Brexit? People do not leave a floating ship or stay on a sinking one. So is it sinking?

Brexit is complex so I wrote myself a note to then share. In summary, the EU is in denial that the Euro is the problem. Political integration is not the solution, even if the EU can pull it off. Trade happens quite well without trade agreements.

I will probably Vote Remain because there is no one credibly identified to lead the post-Brexit process. Also, I suspect UK gets a better Brexit deal in a few years time as the EU starts to unravel in the face of multiple Euro-induced debt crisis.

Creating money should be extraordinary, but is no longer. (UK started it). It will probably once again be necessary when southern European countries face defaults. However, creating money will offend north European economies who are actually earning it! Thus, the most probable risk scenario for the EU is the unravelling of its membership rules caused by the ECB needing to create money to bail out southern Europe.

There are lots of factors missing from this note because they do not in my view point reliably one way or the other. eg How much better off will UK be if they Brexit? Worse for a bit, probably, but eventually better, maybe. Whether Westminster democracy delivers better actual governance than EU democracy? Unclear to me, High Speed Rail aka Hs2 by 2040!; Is Sovereignty better pooled? Impossible to know or measure; Security? EU makes no difference etc.

If the EU ship sinks none of this matters. If I was an SME CEO, I would ignore it all and make some sales.

A Failure of Logic

The captain of a sinking ship has to decide if the passengers should take to the lifeboats.  This big decision rests on whether the ship is sinking and not on where life boats will end up.  Thus, the pressure on Vote Leave to offer more detail on the eventual outcome of the Brexit process, is an irrelevant  factor in deciding how to vote.

Britain Stronger in Europe (Vote Remain) needs to show that despite obvious signs of distress, the EU ship can adapt and is, therefore, not sinking. Conversely, to win, Vote Leave need to show that it is  (and why) and not simply that they do not like it on board.

Vote Remain want people to stay on board by pointing to the comfort of a being on a large ship,  the unusual absence of brawls in the galley, and the frigid, opaque darkness outside. They do not mention that the Euro is an iceberg which is ripping a hole down the side of the EU ship.  This might sink the ship but that depends on the crew’s response which is hard to assess as they are not allowed to talk about the Euro as a problem. One powerful damage-control mechanism the crew do have, is that they can create money and tell banks what to do.

The Euro iceberg hole in the EU ship is the direct consequence of accommodating non-convergent economies, like Portugal/Italy/Spain/Greece and Holland/Germany, in the same currency.

That is the heart of the debate so I am unclear why Vote Leave are not highlighting the Euro as the source of most of the problems that voters care about. Perhaps it is judged too technical to explain.

The problem is the Euro not the EU.

The EU bought instability on itself by creating the Eurozone and then pretending that the economies were similar enough to work within it. If Germany had the Deutschmark and Greece the drachma then exchange rate movement would level their trade imbalance. (Greece buys lots from Germany but Germany buys almost nothing from Greece). This would lead to a rising Deutschmark which would choke off demand, since German goods would at some point become unaffordable to Greeks. Likewise, a falling drachma would attract more German tourists to go to Greece for cheaper holidays thus boosting the Greek economy. With a fixed Euro there is no such corrective mechanism. So the alternatives are to either move people (Greeks to Germany to make the cars to go back to Greece); or send ‘surplus’ Germany money to Greece so they can survive despite not having earned the money.  Germans do not like this!

This is all routine exchange-rate economics and happens all over the world all the time. It was ignored when the Euro was created and rather than institute a substitute mechanism, the Euro founders simply hoped the problem of trade imbalances would not arise on any scale.  The problem was then compounded by admitting eastern european economies, whilst keeping them out of the Euro but applying the Eurozone rules such as free movement. Put in a more technical way, free movement of people and/or capital is required between non-convergent economies in a single currency area. So called Optimal Currency Area theory.

The problem with free movement of people is not just that economic migrants might be unpopular where they arrive. The bigger issue is that free movement does not in fact relieve the pressure on the economies from which the people came.  In theory, if enough Greeks had left Greece to work in say Germany and sent enough money back to Greece, (that was then somehow taxed!) then the Greek crisis of 2015 might not have occurred. They were perfectly free to move but of course labour is not perfectly mobile and they did not.

In practice, even if more Greeks had left to work abroad then there would be less taxable, economic activity in Greece making their sovereign debt situation worse. The Greek workers most likely to leave would have been the ones most useful to Greece. Which ever way you look at Free Movement in its present form, it is not working. It seems to create pressure at the point of arrival without relieving pressure at the point of departure. It is a cornerstone of EU doctrine but ineffective for the purpose intended, namely levelling out trade imbalances.

In the sterling currency area, (UK!) money moves from London which has too much of it, to the north of England which has not enough and conversely people in the north of England come to the South East to get jobs. All completely routine in UK. The fact Northumberland is a bit empty and Surrey is a bit full, raises far less emotion than a full Germany and empty Greece.

All this is because of  the Euro and not because of free trade. Abandoning the Euro is hard to imagine although before the Euro there was an EU which worked well enough. Of course, UK is outside the Euro which gives some relief but UK has not been exempted from any of the people movement conditions.

The main question to the EU and Britain Stronger in Europe is not how they are going to control immigration or solve southern European debt. These are just symptoms caused by an ill-fitting Euro. The question is how will they make the economies in the Eurozone balance and whether measures that work fine between similar economies such as Holland and Germany can be extended to southern and eastern European economies which are so different.

The EU answer to the problem is more political integration but it is not a good one. Further integration has yet to be tested with voters but anyway political integration does not really solve trade imbalances. After all, UK has a huge trade imbalance between north and south but total political integration. The difference is cultural and emotional identity. Money going from London to South Wales elicits almost no adverse reaction. Money from Germany to Greece does.


Germany is the decision maker. When, in the face of a crisis, the ECB wants to bend the rules and create money via QE, Germany must agree. If unplanned cash is to head south for a Greek bail out, Germany must agree.

However, Germany has a very much more austere attitude to money and a particular aversion to creating money. Furthermore, they paid for just the sort of restructuring to unify East Germany that they think southern Europe should have already done. If more money is to go to an unplanned need, they think former Eastern Germany remains a strong candidate for investment. So for practical political reasons German leaders are not able to accommodate the measures and flexibility the ECB will likely need in the next debt crisis in southern Europe. Whoever, succeeds Merkel will likely be a clear expression of this. This will make it much harder for our ship’s crew to repair the Euro damage.

I suspect that not every country in the Euro can stay in it. Some weaker countries might get kicked out of the bottom or some stronger countries, led by Germany, could leave from the top. If the EU continues to cling to the Euro then the EU will unravel, perhaps until it once again becomes its pre-Euro self.

Free Trade

The connection between free trade and free movement is not some economic orthodoxy, rather it is a condition the EU has chosen to require of, perversely, both Euro and non-Euro members. NAFTA is a free trade zone between economies with different currencies but does not make the connection. Migrant EU workers presently in UK might otherwise be in France and Germany so the EU  is apply Free Movement to Non Euro members, is possibly seeking to spread the load by applying the policy to non-Euro trade partners. Fair enough but it is choice they have made not some structural necessity of free trade agreements.  The root cause of worker movement is the Euro, not the single market.

The Numerical Irrelevance of  UKs contributions. 

This is a bit of an aside, but The Vote Leave campaign are making far too much of the £8 odd billion that UK pays net to the EU as, in effect, annual membership fees. This is very roughly 1% of what the UK Government spends each year and about the same as they would get in tax from about a 0.1% rise in GDP. If, as Vote Leave assert, UK has a brighter future outside the EU then GDP should rise by more than +/-0.1% of GDP. Membership fees may be large and irksome to Vote Leave, but after a couple of years they are numerically irrelevant to the merits of whether to stay in or out. A point made by Tim Harford on the BBC’s More or Less.

So what will happen

Vote Leave’s proposition is that UK should indeed head to the life boats to embark on an ‘exciting’ new relationship with the world.  Despite advocating this dramatic step they have not explained why it is a wise one and then focused the voters on the risks to the EU. They just do not like the ship.  Nor have they been able to say who will mange the post Brexit process,  As things stand we are to believe it will be Prime Minister Cameron, who is wholly untrusted by Vote Leave voters. This is a clever move on his part since it prevents Vote Leave from high-lighting an alternative if there is one.

So Vote Leave have little hope of winning.

My own view is that the EU, in its present form, will unravel because of the social and consequent political pressures of imposing a common currency on non-convergent economies.  This is ironic since the Euro was intended to reinvigorate the faltering political integration of  EU nations. It might in fact be its undoing.

The catalyst for this unraveling of the EU will likely be another debt crisis caused by higher oil costs or a global slow down. In this case a post-Merkel German government might well seek partial disengagement from the Euro, in exchange for allowing the ECB to create money.  At this point UK might get much better terms for ‘leaving’ the EU than now, indeed it might able to join other northern European countries who seek a looser arrangement based on sounder money.   So if you buy into this thesis you might in fact vote to Remain.

No real idea when this happens and I used to think it would have happened by now. Most likely the EU/ECB will lurch through a few more crisis-create money-austerity cycles before the rules start to fray more formally.  There will be some of those cycles in 2017 and 2018 as debt becomes due in southern Europe. It will happen over a few years and not in one big leap.

Personal Note

I hope this reads as analysis not advocacy although I am convinced the EU cannot survive in its present form. Even if you believe in the EU’s demise there is a fair case for voting either way in the Referendum. The sudden Damascene certainty of a few campaign advocates is puzzling. I will probably Vote Stay simply because I do not think this is the moment to leave and do not see an appropriate leader for the Post-Brexit process.

Politics affects the business environment, but less than politicians like to think.   For example, UK trade with the US has grown steadily over the years despite there being no trade deal. UK makes things the US wants and vice versa. Far more important to individual businesses are product quality, competition, marketing message and happy returning customers, none of which are affected by the Referendum. So if I was still an SME CEO I would ignore all this, keep tight control of costs and go and make some sales ideally outside Europe.

I have been a political analyst for 20 years and it seemed odd to sit this one out. I am now doing other things and do not have the team that would have made this a better piece of work.

One thought on “Brexit? People do not leave a floating ship or stay on a sinking one. So is it sinking?

  1. Buy 2018. Authors Afternote. Still pretty happy with the analysis. Clearly Wrong about the Leave not being able to win. And curious about the lack of Euro Debt Crisis, is this because the ECB are intervening more than reported.

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