The Sit Down

“These things gotta happen every five years or so, ten years. Helps to get rid of the bad blood. Been ten years since the last one. You know, you gotta stop them at the beginning.”

- Clemenza, The Godfather

What’s all this then?

The British exit from the EU is a civilized sign of growing social unrest. It was in response to a geopolitical framework becoming increasingly counterproductive to those it is supposed to help. Bureaucratically negotiated trade treaties and immigration policies over-reached over time to include ambitions to manage economic production, consumption and labor. Right. Well. It doesn’t seem so.

The vote to leave implies that the majority of Brits want new terms of trade and sovereign control over their borders and resources. It may have been sudden and surprising to political, economic and media establishments, but Brexit was in no way irrational to workers if they feel marginalized, which we now know they do.

In the grand sweep of macroeconomics, global production moved where it had to since the early nineties – to cheaper manufacturing in emerging economies – and yet the general price level around the world for consuming that production was never allowed to reflect falling costs. Natural price deflation was blocked by ever-easier global monetary policies that stoked credit demand and consumption.

The gap separating falling production costs and rising prices manifest itself through rising profits for Western platform companies playing the production/distribution arbitrage[1], and ultimately in widening wealth and income gaps. Investors and consumers benefitted, production and balance sheets now suffer. The vote by British subjects to destroy an institutionally negotiated trade alliance that did not serve domestic production was inevitable.

No matter how it may be spun in the future, fracturing political and trade alliances will not be the cause of a slowing global economy. To think such a thing would be analogous to thinking World War I started because an anarchist shot a duke. In both cases the balance of power became so stressed and removed from popular appeal that it did not take much to make underlying inequities apparent for all to see.

Politicians and policy makers confused by or fearing the implications of Brexit should take solace in the fact that it was not an anarchist and they were not dukes. They were foiled by democratic republicanism meant to give veto power to the people. They were served, in common parlance, and they had better listen.

Fallout

We think rumors of the Pound’s demise are premature. First, Sterling has its own central bank, and a powerful one at that. This makes the consequences of Euro flight different than other EU members beholden to the Euro and ECB. The BOE can continue to coordinate the supply of and demand for its currency with other large trade partners with powerful central banks.

Second, we think there is a reasonable (albeit minority) chance, that the UK never actually leaves the EU. Seasoned diplomats, like powerful armies, have a funny way of degrading and destroying enemies, even if those enemies take the form of unfortunate (for them) democratic demonstrations of popular will.

And if all else fails, there is a reasonable chance that the UK joins NAFTA. Why wouldn’t it? Britain would gain great leverage in forming necessary new trade agreements and the US, Canada and Mexico would gain leverage bringing the fifth largest economy into its orbit.    

The currency most likely to suffer should be the Euro. As we know, Europe is not networked in terms of language, economic culture and protocols, political sensibilities, tax and fiscal authority, and immigration policies that serve all member-states equally. It is unreasonable to expect such a loose understanding among so many disparate entities to remain static.

In periods of economic stress we think it would be virtually impossible for European fiscal and monetary policy makers to find and navigate a unified objective. The result must be that some members will have incentive to exit. When the going gets tough, the weak (or strong?) will get going.

The Sit Down

ZIRP, NIRP and Brexit are acronymic reality checks screaming out for acknowledgment of an increasingly unworkable and acrimonious reality. Perhaps the biggest influence on economic growth, trade, foreign exchange rates and financial asset markets will be negotiated shifts in trade and monetary policies?

Connectivity and credit exhaustion is changing the nature of authority and how it must approach the means of production. It is also changing how authoritative bodies approach each other. Investors should be encouraged that the long period of rising authoritative control over markets, culminating in the current piracy of them, allows fiscal and monetary boards to reach a series of political equilibria that markets would likely adopt. Economies and markets seek clarity of the future, and we argue they are likely to get it soon.

The BOE’s Mark Carney and the Fed’s Jim Bullard have already invoked the phrase “new regime”. It is early in this narrative, but we think it will gain steam quickly. Such transformation would provide cover to address the pillars of a deteriorating global economy. We expect a developing narrative among economic policy makers that wholesale change is needed.

We expect talk of a sit down, as Tony Soprano might say, where global leaders discuss new global trade arrangements and, yes, a new global monetary regime. Given all we and others have argued regarding global leverage, it has to be addressed sometime, and we cannot think of a better time than in 2017 after the US elections.

Paul Brodsky, Macro Allocation Inc. (www.macro-allocation.com)

[1] A platform company is one that outsources production, usually offshore. For example, Apple only designs its products in the US. It manufactures and sells a large portion of them abroad.