My Observations on the Brexit and Europe’s Deflationary Funk

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Greeting from a not-so-summery London.

Market action is neither here nor there of late. Everyone is waiting until Janet holds court on 14–15 June.

For the last month, the All Ords has traded up or down 1% in value. Watching, waiting and looking for some overseas direction.

Supposedly, our economy showed some recent signs of life but, as my colleague Greg Canavan revealed on Thursday, there is a time bomb ticking within those numbers.

The economic problems we have in Australia are a reflection of what’s happening in the northern hemisphere.

The news in the UK is dominated by the Brexit referendum. There’s three weeks to go — 23 June is polling day — and both sides are ramping up the campaign of misinformation.

If you believe the REMAIN camp, the economic world will come crashing down, trade with Europe will be that much harder, unemployment will rise, the British pound will cop a pounding (pardon the pun) and wages are going to suffer. Big business is campaigning strongly to remain in the Eurozone.

Whereas the LEAVE camp is about controlling who comes to the UK — many are referring to Australia’s immigration process as the model to adopt. The refugee crisis in Europe — with its spill over effect on the UK — is causing some people some serious concern.

Others are saying breaking free of Brussels bureaucracy will be like a breath of fresh air — a spokesperson for a mid-size business, that sold smoked salmon, was recounting how the business had to spend thousands of pounds producing new packaging that carried the label ‘this product contains fish’… Seriously, what did Brussels think people who buy smoked salmon think the product was made of? Chicken? Vegetables? It is this type of mindless red tape that is driving people to distraction.

Immigration and bureaucracy — taking back control — is the platform on which the LEAVE camp is running.

If you believe the latest polling, the LEAVE camp is slightly in front. Which is a little disconcerting for the powerbrokers.

Although the currency market does not appear to reflect what the polls are saying. In the last week or two, the British pound has strengthened a little. Which, to me, suggests the smart money (the financial market) is betting the REMAIN side will prevail.

Over a pint of Guinness (or two) I’ve engaged a few locals on the issue and they — at least on the surface — are in two minds. There is the concern about the impact on the economy, jobs and the pound, but they also have equal concerns about immigration and Brussels’ stifling bureaucratic influence over their country.

From my detached position it’s difficult to tell how the vote will go; the overblown arguments from BOTH sides tend to confuse rather than clarify the situation.

If the UK does leave it will not be the end of the world. The UK survived for centuries without a formal European trade pact, and it will survive and prosper again.

Yes, there will be a period of disruption and realignment of the economy and financial markets. But the removal of the gold standard in 1971 was also a disruption to the status quo and eventually the world got over it. People and markets adapt.

My gut feeling is that they should leave. But that’s borne from an anti-establishment streak within. Mainstream politicians, European bureaucrats and G7 leaders are all in favour of staying; therefore, I reckon they should leave.

My long held concern leading up to the Brexit vote is the risk of a terrorist attack in Europe and/or the UK. This would fuel the negative immigration and refugee sentiment, sending a lot of undecided Brits to the LEAVE camp. Financial disruption fits neatly into a terrorist agenda.

The US government has issued a blanket travel warning — that’s been all over the TV and press — for its citizens travelling to Europe this summer:

As part of the [US] State Department’s continuous efforts to provide Americans travelling abroad with information about relevant events, we are alerting US citizens to the risk of potential terrorist attacks throughout Europe, targeting major events, tourist sites, restaurants, commercial centers and transportation. The large number of tourists visiting Europe in the summer months will present greater targets for terrorists planning attacks in public locations, especially at large events. This Travel Alert expires August 31, 2016.

If you have to avoid major events, tourist sites, restaurants, transportation and so on, that pretty much discounts doing anything over here.

Perhaps I am reading a little too much into the warning, but it makes you wonder what they know or suspect.

There have also been plenty of stories about refugees drowning at sea, the overcrowding in detention centres, and interviews with ‘blacked out’ people smugglers acknowledging they’re aware of ISIS ‘refugees’ making their way to Europe.

All this feeds into the apprehension and growing concern people have about porous national borders.

Changing tack just slightly, under the category of ‘different country, same problems’, the retail sector in the UK is hurting. The announcement of Austin Reed, a tailoring brand with 155 stores and 1,000 employees, going into administration, is the latest in a list of retail bankruptcies.

The following table on UK retail failures, compiled by Retail Research, is correct as at April 2016.



Source: Retail Research
[Click to enlarge]

In ‘employee affected’ numbers, the first four months of 2016 are shaping up to be a repeat of the dire 2008 and 2012 periods. After seven years of stimulus you’d think the numbers would be better.

Are the retail failures a function of increased online shopping habits, a change in consumer spending habits, businesses with too much debt, labour and rent costs, or a combination of all these factors?

Either way, jobs are being lost.

Where do those displaced employees go? The hospitality industry? If the hotel we’re staying in, and the bars, cafes and restaurants we’ve been to, are any guide, a good number of employees are Eastern and Southern European.

A sample survey — engaging a few of them in conversation — reveals they’ve come here seeking a better life. Economic conditions in their home country are, as one person said, ‘corrupt’, and offer little prospect of changing anytime soon.

Under the Eurozone arrangement they migrate to London in search of opportunity.

That’s fine while there are enough jobs to go around and everyone is getting their fair share. But if UK citizens start losing their jobs and can’t be re-employed, tensions rise.

That feeds into the sentiment for the LEAVE camp.

Europe’s annual inflation rate came in for May at MINUS 0.1%. This is being heralded as ‘an easing of deflationary concerns’. What BS.

The depressed conditions in southern and Eastern Europe — that have forced people to relocate to London — feed into these bleak Euro growth figures.

Mario Draghi — the ECB head honcho — and his merry band of bankers have been pumping 80 billion euros A MONTH into an asset buying programme — government and corporate bonds — as well as pushing interest rates into the negative to generate a flat lining inflation number.

Enticing European corporates into borrowing more money at cheap rates to move the inflation numbers into the positive is hardly a strategy for sustained growth. The European household debt figures indicated individuals are not taking the cheap debt bait.

Take away the ‘juice’, and the patient is a lot sicker than the numbers reveal.

With a population exceeding 350 million, the Eurozone matters to world growth…globalisation means we are all interconnected.

I am struggling to see how Europe can extract itself from its deflationary funk.

A socialist system with ageing baby boomers is only adding to the deficit burden. Adding to this budgetary pressure is a refugee problem that’s only growing in number and cost (both human and financial). A massive debt overhang — personal, corporate and public — continues to increase as a percentage of GDP.

Every major Western economy is on the same staircase to economic Armageddon…it’s just that we’re all on different floors.

Rapid advancements in technology are disrupting traditional employment. Too few jobs…for too many people. Which gives rise in the trend towards nationalism… ‘Protect our borders for our own people’.

Too much debt. Too many welfare commitments. Too little growth to generate the much needed employment opportunities and investment returns that would address some of these problems.

This all feeds into a negative feedback loop. After 2008/09, China provided an injection of US$21 trillion to mask the structural problems in the global economy. But with China finally recognising the extremities of its debt creation capabilities, the problems are once again on show for all to see and evaluate.

Property and share markets have remained afloat — on price to earnings multiplies that defy gravity — thanks to central banks targeting a ‘wealth effect’ strategy. That wealth was meant to trickle down into the economy.

In totality, the strategy has been an abject failure.

The wealth has been created, but sweet Fanny Adams (as a percentage of the trillions of dollars of wealth created) has ‘trickled down’ to the real economy. This story is being played out in all developed corners of the world.

We are in the UK and Europe for the summer — doing our best to ignore the US warning — and look forward to giving you my insights into what the mood on the ground is over here.

Regards,

Vern Gowdie,
Editor, The Daily Reckoning

Vern Gowdie

Vern Gowdie

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top 5 financial planning firms in Australia. He is a feature contributing editor to The Daily Reckoning and is Founder and Chairman of the Gowdie Family Wealth advisory service and editor of the Gowdie Letter To follow Vern's financial world view more closely you can you can subscribe to The Daily Reckoning for free here.
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