July 5, 2016

By: Bobby Casey, Managing Director GWP

eu italyBrexit was a great economic and political decision for the UK. I stand by that. While I see Remain people calling Leave proponents racists and xenophobes… I likewise see Leave people calling Remain advocates dotty millennials who haven’t the first clue what the EU is or does.

I believe both sides are accurate to some extent in their depictions of the other side, but it can’t be entirely true lest this entire thing boils down to a sociological coin toss. Regardless of what the impetus was, eyes forward, the world keeps spinning and we go on.

So what has happened? There will be shock and fallout of said shock. Uncertainty is certain. I’ve noticed that large radical changes in policy tend to lead to initial schisms and ultimately even out. When Portugal decriminalized all drugs across the board, there was an uptick in drug related deaths. Once that flushed itself out, it looks like a blip on the graph now. People are not dying from STDs and drug related issues in the great numbers as other countries are who still cling to their drug wars.

I don’t expect much different here. Markets, countries, and people are stirred up. And rightly so! The global economy is at BEST precarious. Everyone is relying on everyone else to stay the course and not change anything. That sort of codependency and lack of flexibility is one of the major differences between how businesses work and countries work. Market based enterprises maintain flexibility because they understand the dynamics. Politically based enterprises desperately live from edict to edict.

Market based enterprises merge and find efficiencies. They eliminate redundancies, trim the fat, and play to their strengths. Politically based enterprises also merge. But they bulk up and bloat with more bureaucracy and more inefficiency and more redundancy.

There is a decent list of worrisome events in the wake of Brexit, and by no means should they be glossed over. This doesn’t make Brexit a bad idea, any more than it makes a case against 18 year olds moving out of their parents’ homes and suffering the initial struggles of independence. Being on your own comes with tumult, and that’s okay.

The currency markets were hit.  The USD and Yen both went up, which will hurt their exports. Still, the US won’t be shaken up as much as perhaps China. With the USD becoming stronger, but the Euro being shaky if not weakening, what does the yuan do to balance its exports to its two largest customers? Even then their issues seem to be more domestic than international.

Meanwhile, we also have an emboldened Euroskeptic crowd that is looking at this as their window of opportunity.

Global response is one thing. What was the EU response, though? Leading up to Brexit, we know that Italy was granted “unprecedented” leniency from EU budget rules.

“Brussels has granted Italy’s demand for spending equivalent to 0.85 percent of its GDP to be effectively stripped out of the calculation of whether Rome is acting fast enough to cut its huge national debt.” (Source: The Local)

This article goes on:

“Although Italy’s deficit is well under the three percent ceiling enshrined in the EU’s Stability Pact, Rome is under pressure to cut its annual borrowing requirement as a means of bringing down its huge debt mountain.

“This currently stands at €2.2 trillion, equivalent to more than 130 percent of the country’s annual economic output. Renzi has pledged that the debt level will fall this year for the first time since 2007.

“The Italian premier has been a vocal critic of what he sees as EU austerity. Italy’s budget for this year includes tax cuts and new spending worth around €30 billion, around half of which is being financed by letting the deficit run higher than it otherwise would.”

Before reading any further, I want you to focus particularly on the bolded areas:

  1. Italy under pressure to CUT annual borrowing
  2. Renzi pledged a falling debt level
  3. Spending financed through higher deficits

I also want to point out that this is from an article published BEFORE Brexit: May 18th, 2016.

Now what’s happening post-Brexit?

The European Commission has authorized Italy to use government guarantees to create a precautionary liquidity support program for their banks.” (Source: WSJ/Zerohedge)

Despite Merkel’s opposition and firm “NO” on the matter, the bloc passed it anyway under “extraordinary crisis rules for state aid”. This includes up to 150 Billion Euro in government guarantees, as well as 40 Billion Euro in capital specifically to the banking sector.

This is not a ploy to prop up stocks. This is a ploy to preemptively prevent a run on the banks. This sort of support is supposedly reserved for solvent banks. But Italy’s banks collectively have 360 Billion Euro in non-performing loans… which means NONE of their banks are actually solvent. I guess they just get a pass?

Also, this is newly printed money, not existing wealth. Central banks printing money is quite possibly the biggest wealth transfer from middle and working class to select wealthy conglomerates in any given economy. It’s not a figurative theft, but a digital one. Banks print money; the currency is devalued once said money is in full circulation; but the ones who get their hands on the money first are the beneficiaries because they got to use it when it was still worth more.

In the case of the EU, their bond-buying programs are particularly elitist in that they only buy blue-chip bonds. They buy bonds from companies that have no problem getting private sector funding. And it’s those corporations that get the wealth.

The problem is that when the ECB lends newly minted money to companies by buying their bonds, it transfers wealth from European savers to companies. How so? Because the more money the ECB lends by buying corporate bonds, the lower the interest rate companies have to pay. Consider that Toyota sold a Euro-bond last week that pays no interest. Zero. Who would buy a bond that pays no interest? The European Central Bank is happy to, but in doing so, it forces savers who would invest in corporate bonds to accept a zero rate of interest as well.” (PBS: Terry Burnham)

Japan is also using Brexit as an excuse to delay raising taxes, while printing more money. The UK might very well do the same thing, which would be wrongheaded of them.  This is tantamount to sweeping dust under a rug… only the rug is freshly printed money, and the dust is debt.

The irony is, despite every populist clamoring to help the middle class and lowly proletariat, they would sooner have money printing over tax paying. (I prefer neither, for the record.) Put another way, they prefer the theft they can’t see, and to kick the can down the road.

The point is not to make policy and decisions based on panic, but rather on sound economic principles. No doubt the United States was on shaky ground when it first seceded from the UK. But we opened our borders, and made an altar call to all who would listen to come to our freedom loving shores. Such is not going to be the case for the UK given the rhetoric of some of the spokespeople for Leave. I worry for the EU. They are going to have the hardest time with this break-up given they are proving to be a one-trick pony economically. Unilateral bailouts are just not sustainable.

Click here to schedule a consultation or here to become a member of our Insider program where you are eligible for free consultations, deep discounts on corporate and trust services, plus a wealth of information on internationalizing your business, wealth and life.