Tiger of the Stripe Blog

Does Remaining Guarantee Stability?

The 'remainers' have argued forcibly that Brexit would pose all sorts of hazards to the economy, but they tend to ignore the dangers of remaining in the EU. There has been a tacit assumption in the ‘remain’ camp that no exit from the EU means no change, but this is foolish; despite the often glacial speed of change in the EU, it is nothing like the organisation we joined.

To take one example of a major impending change, in 2010, the European Commission’s 2010 proposed a financial transaction tax (or Tobin tax), despite the fact that the Commission itself originally predicted that this in the long term could reduce EU GDP by up to 1.76%. Sweden introduced such a tax in 1984 and quickly found that it raised very little in the way of taxes, drove traders in bonds, equities and derivatives to move to London, and damaged the economy. It is possible that such a tax might be beneficial, but only if it were adopted by every country in the world. This project is still very much alive and could very well prove to be immensely damaging to the City of London.

However, the biggest threat to the UK associated with remaining in the EU is probably the Eurozone. The single currency was introduced, despite many warnings that it could only work properly with complete fiscal union – which, in reality, means complete political union. As was revealed by Der Spiegel back in 2010, Germany, most of whose population has always been wary of the Euro, was told by France that German re-unification could only take place if it agreed to give up the Deutsche Mark. Some contend that the threats issued by François Mitterrand to Helmut Kohl did not in themselves lead to monetary union, but it seems clear that they accelerated it; that, in turn, may have been responsible for some of the grave mistakes which were made. Der Spiegel Business Insider Vox Europe Helmut Kohl

Among the many mistakes in setting up the Euro was the willingness to allow Greece to participate, even though it was clear that it did not meet the criteria for entry. While it is true that Goldman Sachs helped Greece to massage the figures (Der Spiegel), it is equally clear that other European leaders were aware of the deceit – Guardian. It is also clear that Helmut Kohl knew that Italy was in no state to join the Euro. Der Spiegel

Although there is a new ‘solution’ to Greek debt every few months, it is clear that the problems will continue until (i) most of the Greek debt is forgiven and (ii) Greece leaves the Eurozone. Neither of these two events seems imminent, but both are inevitable and delay is expensive both for Greece and the Eurozone. It must be clear to the European Central Bank and the other members of the Eurozone that these are inevitable but they refuse to admit it, partly for fear of losing face and partly because it could cause further Euro instability. Unfortunately, Greece is the least of the Eurozone’s problems. Italy has the potential to be a far bigger threat. Italy has a debt-to-GDP ratio of about 132%, the second-highest in the EU after Greece. Unfortunately, its banks have a very high percentage of non-performing loans (NPLs), with estimates ranging from 17% to 21%, equating to about €200 bn or 12% of Italy’s GDP. Italy originally proposed to allowing the banks to spin off the NPLs to a state-backed ‘bad bank’, rather as what has been done with various bank assets in the UK. However, EU rules no longer permit this. Instead, Italy will have to sell off the NPLs to investors with some state guarantees for the less risky assets. However, these NPLs are still risky and those holding bonds in these banks are likely to lose heavily. Such turmoil and the response to it by the ECB could also cause knock-on effects in Spain and Portugal. To quote one recent commentator, ‘A deteriorating financial crisis in Italy could risk repercussions across the EU exponentially greater than those spurred by Greece.’ Jeffrey Moore

Of course, the UK is not in the Eurozone and David Cameron has, in theory, received guarantees that the UK will not be required to help fund Eurozone bail-outs. However, Roger Bootle, Executive Chairman of Capital Economics, writing about a possible Euro collapse, asks, ‘How exactly will it be clear what part of this mess will be outside the UK’s financial responsibility?’ (Daily Telegraph, 23 May 2016)

The very fact that the UK is not in the Eurozone is also a danger. With the EU apparently determined to support the existence of the Eurozone at all costs, it will be forced to press for ever-closer political union within the Eurozone, leaving the UK excluded from most of the decision-making. This could cause enormous damage to the UK.

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