Will the EU survive a Brexit?

A recent poll by a Dutch newspaper suggested that 53% of Dutch voters would like to have an ‘in/out’ referendum similar to ours. On reading this it struck me that there has been too much emphasis on the impacts to the UK leaving the EU and not enough on the impacts to the other party. There will clearly be implications for both the EU as an institution and for the wider European economy.

All the economic arguments against Britain leaving the EU also apply to EU member countries access to the UK market, and perhaps more so given that the EU exports more to the UK than the UK exports to the EU. There is a counter-argument in that in the event of an exit vote there could be a flock of organisations leaving the UK to manufacture and provide services within the trading block itself. In other words the losses that Europe would face would be offset by the gains from organisations leaving the UK and moving to other locations on the Continent. It is impossible to make a forecast on the degree to which this position can be substantiated as all we seem to have are reports from various groups of economists and forecasters who, as a profession, are notorious for getting it wrong. It may well be that there will be some who could eventually make a decision to de-camp, but it is equally likely will be a very long period of ‘consideration’ as the politics and economics of an exit start to settle down. The negotiations on cross border tariffs will be more than interesting to watch given the current EU import/export situation and there is little doubt that there will be some furious lobbying in Brussels and Westminster.

Should there be a Brexit vote there will undoubtedly be volatility in the foreign exchange, debt and equity markets as traders and investors realign in accordance with where they think their interests will lie. Attention however could soon switch to Europe, possibly within days of the vote as the European political and economic worlds collide into uncertainty.

The Europe question really falls into two broad but linked areas: its economics and its politics.

I have to confess to being surprised by the ability of the ECB to hold the Eurozone area together. Back in 2011 I was convinced that within a couple of years the Greek debt problem would have torn the EZ apart. My mistake was to underestimate the political willpower in Brussels and Frankfurt to ‘do whatever it takes’ to maintain the integrity of the currency area. With an alphabet soup of ECB initiatives and some prodigious write-offs a bail-out deal was struck with Greek lenders and the debt substantially moved to the European taxpayer. All those French and German banks were helped out of their predicament and lived to lend another day. Greece then effectively voted to say in the EU via the rather convoluted political means of a referendum on whether to accept a ‘plan of agreement’ negotiated with the Troika. The deal done the Greeks now have a debt of over €353bn, a GDP of €168bn and nearly forty years of ‘austerity’ ahead of them, mostly driven by its onerous repayment schedule. What could possibly go wrong?

Meanwhile, over in Spain unemployment has edged up to 21% at the end of Q1 2016; not quite as high as the 24.1% in Greece but getting there. Italy sits at 11.7% and Portugal 12.4%. Overall the Euro are currently stands at 10.2%. Growth in the Euro area as a whole was 0.6% but this masked a negative performance in Greece of -0.5%, a barely measurable 0.3% in Italy and 0.2% in Portugal, and an improved outturn of 0.8% in Spain. Germany, Europe’s manufacturing powerhouse, managed 0.7% GDP on the back of a very respectable 4.2% unemployment metric. Two other useful indicators are the inflation rate and interest rates. For the EZ as a whole these were -0.1% and 0%. Blighty is not quite the land of economic wonders that some parts of the political ecosystem would have us believe but the United Kingdom did manage to deliver 0.4% GDP and recorded unemployment at 0.5%.

The Brexit referendum has naturally focused on the impacts to the British economy of an exit but what about the impacts on Europe and the EZ in particular? If we take April 2016 as a reference point, the UK’s exports to the EU were £12.0bn and EU imports were £19.1bn. Thus, as the HMRC states in its April report: ‘In EU trade the UK was a net importer this month, with imports exceeding exports by £7.1 billion.’ These figures obviously fluctuate but overall we import more from the EU than we export to it. In other words the EU would be taking a mighty big risk if it sought to exclude the UK from Europe via the imposition of tariffs. Let’s be more specific. The EZ is not in a healthy state. GDP is moribund and is arguably only above zero because of the largesse of the ECB and its current €80bn/month QE programme.

Which brings me over to the politics. The EU has an enormous challenge at the moment to assuage the feelings of millions of EU citizens on the state of their respective economies. There seems to be an increasing unwillingness from the citizens of Northern member states to continue funding Southern member nations. But it has more recently started to morph into the immigration minefield. Freedom of movement for EU citizens may be just about acceptable for Northern EZ voters but mass migration from outside the EU is entirely something else. Thus we have a conflation of issues all over the EU and the finger of blame is pointing at the institution itself. Southern states don’t want the austerity that the EU imposes and Northern states don’t want to continue to face the financial and social implications of a financially dysfunctional EZ area.

The results of an Ipsos Mori poll carried out earlier this year carried out in nine EU countries, suggested that 45% of those polled wanted an in/out vote like the British. This was led by 58% of Italians and 55% of the French contingent. In the same poll 33% of the 6,000 surveyed indicated they would actually vote to leave. This still suggests a majority still in favour of keeping the EU intact but it’s hardly an overwhelming endorsement.

There is some ‘domino theory’ type thinking associated with the Brexit vote. Britain leaving the EU could mark the start of a more member states leaving and this of course raises the question of whether the institution could remain intact. Since 2010 the EU/ECB has been able to ‘whatever it takes’, or perhaps it should be ‘whatever it wants’ to hold the EZ together. But the inconvenient intervention of voter dissatisfaction has now ascended the political agenda. In the absence of voters, the EU/ECB has had free rein to use diplomatic and financial levers, but in the immediate future they may well have to face challenge of millions of unhappy citizens and one or more in/out referendums. The odds may well be stacked against them this time.

The economics and politics of the EU and the EZ are inextricably linked. In the absence of any EU activity the ECB has used its full capability to try and kick-start the economy back into life. It hasn’t really worked. At best QE has prevented some disinflation and arguably deflation, but there have been costs to this. The European debt markets have entered the Alice in Wonderland world of negative interest rates with German bunds the latest casualty. In essence the ECB has bought up too much of the EU sovereign debt with the residual element now fought over by institutions desperate to park their short term money somewhere. The Italian banking system and more than a few of the French and German banks are undercapitalised, whatever the ‘stress tests’ suggest. One serious shock and the whole European banking system spins into a turmoil, a turmoil that raises the risk of a 2008 style panic. The whole European system looks less than stable.

So where does that leave the EU on a majority Brexit vote?

With a conundrum and a lot of economic and political risk. The conundrum is whether to play hard ball with Britain and risk the integrity of exports to the UK. In the face of a wave of political discontent would the EU want to undermine what is already a moribund economic performance? The political risk is of course all about those other anti-establishment political initiatives and their own drive for a membership plebiscite. However the EU might spin a UK exit, it will in effect establish a precedent, and a very dangerous one.

Betting against EU survival has been a losing position over the past few years but that was before the not-so-timorous Brits decided they wanted to make a decision. The rest of the EU are now watching and I have no doubt will be as glued to the TV set as the British in the early hours of June 24th. If the British vote to stay my belief is that it will settle many voters in the rest of the EU; the cries for refere

ndums will fade. On the other hand if the Brexits are the majority my sense is that a wave of ‘we want one too’ will sweep across much of Europe. After a week or two of market volatility negatively affecting UK markets and the GBP, attention will soon turn to Europe, its markets and economy. While we in the UK may well have to deal

with another Scottish question the real action will be across Europe as the political implications and economic realities are evaluated. There appears to be little sense of panic or urgency in Europe at the moment but that is likely to change within hours of an exit vote. The first real cracks in the sclerotic EU infrastructure could start to appear before the year is out.

We shall see.

EU crack2

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