Brexit Post-Mortem

It is a month after Britain’s surprise vote to leave the EU. A new Conservative Prime Minister and Chancellor are in place, both David Cameron and George Osborne having fallen on their swords. The third man in the losing triumvirate, Mark Carney, is still in office. Having taken a political stance in the pre-referendum debate, there can be little doubt the post-referendum fall in sterling was considerably greater than if he had kept on the side-lines.

This article takes to task the Treasury’s estimates of the effect of Brexit on the British economy and Mr Carney’s role in the affair, then assesses the actual consequences.

The Treasury’s Economic Weapons Of Mass Destruction

One of the Treasury’s models predicted Brexit would cost each household £4,300 every year. There were at least two things wrong with this prediction. Firstly, it was presented as if it was a loss of net income, in other words the business profit or wages the average household would lose. The estimate was nothing of the sort, it was the Treasury’s estimate of the loss of annual GDP divided by the number of households in the event of Brexit.

A second wrong should be equally obvious. No economic model is capable of predicting an outcome without subjective inputs. This is why garbage in produces garbage out. One can even goal-seek specific answers by feeding assumptions into an economic model. One suspects this was the principal basis of what the press dubbed “Project Fear”.

There were in fact two Treasury models, the first one described above, which is meant to predict the medium to long-term outlook, and a second which predicted an immediate recession in the event of Vote Leave. This is the Treasury’s VAR model, which uses statistical analysis to measure and quantify the level of financial risk. The simple assumption, with no basis in evidence, was that Brexit would amount to an economic shock half as great as the 2008 financial crisis, lasting for two years.

Combining the output of these two models allowed George Osborne to threaten us with an economic disaster if we didn’t vote Remain.

An important point that seems to be lost on government economists when making their forecasting assumptions is that we all quietly get on with making a living, very successfully if we are left alone by the state. It is when they interfere that things start to go wrong. Furthermore, they are convinced we need national trade deals, and appear incapable of understanding that we manage far better with free trade.

We will not digress into why using economic models can never work, and instead note the abuse of its own models by the Treasury. An independent paper by Professor David Blake published by the Cass Business School exposes the intent in the Treasury’s approach, some of which is repeated here. He even goes so far as to describe the published outputs as “dodgy dossiers”, a phrase that was first used to describe the cooked-up intelligence report that led us into the last Iraq war. It is as if the purpose of the Treasury’s economic assessment was to threaten us, to pursue the Iraq analogy, with non-existent weapons of mass economic destruction.

Professor Blake’s findings are damning, but they were less widely read in financial circles than the Treasury’s forecasts, which were almost always accepted without question. The Treasury forecasts were then given added impetus when Mark Carney, the Governor of the Bank of England, took the unusual step of intervening in the political debate. Claiming that the Bank has a mandate to warn us of economic threats, he gave the Treasury forecasts unwarranted credibility in the foreign exchanges and international financial markets. Though he denied his intervention was political, there can be no doubting that that was the effect.

If Britain had voted to remain, there would have been no immediate problem for the markets. Ahead of the vote, sterling rallied in a growing belief the referendum would be in favour of Remain, because the bookies odds said so. Instead, the vote went the other way. There can be little doubt that the markets reacted as sharply as they did on the basis of the Treasury’s dodgy dossiers, and the added spin given to them by Mark Carney’s warnings.

In the event, sterling immediately fell over 10% and markets worldwide took a big knock. A run developed on UK commercial property funds. But the most important event, in terms of the Bank of England’s mandate, was the collapse in sterling. It went against the Bank’s stated mission, “to promote the good of the people of the United Kingdom by maintaining monetary and financial stability”.

Mr Carney’s intervention was a gamble for Remain that failed to pay off. The evidence that he was caught up in the Treasury’s deceit has now emerged, with markets rapidly regaining their poise, apart from the sad exception of sterling. The Monetary Policy Committee on 14 July decided that no further economic stimulus is required. In other words, both markets and the Bank are now signalling that Brexit does not have the consequences for the UK threatened by the Treasury, beyond a 10% sterling devaluation. And that would most likely not have occurred if markets were not preconditioned to think Brexit would be a disaster for the currency.

If it wasn’t for the sensitivity of his position, one would have expected Mr Carney to resign his post immediately. But the replacement of a central bank governor is never hurried, being managed in the interests of market stability. Therefore, Mr Carney might quietly arrange for his early departure.

What Happened To The Brexit Recession?

One month on from the referendum, there is no sign of the Treasury’s VAR model predictions coming to fruition. London is teeming with people, many of them foreign visitors, spending money in cafes, restaurants, theatres and other visitor attractions. The country roads are still jammed with caravans, tractors, tourists and white vans trying in all their productive mayhem to go about their business. Wimpish businessmen dithering over trade and investment plans are being forced to get on with life, and it should be noted that turncoat Remain supporter, GSK, this week announced a massive new capital investment programme, one of several such announcements in recent days.

Our long-abandoned trade friends in the Commonwealth are keen to talk to us, as is China. And who can forget President Obama’s threat when it came to negotiating T-TIP with the EU? Well, we are no longer at the back of the queue, but at the front of the line. Only this week, it was announced that our American friends will shortly be able to enjoy fine Welsh lamb and prime Scottish beef again for the first time in twenty years.

Suddenly, everyone, with the exception of the EU, wants to engage with us about trade. A dyed-in-the-wool bureaucrat, Michel Barnier, has been appointed to represent the EU Commission in the Brexit divorce. He is expected to talk tough, and make any agreement with the UK hard-won. Good luck to him, when the opportunities and everyone’s focus have moved elsewhere.

The scientific community, which warned us about the loss of important subsidies and cooperation on European research projects, is now backtracking. The President of the Royal Society, says he sees no evidence that European funding bodies are discriminating against British research projects. Professor Nick Donaldson, of University College, London, points out that “money is pouring into the research and development pipeline, but new products are not getting to market, because of the expense incurred through the EU’s Active Implantable Medical Device Directive of 1990 (Letters, Daily Telegraph, 26 July). At last, we will be able to set our own rules in this and other matters for the benefit of ordinary people.

It must be extraordinary, to anyone who was sucked in by the Treasury’s forecasts, how quickly markets and the economy have recovered their poise. Mainstream economists are confounded. Again, we must refer to Professor Blake’s paper. He points out that Greenland’s economy grew rapidly when it left the EU in 1985, and Ireland’s trade with the UK was unchanged by her exit from the sterling area in 1979. Both these outcomes are wholly inconsistent with the Treasury’s assumptions. He also points out that the model on the Treasury’s input assumptions would predict the UK is better off joining the euro, and that every country in the world would be better in the EU. Tell that one to Donald Trump.

It is worth reading his key points, if not Professor Blake’s paper in its entirety. That the Treasury got is so wrong tempts one to think there was another agenda, perhaps stuck in the mind-set of the post-war geopolitical establishment.

More immediately, there is the obvious problem that the EU’s economic and financial trajectory is a genuine crisis, and that the whole project is liable to collapse. If so, Britain remaining in the EU would have amounted to a sacrifice of Britain’s relatively free trade values in the interests of the EU’s lemming-like self-destruction.

There is, of course, every possibility that the British government will screw Brexit up. The signals from the establishment are mixed, to say the least. The state-controlled Royal Bank of Scotland and its NatWest subsidiary is preparing its business customers for negative interest rates on their deposit accounts. Many economists, immersed in the beliefs of the neo-Cambridge school and with the Treasury’s forecasts still uppermost in their minds, desire further cuts in interest rates and even helicopter money.

We cannot know what the future holds, particularly when governments attempt to micro-manage their citizens’ economic activities. There is no evidence that compels us to argue that a British government and the Bank of England are much better than any other Western government and central bank. Nor can we assume that an escape from the EU is an escape from their group-think.

We do know with reasonable certainty, on the balance of firm evidence, that if the British or European economies tank, it will have nothing to do with Brexit.

Alasdair Macleod

HEAD OF RESEARCH• GOLDMONEY

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