By Roger Martin-Fagg

Roger_Martin-Fagg_65x95Since my last update a great deal has happened:

– Otmar Issing, the principal architect of the Euro, has stated that the Euro is bound
to fail and that Greece should have left the system in 2010.

– The British Government is beginning to realise that a clean break from Europe is
impossible without doing long term damage, and that a transitional arrangement
must be put in place as soon as possible.

– Jean-Claude Juncker is on record stating that ‘we need less interference from
Brussels when it comes to the things that Member States can deal with better on
their own. That is why we no longer regulate oil cans or showerheads, but
concentrate instead on what we can do better together rather than alone’.

– Near zero interest rates have done virtually nothing to stimulate investment in
productive capacity. The UK Treasury is dusting off the Keynesian model which
emphasises infrastructure spending as a route to higher productivity. But long run
interest rates are rising.

– The UK construction industry will need to recruit 700,000 people over the next 5
years to replace those leaving the industry, mostly through retirement. Currently
13% of the workforce is from overseas, 25% of whom are in London.

– Sterling has lost 16% of its value since the referendum. The UK balance of
payments deficit is a record 7% of GDP.

– Donald Trump could be the next President of the USA and Commander-in-Chief.

– A successful SME corporate travel company has noticed more business travel to
countries further afield in recent weeks.

– The Bank of England expects inflation to be 3% by the end of 2017, but Mark
Carney has said they will tolerate overshoot on the 2% target. This implies a
delayed interest rate hike, but no further cuts. Normally base rate is inflation plus
2.5%, but we are not in normal times!

The Brexit Vote

The British seem to be preoccupied with their own point of view without reference to the
views of our trading partners of the past 40 years.

The run up to the vote clearly depressed confidence for business in the EU, and the
outcome seems to have reduced EU retail sales. One must assume EU consumers are
reflecting on the possibility of changes in their own country.

rmf_october_1 rmf_october_2


Meanwhile the British carry on shopping, with retail spend in September up 1.6%.These
figures are inflation adjusted.

There can be no doubt that the British vote has encouraged the many within the EU who
share similar views, and there is growing evidence that Brussels is beginning to modify its

‘we need less interference from Brussels when it comes to the things that Member States
can deal with better on their own. That is why we no longer regulate oil cans or
showerheads, but concentrate instead on what we can do better together rather than
Juncker September 2016

And Professor Otmar Issing writing in the Central Banking magazine is convinced the Euro
project is on the slippery road to collapse. This is notable as Otmar was the chief architect
of the system. He is clear that “structural incoherence” has been disguised by cheap oil,
quantitative easing, profligate public spending and a cheaper Euro. He suggests that the
next downturn will be the big test. Greater political fatigue, high levels of debt, and
significant unemployment could mark the end of the Euro, he says.

He believes the ECB is in an untenable position because it holds a trillion euro bonds on
its balance sheet, many of which were bought at artificially high prices, and will rapidly
become almost valueless in the next downturn.

These remarks suggest to me that some of the institutions of the EU are being increasingly
recognised as not fit for purpose by those who work in them. What does this mean for the

After Germany we are the biggest net contributor to the EU budget. In 2015 our net
contribution was £9Bn, our gross contribution was £13Bn.

The EU budget is under severe pressure. When we leave, they will need to find at least
£9Bn from other members. The UK, Germany, France, and Italy together provide over
60% of the funding.

The EU needs our money. We need to control immigration (the will of the people). We
need to maintain free access for financial services (last year we made a surplus of £21Bn
on sales to the EU), for manufacturers, for travel, for holiday homes, etc.
The deal for Norway and Switzerland was meant to be transitory, but has become

We need to do a transitory deal as follows:

We pay £ 13Bn per year, we get no farm support or regional aid back. We are free to limit
migration. We only have accept EU law in so far as it affects trading standards. We have
no seat at the table. But our access to the market remains as it is today. It is clean, costed
and simple.

So how do we sell it to the leavers?

It would cost £3.84 per person per week- or one Starbucks latte.

Of course we would probably have to keep regional aid and farm support going, which is
another say £5Bn of cost, 1p on the basic rate of tax.

But for £3.84 a week we save a fortune in lawyers and trade negotiators, we get our
sovereignty back from Brussels (we never lost it, but Boris would have to declare it). And if
the EU does collapse we are not part of it.

Meanwhile the EU is busy saving itself, so this transitory arrangement becomes

If I have understood the leavers arguments correctly, they are not opposed to trading with
the EU, but they dislike the loss of sovereignty, the bureaucracy (which is unaccountable
they say), and uncontrolled immigration (from the EU).

For £3.84 per week we can meet their requirements.

My instinct is that the EU would agree to such an arrangement. As the political mood shifts
within the EU there are clear signs that the free movement of labour is less attractive to the
EU electorate. Many years of prolonged negotiations with Britain when resources are
limited and there are much bigger issues on the agenda could be viewed as a distraction.

What is the alternative?

The so called hard Brexit.
We leave within the next three years and then revert to WTO rules to access the single
market. The current rules would kill the UK motor industry because of the 10% tariff. It
would take at least ten years of negotiation to tailor a motor industry package (which would
need to be agreed by 27 countries, so make that 15 years). Note that the EU-Canada deal
has been 7 years in the making, and Wallonia (the French speaking part of Southern
Belgium) has the power to stop it. As I write this, they intend to.


We would not be allowed to do tailored deals with each country within the EU, so each
prospective deal would require 27 countries to agree.

We would probably lose the inward investment from EU and USA companies (the USA has
£600Bn of investment in the UK). Our balance of payments current account deficit would
have to fall to a level which we could finance. This means a reduction from the current
£126Bn deficit per annum to around £35Bn. It is doubtful we could do this by raising
exports sufficiently, so we would have to reduce imports. This is usually achieved by a
recession: as the weak pound drives up inflation, wages fail to keep pace, and real
spending falls.

The WTO option would without doubt reduce the standard of living as real wages fell by
around 2% a year until a tailored deal was in place.

It would probably also wipe 10% or £600Bn of the value of UK houses in 2021-2023 as
interest rates go above 4% in order to finance the current account deficit.

A look ahead to the UK Autumn Statement


I am one of many who now think Quantitative Easing and near zero interest rates has
ceased to work apart from keeping share prices well above fair value and thus making the
rich richer. It is clear that the money supply in the West is now growing sufficiently to
maintain normal growth. But normal growth is below par because investment spending is
insufficient and productivity growth too low.

Keynes famously said ‘the colour of businessmen’s livers’ determines the investment
decision. And that is largely driven by confidence, which is in turn driven by expected

There are signs of a Keynesian mini revolution in the UK Treasury. Chancellor Hammond,
who used to be in the housing construction sector, has hinted at increases in Government
funded infrastructure spend.

Already announced is the release of £2bn of public land and £3bn of funding for small
house-builders. Both will increase the velocity of existing money and, to a small extent,
new housing will improve labour mobility.

We can expect more announcements in November. I guess the Treasury will be happy to
take the deficit up to £80Bn from the current £67Bn. This will be about 4% of GDP.
They will also announce measures to improve the supply of home-grown construction
workers, because as above a recent report suggests that over the next 5 years the sector
will need 700,000 new workers.


We wait with bated breath. I think Trump will just squeeze past Clinton and become the
next President. His pitch that she is a ‘crook’ and he is a savvy businessman resonates
with those in small town USA who choose to ignore his own illegal and morally repugnant
practices. He is clearly authentic, she is clearly not – or so the message goes. His
repeated challenge that she has had 30 years to get things done, but hasn’t managed to
change much, whereas he is a multi-billionaire because he gets things done is another
plus in so many eyes. He also struck home when he agreed he said many disgraceful and
unacceptable things about women, passed off as ‘locker room’ talk, but Bill Clinton acted
them out – this should bear no reflection on Hillary, but the world isn’t quite advanced
enough for that mindset. However, the majority of women in the US who were considering
voting for Trump have recently changed their minds (according to polls), given the number
of women who have come forward to accuse him of various grades of sexual harassment
and assault. He is currently 8 – 10 points behind, but Brexit showed us the fallible nature
of polls.

The entire process should be a plot in a scarcely credible dystopian novel rather than real
life – but that’s where we are, and it will be an extremely close election with possibly
serious ramifications for social order in the self-styled most powerful nation in the world.

In slightly more positive news, Obama has not managed to achieve a great deal because
of the US system of checks and balances – this will also apply to the next President.

The economic impact is very difficult to call. I suspect a short period of dollar weakness
which will not persist as the markets see who is appointed into key roles.

US business investment peaked a year ago; it could rebound if big tax cuts on business
are mooted.


The leaders of Brazil, Russia, India, China and South Africa have just agreed to double
intra-BRICS trade by 2020.

Brazil and Russia are both in recession, China has stalled at 4% (according to electricity
demand), South Africa is flat. India is booming at 7.6% so I guess the rest want to sell
more to India.


The Outlook

I was impressed by a UK entrepreneur who said the other day he was visiting a trade
show in the USA. He hadn’t been for a number of years and previously he went to buy, but
this time it is to sell.

There is evidence that business travel is picking up and to places further afield.

This suggests to me that there is a spark of get up and go which, given the positive
feedback loop our economy always experiences, will result in growth better than forecast
by the majority for the next two years. Beyond that it is too early to tell, but I confess to
being one of those so called experts who is pessimistic for our growth prospects if we
pursue the WTO option.

Forecast to the end of the year
No change in base rate but long run interest rates will drift upwards as inflationary
expectations rise. This will increase mortgage rates but not until next year. If you can get a
5 year fix, do it now!

Core inflation up from 1.5% to 1.9%
£-$ 1.20 average

If the Government makes it clear they are going for a soft Brexit to preserve current access
then the pound will be 5% stronger than the above figures.

Expansionary budget in November, with an announcement that we will look for
a transitionary deal with the EU.

Third and final quarter GDP growth will be 0.4% and 0.5% respectively.

House prices should slow their rate of growth from the current reported 8% year on year
(which I find difficult to believe) to 3-5%
18 October 2016

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