Brexit. A good thing?

We have all heard lots of commentary on the Brexit referendum, and whilst I am aware that this is a very polarising topic, I am going to attempt to make an argument as to why I think the decision to leave the European Union is a good thing.

Let me start this article by confessing that because I have been out of the UK for more than 15 years, I am actually time barred from voting in the UK, so was unable to vote in the recent referendum. However, if I could have voted, I would have voted for Brexit. I expressed this opinion in a recent event that I organised that had a good number of our European counterparts in it and was nearly lynched in the process. So I appreciate that my views are not widely held, not among our European friends at least.

So why do I think that Brexit is good thing? The pound is tanking, stock markets are plummeting; I must be mad, right? Not really. The cornerstone of my argument is based on the fact that I firmly believe the fundamentals of the European Economic Union are seriously flawed, and on its current path, I believe the EU is a sinking ship and is going to go down like the titanic. And the UK is currently anchored to that sinking ship, and will go down with it.  

So what is the meat of my argument? Member states in Europe have very different levels of skill and productivity. Greece will never be able to compete against Germany in making automobiles, as an example.  It neither has the engineering skills or discipline to do so; it is not in the Greek DNA. And the Greek’s like their siesta, so their productivity is also much lower than Germany.

My favourite question to any statement is, so what? Let’s wind back to the days when European member states had there own currencies. Historically, if Greece was unable to compete with Germany, it had the ability to devalue its currency to make the exports of its products and services cheaper. At some point, those products and services would reach a sufficient discount to equivalent products and services from Germany and people would start buying them. So even if they were not fundamentally competitive with countries like Germany, they could still generate exports and provide employment and money for Greek nationals. 

Fast forward to the today’s monetary union. Greece is still uncompetitive against Germany. The problem is, because it no longer has the drachma as a separate currency and is now using the Euro, it cannot devalue its exports to make them cheaper. And if you are uncompetitive and have no means in your control to make yourself competitive, you go broke. Which is pretty much where most of the Mediterranean countries including Greece, Spain, Portugal etc are at today.

So how do we know that this is actually the case today? When countries become uncompetitive, their companies which are the commercial entities driving exports, start to go bankrupt. They then cannot repay the loans that they have taken from the banks to fund there businesses. 

So what is the state of the banking systems in these countries? Greece currently has 34% non-performing loans. Ireland has 19%. Italy has 18%. Portugal has 12%. In our fractional reserve banking system, banks only have approximately 10% of their capital in real money. If you put $100 in the bank as a deposit, the bank can print $900 out of thin air and lend that money out to you and I. So depending on the capital reserve ratio set by the central banks, once the non-performing loan level exceeds the amount of real money that the bank has taken in deposits, it is effectively bankrupt. That percentage is typically around 10%. Which means the banking systems in Greece, Ireland, Italy and Portugal are effectively bankrupt.   

We have seen this play out over the last few years in Grexit and bank bailouts by the EU. But these bailouts are only addressing the symptoms of the problem, and basically just kicking the can down the road. It does not address the fundamental issue that Greece cannot compete with Germany, and that it no longer has an independent currency to devalue it exports to make it competitive.  It just makes the problem worse by loading more debt on a country that will not be in a position to repay that debt because it cannot generate sufficient wealth from its economic activities, because it is not competitive.

And the inability to devalue your countries products and services to make them competitive is not even the biggest problem in the EU. The idea that you can have monetary union without having common leadership, if the principles that I learned at business school are correct, is also fundamentally flawed. India has a common currency but it has a democratically elected Federal government that can balance the different levels of productivity in its member states. The same is true in the US. The idea that you can have separate economic entities using a common currency without common leadership is comparable to the idea that you have many separately run companies operating off the same balance sheet without a common CEO and Board. If anybody thinks this is a good idea, please contact the author and I would be very happy to run my company off your balance sheet. 

And it gets worse. The final nail in the European Monetary Union coffin will come as a result of demographics and an aging population. At the moment, Germany is the economic engine behind the stability of Europe. Germany is very happy with the European Monetary Union. Because they have the most skilled and productive workforce in Europe, and get access to other markets with very few entry barriers, and nobody can compete with German companies.  Member states that have adopted the Euro no longer have there own currency to devalue their exports, so the Germans make out like bandits.  This can be measured in Germany’s export trade surplus, which is enviable. Problem is, Germany is also about to fall off a cliff.

In 1945, the Second World War ended. Between 1946 and 1960, there was a huge explosion of baby births. This generation is commonly known as the baby boomers. This generation has generated a huge amount of wealth and economic growth in the 1980s, 90’s and early 2000’s when they reached their peak earnings.  Those baby boomers started retiring in 2011.  The math is easy, 1946 plus 65 years which is the standard retirement age. They will retire in droves through to about 2022. And because Germany was at the centre of the Second World War, its demographics are much worse than over developed countries and is currently in the process of falling off a very steep demographic cliff.

When people get older, they naturally cut down on their spending to start saving for retirement years. When you get past the magic number of 50, your mind turns to how you are going to survive when you are no longer pulling in a fancy salary. So you start squirreling away money.  This effects economic growth of a country that has an aging population, which is largely why the west in currently in an economic malaise. Japan has been in it since 1990. But the problem really comes home to roost when the population starts retiring in droves.

When your oldest most skilled workers, and highest earners start retiring, a number of things happen. Governments lose the tax income that they used to pay, which hits tax collections.  High earners also draw high pensions. So as well as losing tax income, retirees convert from being an asset on the balance sheet to a liability. So there is a double whammy. They no longer pay taxes, and they start drawing fancy pensions. Germany is currently in the thick of this process where a significant chunk of its highest taxpayers and highest skilled workers are leaving the workforce and starting to retire and draw pensions. And the process will continue until about 2022. I predict that this is going to have a significant impact on the German economy.  And if the shine comes off the German economy that is the economic engine of Europe, who is going to pay to bailout the uncompetitive failing bankrupt economies like Greece, Italy, Portugal and Ireland?

Germany is correctly trying to address this demographics issue by allowing large amounts of immigrants into the country from war torn countries. But it will be a long time before a Syrian refugee has the skills and experience to replace a 65-year-old German engineer. And refugees are typically an economic burden in the short term before they become trained and productive members of the workforce.  So as well as funding bail outs for unproductive European countries, and funding significantly increased pension liabilities with reduced tax income of German workers, they will also have to fund the liability of refugees. Where will this money come from?

So in summary, the European Union has a monetary union that makes member countries with lower productivity uncompetitive, and ultimately bankrupt. It has no democratically elected common leadership that can effectively deal with the problem, and my reading of it for what it is worth is that European member states would never agree to a European Federal government. Germany, the economic engine of Europe, has a demographic issue that could very well take the country from being a booming economy to possibly pushing it into a recession, or maybe even a depression, depending no how you measure it. So as I stated in my opening paragraph, I think that the EU is a sinking ship, and UK is currently anchored to that sinking ship.

So what difference does Brexit make to the UK? Currently EU directives drive a significant portion of the legislation passed in the UK. I heard a quote in a recent debate of about 40%.  When the Euro goes belly up, which I firmly believe will happen, there will be a financial crisis that will hit the world financial markets like a tsunami.  The UK is going to be hit very hard when this happens regardless of whether it is part of the EU or not. The big advantage that I see the UK will gain by leaving the EU before this happens is it will detangle its legislative process from Europe and bring decision making back locally to the UK. So when the tsunami hits, the UK will be in a much stronger position and more nimble to be able to manage the financial turbulence that will hit it as a result of the Euro tanking. 

Also, due to the constraints put on the UK by its membership to the EU, it is not currently possible to negotiate Free Trade Agreements with fast growing economies like India and China.  The EU Treaties such as the Common Commercial Policy state that the EU has the exclusive competence to negotiate trade policy on behalf of the member states. The UK cannot negotiate independent Free Trade Agreements. So the question that you have to ask yourself is, would you rather partner with an economic unit with flawed fundamentals and an aging population that will at best cause stagnation for the next decade, and maybe even go into a recession or depression, or partner with fast growing young economies like India that has 25% of the worlds population under 25?    I voted with my feet to live in India over 20 years ago so I know what my answer to that question would be.

And that is why I think Brexit is a good thing.

Don’t get me wrong; I am not saying that I think people in the UK voted for Brexit because the economic fundamentals of the EU are flawed. Most people in the UK do not understand the economic fundamentals of the EU, or the Euro. I think people voted out because of issues like immigration and increased pressure on public services. For many centuries, the Welsh language has been the second language of the UK. Welsh was displaced as the second most spoken language of the UK a few years back and replaced by Polish. In my personal opinion, I think immigration is a good thing. If plumbers come from Poland and provide services at a lower cost, it is good for consumers as it costs less to get your pipes repaired.  But not everybody agrees with this view. 

Pressure on local services like the NHS is also an issue. Friends have told me that it now takes three weeks to get an appointment with your local doctor. So by the time you get to see him, it’s generally too late.  When I lived in the UK, if you wasn’t feeling well, you would just walk into your doctors surgery and he would see you immediately. There was no question of booking an appointment. These issues would drive the local population to vote out.

I also believe that people voted for Brexit as a protest vote. I have a suspicion that if David Cameron had pushed for Brexit, the UK would have voted to remain. But he didn’t, and I am glad that he did not.  We now have some time to unanchor ourselves from the EU before it all starts going horribly wrong. My only recommendation is that we get on with job as quickly as possible as I do not know how long it will take for the EU ship to sink.  I do not think it is too far around the corner so the UK needs to trigger article 50 at the earliest and get on with the job before it’s too late.