Eurogeddon – Facts Not Fear

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You would think from all the pro remain wailing and tearing out of hair that Eurogeddon was upon us. The UK has withdrawn from the EU and the Blood-bath is underway.
It appears that they actually started to believe many of wild scare stories that Project Fear was peddling and can now only view reality through this distorted lens!

Since even honest economists accept that Economic forecasting is a fool’s game:

“The only function of economic forecasting is to make astrology look respectable.”
John Kenneth Galbraith

Let’s try and stick to the verifiable facts:

The Stock Market


FTSE 100

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After a short dip as markets were caught unaware it has now risen past its Pre-Brexit level. It is up 14.9% against the year’s low of 5,537 on February 11th.

FTSE 350

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Not quite back to it’s Pre-Brexit level, but very close and 12.7% up against this year’s lows.

All Share Index

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Not quite back to it’s Pre-Brexit level, but close and 12.2% up against this year’s lows.

Even the FTSE 250 The worst performing index and the one the Remainer’s have suddenly defined as the “one true measure”, is up 6.5% against this year’s lows.

The fact is that the markets do not show a Eurogeddon “market meltdown”, they show very little overall change to the situation before Brexit. There are certainly big losers, Banks and Construction, but these are offset by big winners, Manufacturing exporters, Pharmaceuticals, Tourism, Mining.

Cost of UK Government Borrowing

The UK’s credit rating has been cut by the major credit ratings agencies.

Fitch has cut it from AA+ to AA
Moodys remains at Aa1 but the outlook has changed from stable to negative
S&P cut it from AAA to AA

This does not mean that the UK is not credit-worthy. Indeed even at the lower ratings it is rated more highly than Western European Countries such as Spain, Portugal, France, Greece, Ireland and Italy. As well as Asian countries such as Thailand, Taiwan, South Korea and Japan. Oil rich countries like Saudi Arabia, Russia, Kuwait, Qatar. The worlds fastest growing economies China and India. A full list can be viewed here

But why do Credit Ratings even matter ?

The theoretical problem with a lower credit rating is that it could make it more expensive for the UK Government to borrow money. However, as with most things in economics, it’s not quite as simple as that. There are many things that impact the cost of government borrowing.

The fact is that the current cost of borrowing for the UK government has fallen below 1% for the first time in its history and is at record lows even after the credit rating down-grade:

10 Yr Gilt Yield

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Export Job Losses and The Single Market

Now it is clearly too soon to know what sort of deal the UK will manage to negotiate with the Brussels bureaucrats. Let’s assume for the sake of argument the worst case. The EU will not give the UK any form of trade deal. Even though they export far more to the UK then the UK exports to them, they would rather lose jobs in their own countries than run the risk of the EU disintegrating all together.

In that case the UK would find itself trading with it’s neighbours facing the same tariffs as countries such as the USA or China who have no trade deals with the EU. These rules are known as the World Trade Organization (WTO), most favoured nation (MFN) tariffs.

(MFN) doesn’t mean a special deal, it just means that the EU can’t penalize any specific country, it must trade with everyone (outside the EU) on the same basis as its “Most Favoured Nation”.

Tariffs vary across products, but the overall impact can be determined by taking the trade weighted average tariff. i.e. if you take the value of all the exports to the EU from the UK and apply the correct tariffs. Total all the tariffs paid and divide by the total value of exports. The Parliament research team calculated this as part of the pre-Brexit analysis.

The overall tariff that the Remainers say will destroy British Industry and Jobs is…., drum roll, …… 1% (ONE PERCENT)

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Of course tariffs are not the only thing that effects the price that our European trading partners pay for the goods and services we export to them. A far bigger impact is caused by changes in exchange rates between the Pound and the Euro.

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The pound has fallen sharply this year against the euro. Most of the fall was before Brexit but the position for our European customers was made even better after the referendum. The Euro is 18.8% higher now than this year’s low. That means that UK exports to the Eurozone are 18.8% cheaper.

So even if no trade deal is completed and the maximum 1% average tariff is applied to all British exports into the EU they will still be 17.8% cheaper than they were in July. Hard to see how that translates into massive job losses for businesses trading with the EU!

The fact is that even the worst possible outcome (which I don’t expect) will only add an average of 1% to the cost of British exports into the single market. Currency fluctuations dwarf this impact and the fall in the value of the pound means that whatever deal is eventually concluded we will be in a much better position to export to “the single market” than before Brexit.

Sterling & The Cost of Imports

Of course whilst exporters will benefit hugely from the fall in the value of sterling the opposite is true for importers. As a country we import a lot of products and raw materials and these will all be more expensive since sterling has fallen.

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Sterling is down 16.6% against its highest level of this year against the dollar. There is no doubt that a fall in starling will push up the price of imported goods.

However, many of the things we import can be swapped for domestically produced equivalents. If the price of French cheese goes up, the consumer can by English Cheese. If the price of BMW’s goes up, sales managers can buy Jaguars. If the price of holidays to Spain go up then holidays to Center Parks can be taken. Any substitution to domestic producers will be a benefit to the UK economy.

Other products may simply not be bought at all. If Swiss watches are too expensive then many people will decide to go without. Likewise for jewellery, perfume, designer french handbags and shoes, art and other imported luxury goods. Money not spent on imported luxury goods is available to spend on unrelated goods, many of which will be domestically produced.

There are of course essential commodities such as Oil and Industrial Metals that we have no choice but to import and these will be more expensive. However these commodities are at historically very low prices.

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With oil trading at $50 a barrel the cost in sterling has risen from what would have been £32 a barrel to £38 a barrel.

Increasing raw material prices are often offset by more efficient usage. If heating bills go up, people are more inclined to invest in better insulation. If petrol goes up people drive less and plan journeys more efficiently.

Industrial metal prices are also at five year lows:

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The fact is that a falling pound will increase the price of imported goods. However the impact to the UK economy will be mitigated by a reduction in imports as people substitute for cheaper domestic goods where they can and forego some imported luxury products altogether.

Raw material costs will rise, offset in a small way by reduced usage driven by the economic incentive to be more efficient or substitute lower cost materials. However commodity prices are, in the main, at historic lows meaning that the cash loss to the country of the increased price is far less than many people fear.

 

 

 

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