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Saturday, 25 June 2016


The Brexit Vote in one day looks to have wiped $2 trillion off financial assets in world markets. One quarter of that roughly will be UK and sterling assets added to which in time would be a similar size fall in property values, beginning with a fall of about 10% immediately - a rough guess only so far. The hit to banks' share values will require additions to banks reserves and shrinkage in bank lending - many individuals and companies will have their bank loans pulled. Of mortgages currently outstanding, on average borrowers have lost because of the Brexit vote one quarter of their net housing equity. UK banks may benefit short term from rise in net foreign assets measured in sterling by about £25 billions, assuming 10% exchange rate depreciation. My guess is about £250 billions in loans to businesses by banks are now at risk of being called in early. But, thankfully, these loans may not be cut any time soon thanks to the Bank of England's standby fund with which to finance the liabilities side of banks' balance sheets (in the central bank reserves) to cope with the economic shock of Brexit of precisely £250 billions. This amount can support about half of all UK banks' loans to UK businesses, which were already severely cut, halved, since 2009. UK big businesses issued more corporate bonds and there were net private capital inflows and substantial foreign direct investment, though this has now turned sharply negative i.e. outflows. Across the rest of the EU in the last seven years business loans by banks were cut by one quarter. Lower bank lending has a lot to do with EU slow growth since 2009 in both the UK and the Euro Area (EA, also called eurozone). Low growth is also because private capital flows are not funding trade and payments imbalances as before but making them worse. Hence, trade volumes are down as countries seek to balance their current accounts in a confederation of 28 countries where one third run trade surpluses (worth 2 times China's trade surplus or two time Germany's with the counterpart deficits shared among the 20 EU net importers) and the other two thirds deficits. The main reason for higher national debt and lower growth has been zero growth in bank lending and a shift of several hundred £ billions over the past seven years from relatively productive business lending to relatively unproductive property lending. In the Euro Area the shift from business to housing loans was about Euro 850 billions equating to 7% of Euro Area GDP (For those who are sometimes unsure what GDP means it is net output of the economy = all wages and salaries plus net profits as how we measure the value of work plus whatever is the net foreign trade balance of each country in goods and services). When UK leaves the EU, the EU will have an external trade surplus with the rest of the world about the same size as that of China - hardly evidence of economic weakness, but perhaps worrying to the rest of the world, not least to the USA? Lower bank lending is inevitable in retail and commercial banking. How Brexit will shrink investment banking and wholesale markets in the UK is another question? The City of London and Canary Wharf's financial services may lose much of its international business including Euro-denominated issuance and secondary market transactions, forced to re-locate into a jurisdiction inside the EU or into the Euro Area to bolster its stability - at a cost in UK based employment, tax revenue and a worsening of the UK’s current account deficit with the rest of the world? On the one hand the ECB can for regulatory and systemic risk management reasons insist that Euro denominated capital market clearing transfer into the Euro Area. But that in itself may not mean institutions and thousands of jobs following too. London remains a profoundly large skills centre, attractive in many ways, and a possible refuge from transaction tax, and trading and issuance remain while clearing is elsewhere. The threat of systemic risk or other regulation requiring firms and trading to move may overlook that European banking regulations are part of UK law and not just part of EU law. The UK giving up EU membership does not automatically mean banks are no longer subject to Basel II/III, Solvency II and their formulation within CRD law.
In the weekend after the murder of MP Jo Cox, when the referendum campaign was put on ice, Remain Campaign leaders Cameron and Osborne had intended to talk about the economic bounce of hundreds of billions that would flow into the UK following a majority to retain EU membership. And in the Chancellors' annual Mansion House speech, George Osborne was to warn on the impact on threats to UK financial services if Britain leaves the EU. In major banks, such as JP Morgan, Deutsche, BNP Paribas, HSBC etc., jobs will go not only in London we are told, and that is going to happen. London and the rest of the UK have already lost several hundred thousand finance sector jobs since 2009. The BBC news site reported Mathilde Lemoine,former advisor to French Prime Minister Dominique de Villepin, chief economist at Rothschild Banque Privee and member of French High Council of Public Finances, saying transactions for firms across the EU in euro-denominated securities - a large and important part of UK based financial markets operations - would transfer into the eurozone for execution and clearing as an ECB supervisory requirement - adding that many foreign banks, European banks and also non-European banks will relocate to the eurozone. Some will transfer people and business to Dublin.
Some of the argument about the impact of Brexit on the finance sector in the UK and London is provided by the following paper: There is concern that UK based banks, insurers and asset managers etc. will not be eligible for the single market in financial services and its so-called "passport". But that is not obvious necessarily. All banks' branches have to be licensed and appropriately capitalised in each country anyway and they include many banks and other financial institutions from outside the EU in each major EU country. Home and host country supervisors can also overlook each other's reports to take a holistic view of financial institutions wherever they operate in Europe. Arguably, with a lower £ exchange rate the overheads and wages cost of operating in London and or elsewhere in the UK can become more attractive to foreign banks and others. Many banks have also domesticated more of their own borrowing and reduced their international balance sheets since 2009. The real damage to banks may arise only when full-blown recession arrives, when economic activity generally slows dramatically and property values fall. Euro Area commercial and retail banks have grown their exposures to property considerably to match and overtake UK banks so that generally property lending is now 60% of the combined total of all business and household lending. This is a greater risk concentration than in 2009. Mortgage backed securities will again deteriorate in cash-flow and ratings as default rates rise as many recent borrowers experience negative equity and higher delinquency and vacancy rates. Pulling business loans and shrinking banks' customer lending balance sheets will add to the downturn in business. And among contractors and other suppliers to financial services and all other business sectors there will be a rise in closures and bankruptcies. Brexit, even before it comes into full effect, should bring forward UK recession including a fall in trade both internally and externally and capital flight that will not be greater than increased savings by households and businesses as they refrain from new investment and are either voluntarily or forced into deleveraging (reducing their bank debts). Recession is to be expected anyway before 2020, but will now come earlier and be much worse than it would otherwise have been had UK voted to remain in the EU. UK unemployment that is currently just above 5% (1.7 million) will likely more than double and exceed current unemployment rates across most of the EU of 10% (and in EA of 9%), giving UK the third highest unemployment in Europe, which measn below that of Greece and Spain. There are currently about 17 million unemployed in the EU excluding the UK. UK unemployment can be expected to approach 4 million once recession is confirmed and has matured into a full-on Depression (meaning a longer period of falling output than six months) by 2018 (when the USA economy will also be turning severely down). Why should unemployment rise so high in the Brexit crisis and recession? Employment is at its highest just now for many years and unemployment at its lowest for 10 years. In 1984, it was over 12% with over 3.5 million out of work. There are almost 9 million people of working age in the UK who are not in the labour market and are deemed economically inactive. On the assumption that for every person not in employment of working age 3 people are required to support them who are in work, and that these three also support variously one and half others (children and pensioners with some help from the state and private funds), then 2-3 million more UK unemployment means 15% of the workforce out of work and another 3 million experiencing lower income or less support. When today 15% experience poverty that could almost double! In the countries worst hit by the sovereign risk crisis, where unemployment rose to between 12% and 25% and youth unemployment much higher, and given that Brexit triggers a sovereign risk type of crisis for the UK it seems realistic to expect unemployment to more than double to a level not dissimilar to that experienced in 1984. The high unemployment then did not trigger social revolution because the government was popular after winning the Falklands War. Whichever new Conservative government leadership emerges over the coming months it is unlikely to be popular. The question of immigrants is not an easily solvable one although there is little doubt that a sharp rise in unemployment will choke off the officially calculated, net inward, migrancy count. Even if a new leadership looks as if migrancy is being reduced that will coincide with higher unemployment and not therefore the result intended by many Leave voters who believed they were being outcompeted by migrants for jobs.
One irony in all of this is that youth unemployment will be expecially worse, much higher than the aggregate of say 12%. Youth unemplyment (those aged 16-24) are almost a third of all claimant count. 16% of youth are unemployed today. This will surely double to 30%. And yet it is the young who voted most fervently for remaining in the EU. Young voters however, while they voted by almost two thirds to one third to remain, only 54% voted (compared to 65% of all voters), but the young will live longest with the consequences of the country's decision, a decision won by those over 50 and over 65 who are already mostly out of work and pensioned off. Those who are heading for pension funded retirement soon and who voted to leave will have immediate worries about how far stock prices and property values will fall and what this means for their remaining quality of life and standard of living in retirement? While what is happening to UK youth job prospects may be described as ironic, for the older voters, for the 'turkeys who voted for Christmas' their votes may be described as a paradox. For all who voted to remain that the losses already recorded at over £4,000 per person, the amount that so-called 'Project Fear' warned of, but which are likely to get far worse before they recover, their anger at all this irony and paradox will be one of complete rage and disgust and in this I am with them. The next government leadership is facing internal and external challenges that will be as testing as what might be described as something similar to requiring intelligent policy-making equivalent to running a war-economy in peacetime?

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