10th October 2019
Brexit, Tariffs and Protests, Oh My!
by Chris Bailey, European Strategist, Raymond James Investment Services Ltd.
‘Happiness is when what you think, what you say, and what you do are in harmony.’ – Mahatma Gandhi
National stereotypes tend to always have a hint of truth about them. The British can always be relied upon to run a good administration, the Germans are efficient and forward moving, Hongkongers are obsessed about money and property prices to the apparent detriment of everything else, and in Italy it is best to focus on the food and local culture rather than try to get something done. But the times they are a-changing – at least from the perspective of events so far in 2019.
Riddles, mysteries and enigmas
Winston Churchill once described Russia as “a riddle, wrapped in a mystery, inside an enigma,” and this form of words also almost perfectly describes how I perceive the Brexit debate in the United Kingdom must be viewed around the world. Well over three years into the debate – with two prime ministers already sacrificed on its political altar and the country still horribly split down the middle – an end is still not clear. Attempts to forge an agreement (or leave with no deal) on 31 October have been unsettled by a British constitutional crisis involving the British Supreme Court, Parliament, the Prime Minister, and even Queen Elizabeth the Second. Brexit sits like a handbrake on the country, a suppressor to economic forecasts, business investment or employment decisions and, of course, consumer confidence.
Look! It’s Big Ben and Parliament
It is amazing, this long into the debate over Brexit, that multiple finale scenarios still exist. This is due to complexities around issues that have now become central to British political life, such as the backstop underpinning the land border in Ireland. Predictability around a further election occurring, let alone its precise result, remains very low, as well as whether any of this may persuade the European Union to exhibit more flexibility to induce some form of a deal. Most strikingly, however, the average allocation to UK assets by global investors versus recent history is at very low levels. So much is factored in, but the cost in national credibility and cohesion has been material, as well as leading to a fall in value of the pound. As one commentator put it, ‘We want control of our borders… but still an opportunity to buy all our favourite imports.’ Both having cake and eating it tends only to happen after striking a deal. However, the real irony of Brexit is that whilst a compromise (a ‘soft Brexit’) that maintains a good amount of the trade and general coordination infrastructure that has been built up between the UK and the continuing European Union is the least disliked option for a majority of voters, it is far from a favourite option for a majority of voters. It is, however, the sensible option to pursue.
Talking about the continuing European Union, unsurprisingly the region has been extremely worried about both the political and economic fallout from Brexit. However, as Brexit is still yet to formally occur or unduly influence performance, the 2019 economic travails seen in Germany have been cut from broader issues.
No Fest in Oktober?
Germany’s superior average productivity and ongoing commitment to innovation within its core manufacturing competencies helped make the country the dominant economic actor within Europe. This position was only strengthened over the past decade by the seemingly insatiable desire of neophyte Chinese manufacturers to buy German capital goods know-how and equipment, a situation replicated in many other emerging nations. Fast forward to today, however, and an almost perfect storm has developed for Germany. Economic growth has been sluggish across Europe for over a decade and bilateral trade discussions between the United States and China have contributed to a deterioration in the global trade backdrop, impacting key industrial, chemical, and automotive exports from Germany. The net result is an economy on the brink of a formal recession.
Politically, these are sensitive times in Germany. The lengthy chancellorship of Angela Merkel is within a couple of years or so of ending, and a newer generation of political leaders has yet to really establish itself. Coalition governments that span the mainstream political spectrum that once gave a stable leadership backdrop are now struggling to find new ideas. Meanwhile, a rigid orthodoxy to a balanced fiscal budget may appear laudable to many other countries struggling with fiscal (or trade) deficits, but it has led to a growing feeling of inertia. In short, Merkel is yet to pass the point domestically where she feels able to give the green light to more stimulus, but can live with the European Central Bank – in policy moves announced in December – moving deeper down the rabbit hole of quantitative easing and negative interest rates. This halfhearted approach to tackling contemporary challenges is apparent in the country’s global trade policies too. Germany is a quiet player on the global political stage given its economic and export prowess, but would be wise to find its (fiscal) voice fast.
An Italian Renaissance?
If true dynamic regional leadership is missing from Germany, in Italy there has been something of a renaissance in political dynamism. The summer that just passed may have seen yet another Italian government break up, but the strange union between two populist parties lasted longer than many expected and shook up the Italian political establishment. The current forging of a new government, composed of one of the populist parties in combination with a centrist mainstream political group, appears to offer more potential for longer-term stability. The question now is whether the country can move away from the situation of economic intensive care it has been in.
Italy also has been struggling with low growth. However, unlike Germany, Italy has material debts to worry about as well, a situation that naturally causes a lot of concerns. Yet, the tone of the debate within the country has started to change and there is a realisation that this is a time for action. Additionally, the financial markets are giving an opportunity for change with compressed global bond yields reducing any shorter-term burdens from the weak Italian fiscal position. It really is now or never for Italy. A period of technocratic government focused on building both growth and confidence levels in the local economy can go a long way.
For Kong and Country
Finally, we have to look east to Hong Kong, where an unprecedented level of public protest against progressively tighter oversight from China has led to violence, disruption, and a new uncertainty that is already impacting local property prices and economic performance. So, are the times a-changing in Hong Kong too? Certainly, high income inequality, the challenges of getting into the local housing market, and a feeling that the best days for economic growth have passed are very apparent. But the real fear is centred on what a developing China really means for the city state that for so long has been the natural gateway into the broader East Asia region. This longer-term focus is why Chinese authorities have not gone beyond the threat of mainland military and policing forces on the streets of Hong Kong. Go to mainland Chinese cities today proximate to Hong Kong and it is increasingly difficult to tell the difference on the ground. Hong Kong retains the advantage of capital flow freedom and a convertible currency, but this will not last forever. What today is centred around freedoms may still be ultimately influenced by longer-term economic realities.
Change is a constant but also can induce uncertainty. Across the UK, Germany, Italy, Hong Kong, and many other countries, we are seeing the political, economic, and social impacts of an evolving world. These challenges are going to keep on coming in new and varying ways in the 2020s. The challenge for leading politicians and other policymakers is to devise ways to embrace change more as an opportunity than a threat. Where this is achieved, or at least perceived more positively, investment returns will follow. In a changing world, this most commercial of observations, at least, does not change.
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