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The question of a soft or hard Brexit does not lie within UK politics

By David Scott | Monday 19 June 2017


The question of a soft or hard Brexit does not lie within UK politics but with the priorities of the EU. The EU’s number one priority is to avoid setting a precedent of successful exits – the UK election result does not change this. What is clear, however, is that Mrs May is no longer in control of the outcome; parliament will decide on whatever deal emerges. It may well be that Brexit purists will have to swallow their principles and accept Norwegian, or Swiss style arrangements, including continued budgetary contributions, no more than minor tweaks to free movement, and some degree of European Court of Justice rule.

The Phoney War and the fool's prosperity of the last eleven months have lulled Brexiteers into complacency. From now on they will face a darkening picture. Both politically and economically, we seem with breath taking speed to have entered an extraordinarily dangerous place. The Bank of England extenuated a credit bubble by cutting interest rates and relaunching quantitative easing after the referendum. This has temporarily masked the damage below the bubble in the real economy. It has bought time but only by storing up fresh problems.

In the meantime British consumer credit has reached record levels. When the pound fell off a cliff from 2007-2008, the poor were protected. Benefits and in-work tax credit rates were indexed to inflation. This time the benefits for 11.5 million households have been frozen until 2020. They will take the brunt as the cost of imported food, clothes, and fuel grind higher. The Institute for Fiscal Studies estimates that the poorest 8.3 million families will in the end lose an average of £470 a year or more. This was always going to be a time-bomb and it is now detonating before the eyes of Mrs May. Not since the financial crisis has the future looked so precarious, both politically and economically for the UK and this is as Brexit talks start. The global mini-boom stoked by China peaked late last year and has since rolled over. The People's Bank of China is tightening monetary policy and so is the US Federal Reserve, with powerful knock-on effects for a dollarised world system.

Confirmation bias is an ever-present risk for a market participant such as myself. If you're not familiar with the term, 'confirmation bias' it suggests that once we've invested time and emotional energy into developing a worldview, we'll then seek information to confirm that view. After writing about the economy for so many years, I'm now so convinced that we can't print our way to prosperity that I find myself seeing signs confirming this view everywhere, every single day. So that’s the danger to be aware of when listening to me.  I'm going to keep repeating this mantra and I’m going to keep finding data that supports this view. Based on lots of historical inputs, I have concluded that printing money out of thin air can engineer lots of things, including asset price bubbles and the redistribution of wealth from the masses to the elites.  But it cannot print up real prosperity.

As much as I try, I simply cannot jump on the bandwagon that says that printing up money out of thin air has any long-term benefit for an economy. Its only effectiveness is that it can stop a dangerous credit crunch turning into a crisis, but it is only a short term fix and in the respite it gives more fundamental change at a political level has to be. It’s just too clear to me that doing it consistently when fundamental political change has not occurred presents plenty of dangers, due to what we might call 'economic gravity'

There is a famous investor's anecdote from Joe Kennedy, the father of John F. Kennedy, about the onset of the Great Depression – he relates that one day, just before the crash of 1929, a shoe shine boy tried to give him stock tips. He realised at that moment that when the shoe shiner is offering market tips the market is too popular for its own good. He cashed out of the market and avoided the crash that many people now wrongly assume was the “cause” of the Great Depression. I don't know that this story is true, but if it is, it is an interesting example of peak economic delusion. We do not have quite the same investment environment as existed in those days. In our over financialised world today, algorithmic computers dominate the functions of the stock market, chasing headlines and each other, but this does not and will not save the situation. All that the substantial aid (printed money and artificially depressed interest rates) from central banks has done is artificially elevate equities while hard data has painted a very different picture.

The huge and unprecedented level of government debt carrying negative yields, after falling from its peak a year ago, is back on the rise. A number of factors have converged in May to send the global total to $9.5 trillion of sovereign debt, a situation where governments effectively are getting paid to borrow money, according to Fitch Ratings. The total represented a 10.5 percent increase from April. Prominent leading global investors have warned of the dangers of so much negative-yielding debt. Janus Henderson's Bill Gross has called it a "supernova" that will "explode," while Deutsche Bank CEO John Cryan has cautioned about "fatal consequences" of central banks being allured by slashing rates to that extent.

The level spiked last year as global central banks enacted ultra-easy monetary policies in an effort to spur growth. Fitch said the French election, in which mainstream candidate Emmanuel Macron won against right-wing maverick Marine Le Pen, and the decline in the U.S. dollar has helped to pull rates back down. The rise in negative yields comes even as the Federal Reserve has been hiking rates and other central banks globally have been talking about modest tightening in policy.

Economic reset never happens without warning, because it is a process, not an event. The hard data has shown for a long time a global economy that is under severely struggling with huge disruptive economic imbalances, not one in recovery. It is unfortunate that so many people only look at equity markets when accounting for economic health. They have severely handicapped themselves (and potentially there future standard of living if their pension and investments are not accurately positioned for the reset) through their own observations even when often intuitively they know things aren't great. But when the system does destabilised to the point that they actually realise it, they will blame for the rest of their days all the wrong culprits for their pain and suffering. The world is eight years into an economic expansion that is long in the tooth, laden with debt, and looking unbalanced after having polarised society politically.

The question is not “when” we will enter reset we are already in the midst of an economic reset. The real question is, when will the wider world finally notice? I suspect the only thing that will shock the masses out of their stupor will be a swift stock market drop, since this is the only factor they seem to pay attention to these days. This big and more noticeable reset will likely happen soon, only the exact timing is in question.

Not since the financial crisis has the future looked so precarious.

David Scott is an Investment Manager & Market Commentator at Andrews Gwynne

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