, an analyst looking at market substitution must allow for the relative dynamism of economies. Britain’s trade in goods with the EU has been declining, and today represents about 45% of Britain’s exports, having slipped from 55% in 2006. Despite the penalty of WTO terms with nearly all of Britain’s other trading partners, British exports are gaining more traction in trade outside Fortress EU. The future is brighter elsewhere.

Furthermore, the EU’s trade covers physical goods affecting only 8% of Britain’s GDP, with services a separate issue negotiated on a case-by-case basis.[i]] Being predominantly wholesale, most trade in financial services is excluded (though the EU is trying to claim it is not), and those at the retail level are delivered through British-owned subsidiaries based in Luxembourg and Dublin. Attempts to force EU standards on British financial services have a long history of failure, and the most recent suggestion, that the EU will seek to maintain access to British fishing waters in exchange for continued access for financial services to the EU, is an empty bargain.

Trading one issue off against another is a long-standing EU tactic which is no longer relevant. Having secured a good working majority in the House of Commons with every new Conservative MP required to unconditionally support Brexit as a condition of their selection, Britain’s trade need not be compromised in negotiations on political grounds. Furthermore, the new leadership recognises that unilateral free trade is the best outcome for the British economy and is now being overtly championed by Boris now Brexit is done. Boris Johnson realised free trade is the central economic issue when he broke with the establishment before the 2016 referendum.

Before Brexit and Boris, with the all-powerful establishment controlling the post-referendum agenda this could never be admitted, until now. Parliament specifically legislated to remove the no-deal option, not just to emasculate British negotiators and thus for Britain to remain within the EU’s customs union, but because the Westminster and Whitehall establishments did not understand trade, let alone free trade, and are subjugated by their socialising instincts.

That is now history, and if the new Conservative government cares to do so, it can play hardball as hard as it likes in the upcoming negotiations. So far, in doing so it has been careful not to appear in favour of free trade, but that is changing. The issue was camouflaged by Boris in socialist ideals: more hospitals, more schools, more police, and promoting the climate change agenda. But make no mistake, an understanding of the benefits of free trade and the true cost of a socialising establishment are at the heart of this government’s policy, now publicly admitted and declared by Boris Johnson.

How it leaves the EU

The people and their 27 remaining governments in the EU have been watching the UK’s escape from their Hotel California with interest. There is widespread discontent, but no other nation has raised seriously the possibility of following the UK out of the EU. Instead, the mantra has been to get more handouts or promote reform. Good luck with that. And we can blame the Americans for this dysfunctional project.

Once upon a time (all fairy stories start with this way) some senior bigwigs at the CIA decided to set up a committee. ACUE sounds like a sneeze, but it actually stood for the American Committee for United Europe. In the late 1940s, ACUE funded, and therefore chose the direction of fledgling pan-European movements in a plan to keep Germany pacified and the Soviets out of Western Europe. It was something Britain had no desire to be part of, content with its role in the British sector of Germany and the newly-formed NATO.

While ACUE set the direction for European integration, Britain was busy trashing her economy with post-war nationalisation and the kneejerk socialism that followed the war years. In 1957, having become Prime Minister after Eden’s Suez disaster, Harold Macmillan found he had been dealt a poor hand: a vanquished Germany was powering ahead, and De Gaulle’s France was hitched to the German wagon. The Common Market was busy protecting itself from foreign imports with tariffs and import restrictions, disadvantaging Britain’s trade. These were similar policies to those of President Trump today.

Macmillan’s droopy, rheumy eyes were an apt metaphor for a tired post-war Britain. With what money it had left from socialist partying, Britain faced being excluded from trading with her European neighbours. De Gaulle said non, twice, and it was only when he was replaced by Georges Pompidou that France relented and eventually let Britain in. Protected from outrageous fortune by a fortress of tariffs and having ditched her empire, Britain contented herself with further decline, earning the soubriquet of being the sick man of Europe.

Then Margaret Thatcher happened. Britain was revitalised. Exchange controls were abandoned, and even German businessmen envied Britain in her leadership. But it was clear that with Thatcher came revived British nationalism and political confidence. It was as if Lazarus had risen from his sickbed. Maggie restored the nation’s desire for independence, which took thirty years after her premiership to finally realise.

Brussels will console itself that without Britain it will be free to pursue other objectives. It is assembling an EU army out of its members’ military resources, having already established a network of embassies around the world. It seeks tax harmonisation, and an additional federal tax cannot be far away. It will miss the UK’s annual contribution of about £11bn, funding which will be made up by the other members.

In truth its bureaucratic, undemocratic model is outdated and inflexible. Its ethos has become a paralysing mixture of big business cronyism and socialism. Free markets are a threat and despised. Its central bank, the ECB, has got the inflation bug, financing spendthrift member governments and undercapitalised big banks. And its new head, Christine Lagarde wants to fund climate change, all by printing euros.

More nations are bound to abandon this out of date political project. Ordinary Germans have had their hard-earned savings trashed, most recently with negative interest rates. The mittelstand, the backbone of Germany’s engineering and technology, is being sacrificed on the alter of climate change. The Mediterranean nations have their hands out for more subsidies. As Mrs Thatcher once said, the problem with socialism is that you eventually run out of other people’s money, a truth which hapless EU residents will learn the hard way. It’s a lucky escape for Britain.

The trade negotiations ahead

Trade negotiations will not start until March, because the EU’s negotiators are consulting with all member states to gain support for its negotiating strategy. In effect, it means the EU will come to the table with its red lines confirmed and will use them in an attempt to stop the UK thinking the EU will concede ground on trade, regulations and the supervision of the European courts over trade disputes. It seeks continual access to British fisheries, and instead of using the Irish border issue to stymie negotiations, the EU intends to drive a wedge between Britain and Gibraltar.

Meanwhile, Britain has made a strong start on the novation of existing EU trade agreements with Japan, South Korea and Canada; the only issue being Britain’s desire to make agreements even more comprehensive than the existing ones with the EU. At the same time, new trade agreements are being fast-tracked with the US, Australia, New Zealand and all other countries keen to sign up, predominantly members of the Commonwealth and the Trans-Pacific Partnership.

The principal sticking point in these negotiations is movement of people. Countries like India, Pakistan and the states of South-East Asia, some with large UK diasporas are seen to be an immigration problem which could become a trade negotiating issue. Doubtless, new immigration controls based on the Australian system will be modified to alleviate these problems, on the basis that there is an ambition for Britain with its top universities to become the pre-eminent educator for the world.

While these difficulties must not be belittled, by the time the UK and EU start talking turkey in March, the British should be in a position to announce tangible progress on a number of trade deals. Furthermore, the abandonment of the EU’s import tariffs will reduce consumer prices, without directly affecting output prices, and increased competition between domestic and foreign manufacturers are likely to have a beneficial effect on consumer prices as well.

The benefits to the consumer of tariff-free trade have received little mention so far. But given Keynesian economists are likely to see them as deflationary it must raise in their minds an awful dilemma. For a Keynesian, it is impossible to argue convincingly in favour of tariffs yet at the same time have an unquestioned belief that higher prices are a stimulant to consumption and deflation of them a tool of the devil. Consequently, the establishment is likely to be confused on this issue. Nevertheless, the free traders in government will need to drive hard the British response to the EU’s red lines and ensure change is so rapid that critics in the establishment and lobbying industry will always be left arguing yesterday’s issue.

As the backstop to trade negotiations, free traders see no problem with no deal, but the EU does in two respects. Firstly, the whole ethos of the EU is protectionism and secondly, it fears that the UK will use a trade agreement to undercut EU trade if it is freed from EU bureaucracy. From the EU’s standpoint, this was their means of control embedded in Mrs May’s Withdrawal Agreement, and subsequently in the toned-down version which was eventually passed under Boris Johnson.

But it seems that Boris has worked a blinder. Details of the final agreement are open to interpretation, and the Political Declaration was to set the tone for what is fair. In reality, the political declaration is meaningless, or will be rendered so. No doubt, Boris Johnson, Michael Gove and Dominic Cummings knew this at the outset and will simply disregard it. The first challenge will be on access to UK waters for fishing, due to be agreed by 1 July to be implemented at the end of the implementation period. This is where the Political Agreement is likely to break down.

As mentioned above, there is a view that in order for EU fishing vessels to be permitted to have access to British waters, they are prepared to concede something on financial services. Quite possibly the French, who face pressures from their fishing industry, will be behind an attempt to rob Peter to pay Paul, as will the Spanish, wanting Britain to give ground on Gibraltar if they are to be excluded from British waters.

This negotiating tactic, if deployed by the EU, cuts across the compartmentalised Political Declaration and can be ignored by the British. Interestingly, Brexiteers who initially opposed Johnson’s agreement with the EU (being the Withdrawal Agreement and the Political Declaration combined), including members of the European Research Group of free-trade Conservative MPs and even Nigel Farage’s Brexit Party, have now accepted it. Were they briefed that the Political Declaration was actually as watertight as a sieve, and bound Britain to nothing?

Added pressure has come from Boris Johnson himself, refusing to consider any extension of the transition period beyond the end of this year. He is now openly talking about being prepared to settle for an Australian solution, for which we should read WTO terms.

As has been the case since the referendum campaign, Dominic Cummings will almost certainly be a background figure in the negotiations. His success in working with Michael Gove in Education (now de facto deputy Prime Minister), his success in managing the Vote Leave campaign, and his success in managing Johnson’s election strategy will all ensure that more than anyone else on the British side, he will set negotiation strategy. For him, his work is not yet done, and he gives no quarter.

The future for Britain’s trade outside the EU

There is every reason to be optimistic for the UK economy in the coming years. Freed from the EU’s restrictive tariff regime, Britain can become a competitive global supplier of goods and services and an entrepôt. Assuming the government does not make the mistake of introducing new tariffs to replace those of the EU, the full benefits of comparative advantage will also apply. Comparative advantage refers to the competitive benefits of allowing individuals and businesses full access to the cheapest, best or most suitable goods and services irrespective of by whom and where they are produced. It was, besides a monetary gold standard, the reason why Britain became the most powerful trading nation on earth in the seventy years before the First World War.

In his speech last Monday at the Painted Hall in Greenwich, Johnson even championed Ricardo’s theory of comparative advantage, which tells us that he understands its importance, and he further confirmed his ambition for Britain to become the driving force behind global free trade, referring to Adam Smith’s “invisible hand”. As noted above, immediate negotiations will encompass almost two-thirds of the world measured by GDP.

But that has to be only Phase One. Absent from his recent speeches has been mention of trade with China and Russia. Putting Russia to one side, China cannot be ignored, and before America upped the anti on China’s trade, Britain was developing a leading role, in conjunction with Hong Kong, in offshore markets for the yuan.

As an Anglophile and a disparaging critic of the EU’s protectionism, President Trump is personally committed to negotiating a fast-tracked trade agreement with the UK, which means free trade with China will have to be on the back burner for now. China will have to wait, but there must be no doubt that in the fullness of time Johnson will embrace a free trade agreement with China, and possibly with the full membership of the Shanghai Cooperation Organisation.

Only, there is an overriding problem. While Johnson understands the economics of free trade, as yet, there is no evidence he understands the importance of sound money. Nor, perhaps, does Dominic Cummings, if his recent advertisement for new talent to work with him and his team of special advisers, including mathematical economists, is any guide.[ii]

Another financial crisis is in the wings

In common with other jurisdictions, the financial crisis twelve years ago was countered by an explosion in outstanding government debt, financed by quantitative easing. Subsequently, the UK government has achieved a return to a balanced budget. As long as there is not a repeated credit crisis, the UK government’s finances are in good shape. The intention is to improve them further by cutting bureaucratic waste and eliminating political grandstanding.

But another crisis is due, and no substantive preparation for it has been made, other than some wishy-washy stress tests on the banks. Not only has there been little preparation, but the Keynesians at the Bank are clearly out of their depth. Unless it is being secretly done, the Bank has made no attempt to rebuild its gold reserves, if only as a vague insurance policy against the day some sort of reset is required. In common with other central banks, a state-issued cryptocurrency and blockchain technology are being examined instead, a solution to future monetary challenges that owes more to fashion than reality.

Realistically, the Bank and the Johnson government will have no alternative to inflationary solutions to the next crisis. While nearly everyone sees London’s financial and banking dominance as a good thing, it will mean the cost of rescuing it will fall disproportionately on the UK in the event of a global financial and systemic crisis. And one is now due.

The point about understanding the importance of sound money in this febrile environment is not that it will somehow improve the UK’s response to a credit and financial crisis. It is more about how the government stops it undermining the currency. With America’s Fed and virtually all other major central banks tying in their currencies to continually rising financial asset values, a systemic crisis threatens to undermine both financial asset values and unbacked fiat currencies, perhaps entirely. It is only by understanding why this is the case and avoiding the trap that second line currencies such as sterling faces that it will survive a currency holocaust. But with an understanding of free markets, at least the Johnson government should have a head start in its dealings with the aftermath of the next financial crisis.

However, the UK is still tied financially into the EU, paying into its coffers until the transition period is over. There will also be a monetary settlement to be finally agreed, but that is thought to be just under £30bn, less than the £40bn touted under Mrs May’s proposed withdrawal agreement. What’s more concerning is the cost likely to arise from a financial and systemic crisis in the EU, which the UK might still be required to backstop.

[i] House of Commons Library: Statistics on EU Trade (December 2019)

[ii] See https://dominiccummings.com/

The views and opinions expressed in this article are those of the author(s) and do not reflect those of Goldmoney, unless expressly stated. The article is for general information purposes only and does not constitute either Goldmoney or the author(s) providing you with legal, financial, tax, investment, or accounting advice. You should not act or rely on any information contained in the article without first seeking independent professional advice. Care has been taken to ensure that the information in the article is reliable; however, Goldmoney does not represent that it is accurate, complete, up-to-date and/or to be taken as an indication of future results and it should not be relied upon as such. Goldmoney will not be held responsible for any claim, loss, damage, or inconvenience caused as a result of any information or opinion contained in this article and any action taken as a result of the opinions and information contained in this article is at your own risk.

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