Friday 2 August 2019

The bullish case for Brexit and a new investment led economic cycle

Most forecasts for the impact of Brexit are negative. Since its never happened before the process seems to be to identify disruption factors, link them to an assumed GDP impact and conclude that in all scenarios Brexit leads to some level of a worse outcome.

While I accept its difficult for statistical analyses to take into account positive events that could happen in the future, the fact is we run a £100bn a year goods trade deficit principally with 4 or 5 countries (China and EU countries) and that means there is about 1 million or so high quality manufacturing jobs sitting abroad that should be here, leading to lower direct taxes, higher government deficits and further second round effects.

The UK (and US) post-1997 (the Asian mercantilist era) economic framework of gutted manufacturing and double deficits is simply not sustainable or optimal and we have seen the election of Trump and Brexit as the political mandate to change it.

Per the BoE, Inflation Report, the consumer, business investment and exports have all been subdued for several years in particular since the 2015 Brexit Referendum Act.
I don’t see a reason for the consumer to lever up.

Business investment in particular has really lagged, with companies preferring high margins on exports rather than increased export volume and that is one reason why the trade deficit hasn’t rebalanced much despite Sterling weakness since 2016. Per the chart below, business investment could bounce 40% or so vs. previous economic cycles.

The tightening of the labour market and rising wages is also causing companies to focus on using capital over labour to boost output, which again supports investment.

They have long term growth potential at 1.4% vs 2.9% pre-GFC. The two main dragging factors are capital and productivity. So a rebound in investment should boost growth potential.

I have long argued that MAGA/ Trumponomics involves: higher wages; forcing higher investment; leading to higher productivity; improved trade balances and higher interest rates/ discount rates over time, plus zombie companies going bust. 

Also that fiscal deficits and low real rates can be used to transition from the credit led economic cycles seen since the early 1980s to a new wage/ inflation/ investment cycle, without having a meaningful recession in the middle

So UK government fiscal stimulus combined with the Brexit windfall discussed above, would lead to a pick-up in investment, productivity, exports, wage growth, inflation etc.

If that happens, the MPC expect rate hikes to be likely over the next two years, but for rates to still be much lower than nominal GDP.
(For the sake of clarity this article discusses what may happen in 2020-2022, not in the rest of 2019, as I think the economy will deteriorate into Sept/ Oct. I also think a base rate cut to 50bps is quite likely if we have a hard Brexit at the end of October. ).


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