The Brexit impossibility conundrum

Events over the last week have taken us further into the looking glass world which we now seem to inhabit. Donald Trump is never far from the headlines and his trip to Europe last week raised some uncomfortable questions – some of which did need to be raised and many that did not – but I will deal with those in my next post. However, it is the surreal events in the arcane world of Brexit that are currently top of my thoughts.

The government’s White Paper, published last week, was supposed to be the moment when we finally got some clarity on the post-Brexit nature of the relationship between the UK and the EU.  After all, it is the document that the EU has been requesting for the past 16 months. “Tell us what you want,” they demanded of the UK. But when they finally saw what the UK was proposing, they probably wished they had never asked. In short, the UK is asking for an Association Agreement with the EU which preserves many of the rights and privileges which it enjoys now. It is suggested that the UK and EU create a free trade area for goods governed by EU law, underpinned by elements of the customs facilitation plans which the EU has already derided as unworkable. Moreover, although “the UK would not have a vote on relevant rule changes, its experts should be consulted on the same basis as Member States.” Meanwhile, it intends to end the free movement of labour and proposes only paying into “those EU agencies that provide authorisations for goods in highly regulated sectors” without any mention of more meaningful budget contributions.

As a brazen piece of cherry-picking, this document is up there with the best. There is absolutely no way that the EU can agree to a free trade area whilst the UK seeks an opt-out from one of the four freedoms and at the same time shows no interest in paying into EU schemes. As a starting point in negotiations, the document has its merits but it is the paper that should have been presented a year ago – and ideally before the Article 50 process was even triggered. It is very late in the game to be presenting a plan which has virtually no chance of success, especially when the UK hopes that it can determine the basis of its future relationship as soon as the EU summit in October.

Then of course, there is the small matter of domestic opposition. The ideas set out in the White Paper satisfy neither the pro-Leave nor the pro-Remain camps because the former see it as an attempt to remain in the EU by the back door whilst the latter group view it as a far worse deal than the UK enjoys today. And both are right. There is little point in leaving to get a worse deal than we have now (as I have argued all along) and the Brexiteers are right to argue that the plan crosses many of the red lines that Theresa May has delineated over the past two years. So both have been betrayed.

To add insult to injury, the plan focuses on trade in goods and downplays services trade. This makes very little sense given the importance of services to the overall economy. As the German newspaper Handelsblatt pointed out (in English) “Theresa May's long-awaited White Paper aims to keep manufacturing in Britain, and is willing to surrender London’s financial access to the EU in return. That suits Germany just fine.” Indeed, the financial services industry can argue that it has been thrown under the bus – the one part of the economy that generates a trade surplus – with the government opting not to pursue a policy of mutual recognition for financial regulation but instead relying on enhanced equivalence in which recognition will take place on a piecemeal basis. It is not the deal that the City was looking for to remain competitive at a time when life is already being made difficult by overarching regulatory changes and general trading conditions.

Yet, despite all the carping, it is probably the best that the government could deliver under the circumstances. The hard Brexit vision championed by David Davis, Boris Johnson et al risks driving the economy over the cliff (see this clip of MP Anna Soubry blasting the ideological nature of the Brexiteers’ case). Thus, in order to avoid the worst case outcome, the government has no choice but to accede to many of the EU’s demands in order to secure access to the continental European market. Hence we will end up with a half-in, half-out Brexit that satisfies nobody.

Increasingly, there are calls for a second referendum, to which the Brexiteers respond that this would be to sell out what was decided in June 2016. Yet they have had more than two years to present an acceptable plan as to how to proceed with Brexit and have failed to do so. But they oppose the government’s plans which envisage a closer relationship than they deem acceptable, and all the while we get nowhere whilst the clock ticks down. If politicians cannot come up with an acceptable compromise, they may be forced to throw the question back to the electorate. I am no fan of a rerun (Brexit II) but I am increasingly of the view that there may be little option. Former education secretary Justine Greening yesterday called for a ballot with three options: the prime minister's Chequers deal, staying in the EU or a clean break from Europe with no deal. At least the electorate will have to think about the implications of leaving in a way that they did not two years ago.

In a way, these are the choices that we always faced: The choice was never about a straight “in” or “out”. It was always “in” or choosing the least worst version of “out”. The prime minister predictably has ruled out a second referendum. But with her position weaker than ever and with an increasingly impressive track record of saying one thing and doing another, it would be unwise to rule out the second referendum option altogether.

It’s goodbye from me and it’s goodbye from him

Today’s news that two of the “big beasts” in Theresa May’s cabinet have quit is all of a piece with the actions of prominent Brexit supporting politicians who, when the going gets tough, also get going – generally in the other direction. Both resigned when it became clear that the rest of the cabinet would not support their version of Brexit, which amounted to nothing more than “let’s just leave and sort out the problems later” despite the chill winds of reality which make it clear that a hard Brexit is an economic non-starter.

Johnson’s resignation letter is a clear illustration of his inability to see the reality of Brexit. It should, he says “be about opportunity and hope … That dream is dying, suffocated by needless self-doubt.” If the UK were the EU’s economic equal, able to wring concessions by applying its clout, he might have a point. But that has never been the case: The UK was always going to be disadvantaged during the exit process. The ultras only ever see Brexit in one dimension and have totally failed to grasp that the rest of the world may not see the process in quite the same way.

Regular readers will know I have no truck with the positions of Boris Johnson or David Davis on Brexit. But I am both encouraged and depressed at their departure. Encouraged, because I believe the chances have risen that the government will be able to unify around a plan that delivers a softer Brexit than might otherwise have been the case. But the depressing aspect of it all is that it has taken supposedly intelligent people two years to arrive at a position that many of us realised was inevitable five years ago. That said, the Brexiteers are right about one thing: The idea of accepting the plan outlined by the prime minister at last weekend’s Cabinet away-day represents a significant crossing of Theresa May’s red lines which puts the UK in a very awkward position.

Indeed, these red lines which have been set out over the last 22 months have all but been rubbed out. The plan – further details of which are due to be published later this week – calls for a “common rulebook for all goods including agri-food”; adherence to common standards in a whole range of areas and an ongoing role for the European Court of Justice “as the interpreter of EU rules.” In short, the UK is proposing associate membership of the sort enjoyed by Norway. Johnson might be overdoing it when he says “In that respect we are truly heading for the status of a colony – and many will struggle to see the economic or political advantages of that arrangement.” But he has a point in that a policy requiring the UK to remain a rule taker with no say over the drafting of legislation, and which will probably require continued contributions into the EU budget, puts it in a far worse position than it enjoys today.

Furthermore, we have so far only heard from the British side. The EU’s negotiators in Brussels might well view the plan as representing another attempt at cherry-picking by the Brits. For example, the document talks about a trade partnership with the EU whilst simultaneously calling for an end to free movement of labour thus  “giving the UK back control over how many people enter the country.” As an aside, it is worth noting that on latest data through September 2017, the decline in net immigration has come about purely because of a decline in migrants from the EU. Net immigration from non-EU countries – the element that the UK already controls – hit record levels over the preceding 12 months.

Nonetheless, the departure of Davis and Johnson raises the chances that the government will be able to coalesce around a plan for a soft Brexit without having to worry about Davis’ view. Johnson will be more of a problem but since he never cared much about collective cabinet responsibility in the first place, he will simply continue to take a position that is at odds with the government.

Naturally, the press is now full of “crisis talk” and speculation of a leadership challenge. But the rebels do not really have the numbers to mount a challenge. The (inaptly named) European Research Group, which is the bastion of pro-Brexit support within the Conservative Party, has at most 80 members of which only a maximum of around 50 are believed likely to support a change of leader. With the Conservatives comprising 316 MPs, the arithmetic is currently in May’s favour so market talk of a “government crisis“ looks overdone. Johnson may be a charismatic politician with a high degree of public support, but his parliamentary colleagues simply do not trust him. He is not in a position to challenge for the leadership of the Tory party, and as one who has flouted the rule of collective cabinet responsibility over the past two years, many people will be very happy to see the back of him. But as Donald Tusk put it in a Tweet today, ”politicians come and go but the problems they have created for people remain. I can only regret that the idea of Brexit has not left with Davis and Johnson.”

Two years on

It is two years ago to the day since the UK voted to leave the EU – albeit by only a very narrow margin and certainly not by enough to justify the hardline position adopted by the British government. For a brief period, the UK was the centre of world attention, but over time international interest has waned in what can only be seen as a parochial problem. The EU is preoccupied with other issues, notably the problem of immigration with Italy and Germany apparently at loggerheads and even the German government split on this particular topic. The fact that immigration was a central theme of the Brexit campaign is a reminder that the EU never really thought through the implications of its immigration policy, and is an indication that it has failed to tap into the differing priorities of its member states. 

Brexit is not the EU's top priority 

As time has gone on, external threats such as the perceived threat of Russian aggression; the economic problems posed by China and the very fact that Donald Trump occupies the White House are much higher up the EU’s agenda than Brexit, which is increasingly a sideshow. Brexit is a British problem and requires the government to come up with a clear plan for what it wants. But it has not done so two full years after the referendum which, lest it be forgotten, was legally only advisory. The government was not required to implement the decision.

Twelve months ago, I wrote “As for where we will be in a year’s time, I suspect not much further forward. If the EU plays hardball on the Brexit bill and the UK refuses to back down, the clock will be running down without any tangible sign of progress on the trade deal which the UK so badly wants.” To a greater or lesser degree, that is exactly what has happened. The UK has been forced to concede ground on some of its key issues, notably the role of the ECJ, and the government is beginning to realise that delivering a Brexit that works is much harder than many of its proponents believed. 

The lack of domestic political coherency is making things much worse 

There are still those who blame Remainers for hindering progress, but the less cerebrally challenged Brexit supporters realise that the government’s headlong rush to deliver has placed it into a box from which it cannot easily escape. Political journalists have had a field day reporting on the parliamentary machinations as pro- and anti-Brexit supporters slug it out. But the fact that the UK still does not have a coherent Brexit plan speaks volumes for the degree of disorganisation at the heart of government.

One of the more depressing aspects of this week was that rebel MPs, who threatened to mount a challenge to the government’s lunatic policy, chickened out of the fight when the chips were down. Their proposal was that parliament should have the power to take over Brexit negotiations in the event of a ‘no-deal’ with Brussels. In the end, they were bought off with a compromise in which the Speaker of the House of Commons would decide whether any motion put forward by the Government on Brexit was amendable. This was enough to buy off chief rebel, former Attorney General Dominic Grieve, who stated “Having finally obtained, and I have to say with a little bit more difficulty than I would have wished, the obvious acknowledgement of the sovereignty of this place [parliament] over the executive in black and white language I am prepared to accept the Government’s difficulty and support it.” He then proceeded to issue his original proposal (that parliament could take over negotiations), only to then vote against his own amendment.

If that does not sum up the bizarre nature of political proceedings, I don’t know what does. Former Permanent Secretary to the Treasury, Nick MacPherson, summed it up perfectly in a tweet when he pointed out that “Europhile Tories always compromise to preserve party unity. Their opponents don't.” 

And business is losing patience 

For all that the electorate appears to have lost interest in the minutiae of Brexit, big business has not. Only yesterday, Airbus announced that it was considering whether it would continue investing in its UK operations. COO Tom Williams said in a radio interview, “over the next weeks we need to get clarity. We are already beginning to press the button on our crisis actions ... We have got to be able to protect our employees, our customers and our shareholders and we can’t do that in the current situation … we need to have clarity. We can’t continue with the current vacuum.” This matters because according to a report produced last year by Oxford Economics, Airbus contributed £7.8bn to the UK economy in 2015 which is “larger than the economy of Newcastle upon Tyne” (the principal city of NE England).

Business is no longer prepared to take the government on trust, and with the March 2019 exit deadline just nine months away, time is increasingly pressing. A number of other businesses have also spoken out to warn of the dangers of a hard Brexit and as one commentator suggested recently, the true costs of Brexit will only become evident too late to stop it. It is not as if it is not already hurting. According to the latest estimate by John Springford at the Centre for European Reform “the UK economy is 2.1 per cent smaller as a result of the vote to leave the EU. The knock-on hit to the public finances is now £23 billion per annum – or £440 million a week.” Recall that the UK was meant to save £350 million per week by leaving the EU!

It is simply astonishing that a traditionally pro-business Conservative government can take a project like Brexit and totally ignore all the evidence placed before it. By leaving the single market and placing barriers in the way of EU migration, the government will reverse the liberalisation of the UK economy overseen by Margaret Thatcher in the 1980s – a process that was copied by many other countries. Part of the problem with the Brexit concept is that it was sold as a vision of making Britain great again (sounds familiar). But many voters are guilty of seeing old Britain through rose-tinted spectacles: Ironically, the age group most in favour of Brexit were those who lived through the strikes and the power cuts of the pre-Thatcher 1970s. 

I have long argued that whilst Thatcher was no fan of the EU, she recognised the potential of the Single Market in a way that the generation of politicians who succeeded her clearly do not. In that sense, the current generation of Conservative politicians who revere the legacy of Thatcher and talk about the benefits of free markets clearly do not understand what the 1980s revolution was about. Quite how they hope to enhance living standards whilst simultaneously putting obstacles in the way of the free movement of goods and labour demonstrates the economic illiteracy of their argument.

My late father never had much time for politicians, believing them to be more interested in looking after their own interests than those of the people they were meant to serve. Whilst my dad and I did not always see eye-to-eye on matters of politics, we were united in our assessment of the current generation of politicians.

The NHS and the Brexit dividend

As we approach the two year anniversary of the EU referendum, it seems that British politicians have learned nothing about the economics of Brexit. Only last weekend, the prime minister herself announced that the government plans to raise the NHS budget by £20bn per annum by 2023, partly funded by a “Brexit dividend.” But like the unicorn and the Loch Ness Monster, there ain’t no such thing as a Brexit dividend.

It is a well-worn story that Leavers promised the UK would have an extra £350 million per week to spend on causes such as the NHS once it leaves the EU. It is an equally well-worn story that the number is a complete fabrication because it reflects the UK’s gross contribution to the EU budget, not the net figure – which is far more relevant. After all, the UK gets roughly half of its gross contribution back in the form of EU funding for domestic projects. Then there is the small matter of the Brexit bill: Assuming that the UK pays a sum of around £40bn to settle outstanding liabilities following EU departure, that is around four years of net contributions up in smoke. Moreover, since Brexit is widely expected to result in slower GDP growth than would otherwise have occurred, there is a strong likelihood that public revenues will be lower than in the absence of a Brexit vote. The OBR’s latest forecast suggests that by fiscal year 2020-21 total revenues will be £27 bn below the projection made in March 2016 (the last official forecast before the referendum, see chart). But even if revenues do somehow match 2016 expectations, the final exit bill means that the UK will be fiscally worse off on a five year view compared to pre-referendum forecasts.

So let’s be clear: There is no Brexit dividend. So why do politicians continue to say such things? Well for one thing, it is a snappy soundbite. Secondly, as this article points out, language shapes the way we think. Thus if a phrase is repeated often enough, it becomes an unconsciously accepted fact no matter how nonsensical it is. Thirdly, there is also a sense that the media increasingly does not hold the government’s misrepresentations to account. The interviewer to whom the prime minister made her claim did not challenge the notion of a “Brexit dividend.”

All that aside, nobody disputes the fact that additional spending on the NHS is welcome. But if there is no “Brexit dividend” where will the money comes from? The PM did suggest that “we as a country will contribute a bit more” which is code for higher taxes. The Institute for Fiscal Studies reckons that raising National Insurance Contributions (NICs) by 1 percentage point could raise around £8.5bn. Freezing personal allowances would raise around £3.5bn. Furthermore, the government is believed to be seriously considering not implementing planned cuts to corporate taxes which, as I pointed out in February 2017, would yield around £7bn. Putting all that together gets us close to the planned £20bn.

Rather than play with existing taxes, there is an increasingly strong argument for a hypothecated tax solely to fund the NHS. The Treasury has long been opposed to hypothecation, partly because revenues have tended not to be linked to individual projects but have instead gone into the general pot. Think of taxes such as the Road Fund Licence, which was initially introduced in the early twentieth century to pay for road construction and maintenance, but it soon became clear that revenue was not growing sufficiently rapidly to meet construction needs. Whilst hypothecation was abandoned in 1936, vehicle owners still have to pay their road tax. An additional objection is that tax revenue tends to be pro-cyclical which might starve the NHS of funds during times of downturn. Thus, if hypothecation is on the table, it would not be possible to use it as the sole source of funding but it could be a useful top-up option.

There is also no reason why the government could not borrow slightly more than planned. Although it unveiled a manifesto commitment to eliminate the deficit by the mid-2020s, there is no reason why it needs to do this. It could run a modest deficit relative to GDP whilst still running down the debt-to-GDP ratio (in simple terms, this is possible depending on the size of the primary balance and the extent to which the rate of nominal GDP growth exceeds the interest rate on outstanding debt). The economic logic of balancing the budget simply escapes me.

One of the standard definitions of economics is the study of the allocation of  scarce resources. Ageing European societies will increasingly have to make choices about how to fund rising demands on the health care system. Countries such as the UK will either have to cut spending on other areas or raise taxes in order to fund healthcare provision. But what is not possible is to use a “Brexit dividend” to pay for it. If it really were that simple, everyone would leave the EU.

Stuck in the middle (with who?)

This week promises to be an important one for Brexit legislation with parliament voting on amendments to the EU Withdrawal Bill following its return from the House of Lords (see below). With time running out ahead of the EU summit on 28-29 June, the government is further behind on its legislative agenda than is needed at this stage of the proceedings. As ever, the issue remains the split within government regarding the nature of the deal which the UK is seeking with the EU.

Davis and the Irish border 

The big story last week was the apparent threat by Brexit Secretary David Davis to resign on the basis that the backstop plan for the Irish border issue contained no end date. As a consequence he perceived a real threat that the UK would be tied to the EU customs union indefinitely. It is not the first time that Davis has threatened to withdraw his services. It is exactly 10 years since Davis resigned as an MP over the issue of the erosion of civil liberties following a parliamentary vote which saw the detention period for terrorist suspects extended from 28 to 42 days. In Davis’ words, this represented "the slow strangulation of fundamental freedoms by this government.” The irony is, of course, that the current government has tried to keep parliament out of the Brexit process and it was only thanks to the intervention of the courts that it was given any form of jurisdiction.

According to the New Statesman, this marked Davis’ fifth resignation threat. Given the lack of progress in Brexit negotiations so far, many people are wondering whether the chief negotiator might be part of the problem, and it speaks volumes for the weakness of Theresa May’s position that she has not called his bluff. In the end, the prime minister acceded to the threat by publishing a document outlining the backstop plan in which the temporary customs arrangement with the EU “should be time limited” and run to the end of 2021.

There are a number of issues with this suggestion. On the one hand, a backstop is designed to be put in place on the assumption that the first best solution does not work out. By definition, it cannot be temporary. Second, it incorporates a date that the EU has not agreed to and runs a year beyond the end of the planned transition agreement (which the EU has still not yet signed off).

In response to the UK’s proposal, the EU yesterday released an infographic (here) outlining how it sees the solution to the border problem. This plan envisages an open border between Ireland and Northern Ireland with the north retaining access to the single market for goods. In the Commission’s view, “the EU backstop proposal to apply unless and until another solution is found.” The key difference with the British plan is that it allows no prospect for the UK to remain within the customs union primarily because, in the Commission’s view, the UK’s plan leaves too much “uncertainty on the scope of EU trade policy applicable to the UK.”

Whilst the UK government is way too ambitious and its plans do smack of cherry-picking, the Commission’s response has been criticised by some trade experts as being overly provocative (see this Twitter thread from David Henig). For example, the slide pack released by the Commission requests “Full application of EU VAT and excise rules on goods in Northern Ireland” which no UK government is likely to grant. Given that the EU sees no alternative to its plan and holds all of the aces ahead of the summit this puts the UK in a very awkward position. Either it will have to cross yet more of its red lines in order to get a trade agreement or we run the risk of moving ever closer to the cliff edge, as the chance of a deal by October would look very remote. 

Seeking domestic compromise 

As it happens, the likelihood that the UK will leave the EU without a deal has been significantly reduced by the concessions offered to MPs who planned to vote against the government on the second reading of the Withdrawal Bill. In order to stave off defeat, the prime minister promised rebels that she would put down a new amendment, expected to give MPs new powers over the final stages of Brexit. The proposals are designed such that in the event of parliament rejecting the final Brexit deal, ministers would have seven days to set out a fresh approach. In the case of talks with the EU breaking down, they would have until 30 November to try to strike a new deal. Rebel MPs also previously demanded that if there was still no deal by 15 February 2019, the government would have had to hand over stewardship of the process to the House of Commons to set its Brexit strategy (though this has not been adopted). In effect, the plan envisaged two years ago that the government (not parliament) would handle the Brexit negotiations has been scuppered. And rightly so.

But the Brexit department issued a statement suggesting “we have not, and will not, agree to the House of Commons binding the government’s hands in the negotiations.” So we are clearly not yet home and dry. Moreover, there is a worrying sense of authoritarianism in that comment because parliament is the people’s representative body: Cutting it out of the loop makes the negotiating process a partisan party-related matter. Theresa May finds herself increasingly under pressure. On the one hand, she has to balance her domestic problems but on the other she has to deal with an EU27 that shows no sign of accepting the UK’s Irish border solutions.

Of course, all sides at present are still playing poker and there will be a considerable amount of give and take along the way. At home, the Brexit camp is beginning to realise that the realities of delivering Brexit on the terms suggested two years ago are not what was envisaged. And as obstinate as Theresa May’s government has proven to be in the Brexit negotiations with the EU27, both sides know that the alternative is a UK government that is much more hard-line – think of Boris Johnson or Michael Gove as PM – which would be even more unpalatable for the EU27. We may be in a desperate situation today but it could be an awful lot worse – believe it or not.

The myopic Mr Trump

European newspapers today lead with the story that Donald Trump has disassociated the US from the communique agreed at the G7 summit in Canada. There did not seem to be anything particularly controversial in the communique which, amongst other things, “acknowledge[s] that free, fair and mutually beneficial trade and investment … are key engines for growth and job creation. We … underline the crucial role of a rules-based international trading system and continue to fight protectionism. We will work together to enforce existing international rules … to foster a truly level playing field.” In short, everything that that the international community has endorsed for the past 70 years.

Then this

 

which is an ad hominem attack on a fellow G7 leader – and a good neighbour to boot.

This, of course, comes after the US imposed tariffs on steel and aluminium imports, which affected Canada and the EU. It follows the unilateral US decision to walk away from the Joint Comprehensive Plan of Action designed to slow the rate at which Iran develops its own nuclear capacity – something by which the EU has set great store. More damage has been done in the last couple of months than at any time since the 1930s to the global order which has underpinned economic prosperity and stability since 1945, as European leaders realise that they can no longer trust a US leadership which puts its own interests first in such a naked way. There is, of course, nothing wrong with putting your own interests first – all nations do. But the way to do it is in the conference hall behind closed doors. In any case, the US has the clout to get its own way most of the time. But capricious decision making, of the kind demonstrated by Trump, destroys trust and it will cause a rethink on the global stage.

It puts the UK in a particularly difficult position. The British government has long believed that it has a special relationship with the US and that it could turn to it for some support in the wake of Brexit (there again, most nations think they have a special relationship). Trump’s actions of late have confirmed what some of us thought all along – the UK cannot rely on the US. I will deal with the ramifications of last week’s Brexit events in my next post but it is now clearer than ever that the UK’s future lies with Europe – for better or worse. The government will thus have to think very carefully about whether and how it wants to loosen ties with the EU at a time when geopolitical threats are rising and the degree of competition from the likes of China are intensifying. This makes Boris Johnson’s recent (leaked) remarks about Trump all the more interesting. “Imagine Trump doing Brexit … He’d go in bloody hard… There’d be all sorts of breakdowns, all sorts of chaos. Everyone would think he’d gone mad. But actually, you might get somewhere. It’s a very, very good thought.”

It’s a very, very bad thought for many reasons. Not the least of which is that the UK does not have the clout of the US. And as Louis Staples put it in The Independent, “What is most worrying here is that Boris seems to admire the chaos that encircles Trump. Suggesting that a man who simply can’t decide whether he wants a summit with North Korea or not, and whose shambolic and widely condemned decision to move the US embassy in Israel to Jerusalem … shows borderline contempt for the wellbeing of UK citizens and those abroad.”

What about the rest of Europe? There has been mounting concern for some time that the US has been throwing its weight around to excess. There is, for example, a lingering grievance that European banks were singled out for transgressions by the US authorities in the wake of the financial crisis and were slapped with heavy fines. There is also concern that the US is increasingly willing to exert its financial muscle by putting pressure on countries using the dollar to process transactions which run via the US financial system, if they fall foul of the US government’s policy objectives. Moreover, the US can impose extraterritorial or “secondary” sanctions by refusing to do business with a company that does business with a blacklisted party. If Europe continues to feel bullied in this way, it can and will do more to encourage the use of the euro as a means of international payment. Also, the inexorable rise of China means that its currency will eventually become part of the global reserve system resulting in a diminution of the dollar’s role (another subject I will deal with at a later date), and with it a reduction in the US’s ability to exert its financial muscle.

 As The Economist put it this week, “In the short term some of Mr Trump’s aims may yet succeed … Yet in the long run his approach will not work. He starts from false premises. He is wrong to think that every winner creates a loser or that a trade deficit signifies a “bad deal”. He is wrong, too, to think that America loses by taking on the costs of global leadership and submitting itself to rules On the contrary, rules help deter aggressors, shape countries’ behaviour [and] safeguard American interests.” In short, all this posturing may help Trump's poll ratings but he will not be the one who has to pick up the pieces when it all goes wrong.

The Swiss Vollgeld proposal

On 10 June, the Swiss electorate will be asked to vote on the question of whether the National Bank will be the only institution allowed to create money within Switzerland (the Vollgeld initiative). This is not a vote sanctioned by the government: It is a so-called people’s initiative which allows any changes to the Swiss constitution to be put to a vote so long as the supporting petition contains 100,000 signatures. Indeed, the government’s official position is to oppose the initiative and in all likelihood it will be rejected by the electorate. But it is nonetheless a subject worthy of debate (if not a vote).

The motivation for the vote is simple enough: Since banking crises throughout history have tended to be propagated by a fractional banking system that creates money as a sizeable multiple of that created by the central monetary authority, stripping banks of their money creation powers will enhance the stability of the financial system. The idea is far from new: Indeed, one of the first intellectually coherent forms of the plan was drawn up in the US in the 1930s (the so-called Chicago Plan). The Chicago Plan envisaged the separation of the monetary and credit functions of the banking system by requiring 100% reserve backing for deposits and by ensuring that the financing of new bank credit can only take place through retained earnings. The Vollgeld initiative applies the same principle.

It is all very radical and the SNB wants nothing to do with the idea. It argues that the Swiss financial system has a proven track record and regulation put in place over recent years has made the system more secure. In its words: “There is no fundamental problem that needs fixing. A radical overhaul of Switzerland’s financial system is inadvisable and would entail major risks.” It also points out that forcing the central bank to be the single issuer of money would erode its independence by subjecting it to undesirable political influences. This arises from the fact that the SNB would have to make a decision about the desired quantity of money in the economy, which will undoubtedly be subject to political influence at times when government wants to curry favour with the electorate. In any case, introducing a Vollgeld experiment in a small open economy such as Switzerland will do little to reduce the risks to a banking sector which operates across a whole range of international jurisdictions.

Whilst the Vollgeld proposal is generally viewed by the mainstream of the economics profession as a left-field idea, it does have some support from sane commentators such as Martin Wolf at the FT. Wolf is not exactly an unbiased observer, having served on the UK’s Independent Commission on Banking back in 2011, which was tasked with making the banking system less vulnerable to shocks that could propagate throughout the rest of the economy. There is a belief in many quarters that the ICB’s recommendations were ignored as governments rushed back to business-as-usual so Wolf’s views may be coloured by this experience. But he has long believed that under the current system, banks have an incentive to cram their balance sheet full of risky assets which ultimately require a public guarantee in the event that the economy turns south. And there is truth in this. As a consequence, banks are now required to have much greater capital buffers than in the past. However, it is one thing to raise capital requirements but another thing entirely to require 100% reserve backing.

For all the advantages associated with curbing the powers of private sector monetary creation – it would after all limit the private sector’s involvement in what is essentially a public good – I  am struggling to get my head around how much money the central bank should be allowed to create. Milton Friedman once advocated a k-percent rule in which “the stock of money [should be] increased at a fixed rate year-in and year-out without any variation in the rate of increase to meet cyclical needs.” In such an instance, it is difficult to avoid the conclusion that a slower rate of credit growth will impose limits on the pace at which living standards will rise. For example, there will be limits on the central bank’s ability to create sufficient credit to match demand for mortgages. And someone will have to make a decision on how to prioritise one category of borrowing over another.

In any case, as the Swiss government points out, banks cannot increase the supply of credit indefinitely. The price of credit in the form of the central bank interest rate acts as a constraint on both demand and supply. Although full deposit coverage of credit creation has not been tried before, the UK experience of limited credit rationing prior to 1971 was not good and was perceived to be one of the factors restraining UK growth compared to other European nations. The real irony in all of this is that Switzerland is one of the world’s most stable economies. As the chart (taken from the FT) indicates, Latin American and Asian nations have taken a big hit in the wake of a credit crunch in recent years – as have the US and UK. But of all the places to justify experimenting with a Vollgeld programme, Switzerland would not be high on the list.