Brexit: Epater les Eurogarchs

britain brexit

Confounding all elite prognostication (more on this aspect below), British voters repudiated their self-anointed better-thans and voted to leave the EU.

Market reaction was swift and brutal. The pound sold off dramatically, as did UK stocks. Interestingly, though, Continental stock markets fell substantially more. Bank stocks took the brunt. Volatility indices spiked. Oil was down modestly.

These reactions were not due, in my view, to the direct effect of a British exit from the EU, via conventional channels (e.g., increased costs of trade resulting in inefficiencies and a decline in productivity due to failure to exploit comparative advantage, resulting in a decline in incomes). Instead, they reflect a substantial increase in risk, and in particular geopolitical risk. The unexpected result increases substantially the odds of a falling apart of the EU–or at the very least, of it losing quite a few of its parts. That’s why German, French, and Dutch markets sold off more than the UK.

I was in Denmark last month, speaking to shipowners. Several said that if the UK were to leave the EU, Denmark is likely to go as well: since Denmark is not on the Euro, it is easier for it to leave than Eurozone nations, and the Danes have had their fill of European immigration policy, among other things.

But there is now talk of core countries–including France–leaving. What’s more, the Brexit vote demonstrates the depth and intensity of populist, nationalist sentiment, something the elites had convinced themselves was a marginal force that could be contained by insulting it as racist and isolationist. That was tried in the UK, and failed spectacularly. Now everyone should be on notice that the smug, supercilious, and superior are sitting on a caldera.

It is this fear that the British departure creates a bad precedent that is leading some European leaders to advocate a punitive approach to negotiations with Britain. As a one-off, this makes no sense: a battle of trade barriers and regulations and red tape would harm continentals too. But if the Euros view this as a repeated game, punishment of the British to deter others from getting any notions in their heads about following their lead has some appeal.

But this is a finite game: there are only so many countries in Europe. The Euro threats make sense as a rational strategy only if there is some appreciably probability that the leadership is viewed as crazy, and will punish even when that is self-harming. Come to think of it . . .

As for the immediate effects, Brexit has the biggest potential to cause disruptions and inefficiencies in the financial sector, because of London’s dominance. Clearing is one example. How will LCH fit into the fragmented regulatory landscape? Recall the tortuous negotiations between the US and EU over recognizing each other’s CCPs. Will that have to be repeated between the UK and the EU, and under the clouds of recrimination and punishment strategies? As another example, MiFID II is scheduled to go into effect before Britain leaves. Will it be implemented, then changed? Post-exit British firms will no longer be subject to the regulatory and judicial bodies in charge of enforcing these regulations: how will they fill that breach?

Regardless of the specifics, there will inevitably be greater regulatory and legal fragmentation, and this will increase complexity and cost. But it also creates opportunities. The UK can now engage in regulatory competition with the EU (and the US), which is a different thing altogether from trying to influence regulatory policy from inside the tent (which Cameron attempted with a notable lack of success). This is constrained to some degree by supranational regulation (e.g., Basel), but London prospered quite well as a financial center post-War, pre-EU by offering regulatory advantages over the US and European countries. (Remember Eurodollars!) (One specific thought: would the UK proceed with something as inane and costly as the MiFID commodity position limits? Or applying CRD IV capital requirements on commodity traders? Since these initiatives were driven by the continentals, I seriously doubt it.)

This is all very complicated, and will be played out in the context of a larger game between Britain and the EU (and between the EU and individual EU countries). Hence the outcome is wholly unpredictable. But having Britain as an independent player will change dramatically the regulatory game. The greater competition is likely to result in less regulation, and crucially less stupid regulation. Further, even to the extent that one jurisdiction insists on stupid regulations (with the EU being the odds-on favorite here), the existence of competing jurisdictions means that many will be able to escape the stupidity.

As for the broader political lesson here, it is a decisive repudiation of a self-satisfied soi disant elite by the great unwashed. The EU has been neuralgic about democracy since its inception, and Brexit shows you exactly why their fears of it are justified. The people have spoken. The bastards. And the Euros will try mightily to make sure that never ever happens again.

There’s been a lot of commentary along these lines. Gerard Baker’s piece in the WSJ is probably the best I’ve read. This piece also from the WSJ is pretty good too.

This is a global phenomenon: the Trump insurgency in the US is another example. What is most disturbing–and most revealing–about the reaction of the elites to these outbursts of popular opposition to their direction and instruction is their lack of self-examination and humility, and their immediate resort to scorn and insult directed at those who had the temerity to defy them. Immediately after the results were clear, those voting leave were tarred as old/white/stupid/poor/uneducated/racist.

Totally lacking was the question: “If argument and evidence are so clearly on our side, why did we fail so miserably in convincing people of the obvious?” To these self-perceived elites, their superiority is self-evident and any opposition can only be attributed to mental defect or bad faith.

Not only is this superficial and immature–nay, juvenile and narcissistic–it is amazingly self-destructive. You were rejected because it was widely believed–with good reason–that you were aloof, condescending, and lacking in understanding of and empathy for the concerns of millions of people not of your social set. What better way to cement that reputation than by proceeding to piss all over those people? You think that will help them get their minds right, and vote for you next time? Think that, and you truly are delusional.

And mark well: this elite condescension is not heard just in the Midlands, but it comes through loud and clear in France, Germany, the Netherlands, and other countries in Europe. Consequently, this reaction actually increases the odds of an EU crisis. Those who refuse to respond constructively and thoughtfully to adverse feedback are likely to see things get worse, rather than better.

This condescension also helps explain the surprise at the Brexit outcome. So convinced of their virtue and intelligence, the Remain side could not comprehend that large numbers of people could take the opposite side. Secure in their bubble, talking only to one another, they had no idea of what was going on outside it. The Pauline Kael effect, with a British accent.

Further, the concerted effort in the establishment media to malign the Leavers succeeded in silencing many of them–but not in changing their minds. (Most disturbingly, the Remain side took strange comfort in the murder of Jo Cox.) They were bludgeoned into stubborn silence, which lulled the establishment into believing that the opposition was marginal and marginalized: this helps explain the pre-vote 90 percent betting odds on Remain, with the betting being dominated by those inside the bubble. But the silent bided their time and exacted their revenge.

Payback, as they say, is a bitch. But are the elites learning from this lesson? The first indications are negative.

The EU epitomizes what Thomas Sowell referred to as the Vision of the Anointed. This review summarizes the book of that title well, and although Sowell focuses on the US, what he said applies in spades to the EU, and Europhiles:

In The Vision of the Anointed, the distinguished economist and social theorist Thomas Sowell makes an important contribution to classical-liberal and conservative thought by scrutinizing the ways in which a self-consciously elite, or “anointed,” group uses ideas to maintain its power in American political life. Sowell regards American political discourse as dominated by people who are sure that they know what is good for society and who think that the good must be attained by expanded government action. This modern-liberal elite exerts its influence through institutions that live by words: the universities and public schools, the media, the liberal clergy, the bar and bench. Its dominance results from its command of the information that words convey and the attitudes that words inspire.

People who live by words should live also by arguments, butas Sowell richly documentsthe modern-liberal elite is not so good at arguing as it is at finding substitutes for argument. Sowell analyzes the major substitutes. Suppose that you doubt the necessity or usefulness of some great new government program. You may first be presented with a quantity of decontextualized “facts” and abused statistics, all indicating the existence of a “crisis” that only government can resolve. If you are not converted by this show of evidence, an attempt will probably be made to shift the viewpoint: outsiders may doubt that there is a crisis of, say, homelessness, but “spokesmen for the homeless” purportedly have no doubts.

. . . .

If even these methods fail to win you over, attention will be redirected from the political issue to your own failure of imagination or morality. It will be insinuated that people like you are simplistic or perversely opposed to change, lacking in compassion and allied with the “forces of greed.” (As Sowell observes, it is always the payers rather than the spenders of taxes who are considered vulnerable to the charge of greed.) [Emphasis added.]

The Anointed are a self-identified elite. They think that elite is a synonym for “meritorious,” “intelligent,” “wise,” or “morally superior.” But “elite” refers first and foremost to a place in a hierarchy, and the merit, intelligence, wisdom, and morality of those at the top of a hierarchy depends on the system. Hayek noted over 70 years ago that in a statist, crypto-socialist system the worst get to the top, i.e., the elite is a collection of the worst. The Eurogarchy shows just how right Hayek was.

For all the paeans sung to it, the EU has become far more than a means of reducing barriers to the flow of goods, capital, and people: that could have been accomplished with something as simple as the commerce clause to the US Constitution. Instead, the Anointed have constructed a vast hyper-state that controls and regulates every aspect of commercial activity, and much beyond. Cost raising and incentive sapping explicit restrictions on trade and investment across historical borders have been replaced by border-spanning onerous and minute regulations that raise costs and dull incentives: innovation has been especially hard hit. Moribund growth in the post-crisis EU should raise questions, but the Eurogarchs plunge ahead with their vast regulatory schemes.

I would approve of a supra-national organization that reduced the impediments to individuals consummating mutually beneficial bargains and exchanges. But that is not what the EU is. It is a dirigiste organization predicated on the belief that a technocratic elite knows better, and can direct and guide far more effectively than the invisible hand. Although its demise could lead to something worse, there are definitely better alternatives. Hence, the discomfort of the EU worshippers is music to my ears.

European leaders–Merkel most notably–are fond of saying “More Europe,” meaning more centralization and more suppression of local control. If they want Europe to survive as a political entity, they need to reverse their mantra to “Less Europe.” They need to reverse the creation of a hyper-state. They need to be more respectful of local, national sentiments and differences. Brexit shows that if they fail to do so, they are running the serious risk of having no “Europe” at all.

Are they heeding the lesson? Early signs suggest no. So be it. They are reaping what they sowed, and if they decide to sow more, so shall they reap.

About Craig Pirrong 223 Articles

Affiliation: University of Houston

Dr Pirrong is Professor of Finance, and Energy Markets Director for the Global Energy Management Institute at the Bauer College of Business of the University of Houston. He was previously Watson Family Professor of Commodity and Financial Risk Management at Oklahoma State University, and a faculty member at the University of Michigan, the University of Chicago, and Washington University.

Professor Pirrong's research focuses on the organization of financial exchanges, derivatives clearing, competition between exchanges, commodity markets, derivatives market manipulation, the relation between market fundamentals and commodity price dynamics, and the implications of this relation for the pricing of commodity derivatives. He has published 30 articles in professional publications, is the author of three books, and has consulted widely, primarily on commodity and market manipulation-related issues.

He holds a Ph.D. in business economics from the University of Chicago.

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