Martin Wolf: Markets teach Theresa May a lesson over Brexit

Politicians propose; markets dispose. Last week began with a statement by Theresa May, the UK prime minister, of her plans for Brexit. The foreign currency markets responded by writing down the value of UK assets. The UK is determined to "take back control" of its fate. But formal sovereignty is not power. The UK government announces its intentions. The reaction of others determines results.

The two speeches made by Mrs May at the Tory party conference last week make a hard Brexit by far the most probable outcome. That is so for both procedural and substantive reasons.

The procedural reason is that she has decided to trigger the European Union’s article 50 exit procedure by no later than March next year. This would give the initiative to the other members and focus the negotiations on a divorce, to be finalised within just two years. Given the complexity of EU decision-making, this is too short for negotiating a bespoke deal.

Norway model

The substantive reason why a hard Brexit is overwhelmingly likely is that the prime minister has also ruled out all but such a bespoke deal. In her words, “We are going to be a fully independent, sovereign country, a country that is no longer part of a political union with supranational institutions that can override national parliaments and courts . . . So it is not going to be a ‘Norway model’. It’s not going to be a ‘Switzerland model’. It is going to be an agreement between an independent, sovereign United Kingdom and the EU.”

The procedure and goal she has outlined would in practice put the country on a timetable to exit not just from the EU, but from the preferential terms of access to EU markets on which investors, both foreign and domestic, rely. This would be a hard Brexit.

Furthermore, UK trade negotiators simply could not negotiate offsetting agreements with the rest of the world. This is partly because no such possibility plausibly exists, since the EU takes almost half the UK’s exports. It is also because the UK will not be deemed a credible negotiating partner until its EU deal is finalised. By March 2019, then, the UK is likely to find itself without preferential access to any markets.

Yet this is far from all. Mrs May also stated that “if you believe you’re a citizen of the world, you’re a citizen of nowhere”. She denied the possibility that one might be both a citizen of the world and a citizen of somewhere.

But many of the skilled foreigners on whom the UK depends view themselves as just that. Why should they wish to stay in a country whose prime minister appears to despise them? Xenophobia was also an important part of the Brexit campaign, whatever Brexiters claim. Does anybody believe such language has no effect on potential workers and investors or, not least, our EU partners?

Devaluation

Unwise words have consequences. The UK government’s extreme goals are now clear. Investors have duly marked down the value of the country’s assets in the simplest way, by selling the pound. The real effective exchange rate is close to where it was in late 2008, immediately after the financial crisis. In dollar terms, stock market indices are lower than before the referendum and also relative to other markets.

Such a devaluation of UK assets was inevitable. It reflects investors’ correct belief that the UK’s economic prospects have worsened. But its poor past export performance suggests that the depreciation is still not big enough to generate the needed shift in the structure of the economy towards production of tradeable goods and services.

Moreover, it is quite likely that today’s huge current-account deficits will be unsustainable post-Brexit. If so, the UK will need a big decline in aggregate spending relative to incomes. The depreciation alone is most unlikely to deliver that. Macroeconomic policy might also need to be tighter. But such a tightening is precisely what the Bank of England and the new treasury team wish desperately to avoid.

True, the inflows of capital needed to finance the UK’s huge external deficit might continue, supported by the perception that the land of the depreciated pound had at last become a bargain. But suppose the inflows ceased, instead, as investors became ever more nervous about the path the government had chosen.

Then the currency might collapse. Yields on gilts might also jump. Policymakers could face a predicament familiar to emerging economies that lose the confidence of investors: the need to raise interest rates and close fiscal deficits during a crisis. Is this likely? No. Is the government’s loose talk making it rather more likely? Yes.

The government would then learn the limits of sovereignty in an open economy. The views of Philip Hammond, chancellor of the exchequer, who reminded his party last week that the British people did not vote on June 23rd "to become poorer, or less secure", might then count for more, and those of the Brexiters in the cabinet for less.

The unthinkable

In a crisis, the unthinkable becomes thinkable. Triggering article 50 without parliamentary approval might be impossible. It surely ought to be impossible. By a thin margin the country voted for some kind of Brexit.

But the government has no mandate for the rather extreme version it is choosing. Moreover, Brexiters insist that their goal is to restore parliamentary sovereignty. Why then does the government plan to ignore parliament when these decisions are taken?

What drove Leavers was, we are also told, “ the principle that decisions about the UK should be taken in the UK”. The currency markets demonstrate the emptiness of that principle.

Britain’s EU partners are about to do the same. The premise of the Leave campaign was false: a host of decisions that affect the UK will always be taken outside it. But this truth is unlikely to stop the train towards a complete Brexit from departing on its timetabled journey.

Stopping it would take a miracle, or rather a crisis. Is that likely? No. Is it possible? Yes. – (Copyright The Financial Times Limited 2016)