The “Brexit” referendum is already turning out to be more toxic than many people would have thought, and that’s before we even know the result.
Britain is surrendering the ace it had in the global (or at least the European) poker game and it is doing so without realising it. That ace is the ability to project a good image.
If you think about it, the UK’s image in the European Union, and especially in the “young” democracies in the East, as some analysts like to call them, is much better than it should be based strictly on historic facts (let alone the current wave of anti-Eastern European sentiment in the UK).
Britain ended World War II by promising to give Eastern Europe to Stalin — for a refresher on that, read up on the percentages agreement between Churchill and Stalin in Yalta and check out this fascinating picture of the note scribbled by Churchill, in which he proposes how much influence the two countries should have in the region. Stalin’s contribution was the thick check mark.
(In his Memoirs, Churchill says he immediately regretted the note, fearing that history will judge the two men as callous, and asked Stalin to agree to tear it up; Stalin just laughed at the request).
Stalin’s crimes and the oppression that followed in the region are well documented. The fact that the UK enjoys such a favourable image in Eastern Europe nowadays, without ever uttering a word of regret for that agreement, is a remarkable achievement of its diplomacy and foreign policy.
It also means the UK has sometimes benefited from the support of Eastern European states in matters dealing with EU policy. It may sound unimportant, but such support can be very significant when trying to win policy or security concessions.
The UK has also by and large enjoyed a good image in Western Europe as well, despite the sometimes open disdain expressed in the British press for the countries on the continent. The waves of political goodwill from abroad have manifested themselves in positive investor sentiment for the UK as well.
However, ever since talk about leaving the European Union has grown louder in Britain and the polls are showing that many in the electorate are inclined to turn their back on the EU, this positive image has slowly been eroding.
What this means is that investors will be more likely to look carefully at the UK’s weaknesses than they were before. The thing with momentum is that, when it turns, it tends to swing the other way quite abruptly.
For a long time, Britain has enjoyed inflows of money into stocks, property and bonds from foreign investors who weren’t too worried about the risks that the UK economy was facing; but now they are likely to look at it more closely and possibly reassess their position.
The most obvious weakness is the current account deficit, which hit levels of around 7% of GDP last year, more appropriate for a fast-growing developing economy than for a developed, stable one.
The gap is only threatening to get wider, if we judge by the latest trade data, which show that in the first quarter the UK’s trade deficit was the widest since the recession started in 2008.
This puts sterling at risk. It has already depreciated markedly to the dollar and the euro. Balance of payment shortfalls have had the nasty habit of resolving themselves via currency crises.
Another worrying shortfall is that of the budget. Far from managing to head down towards some sort of balance, last year the fiscal deficit was 5.7% of GDP. Again, a gap more suited to an emerging market.
In fact, the UK has spent the last seven years in the EU’s Excessive Deficit Procedure, destined for countries that have breached the 3% of GDP limit considered to be prudent fiscal management. This is not something that policymakers in the UK like to openly advertise.
Some British analysts point out that because Britain has its own currency rather than being part of the eurozone, the Bank of England can (again) jump to the rescue by buying the debt, in effect monetising the deficit.
For sure it can, and it probably will, judging by its record. However, an old enemy will almost certainly make a surprise comeback: inflation. It has for a long time manifested itself in the housing sector and been duly ignored by the Bank of England, which together with the government has preferred to feed the fire of house price rises.
It is also why demand has been so weak after the recession: people who are forced to pay more and more for housing see their disposable income diminishing, therefore are unable to consume as much as they should to boost the economy.
This time, UK consumers will see the double-whammy of both higher rents and higher consumer goods prices. Energy, food and clothing prices are going to rise for sure, as a lot of those are imported and the pound’s weakness is already putting pressure on prices, not to mention the fact that oil prices have bottomed.
If everything else had been ticking nicely along, there might have been a chance that investors would ignore these weaknesses. As it is, with the approach of the ‘Brexit’ referendum dialling up the jitters in the markets, they are likely to look at them with a magnifying glass instead.