Dear Pound Sterling Investors, Keep Calm and Carry On

The pound fell to a 30-year low against the dollar on Monday, after British Prime Minister Theresa May said she had no intention of keeping “bits of membership of the EU” after Brexit.

The comment was widely interpreted as meaning that Britain would leave the European Single Market as part of Brexit negotiations, and the pound’s sharp fall suggests investors see this as an economic blunder.

However, while the British electorate voted for Brexit in June 2016, nothing has actually changed yet. What’s more, the British economy has consistently defied expert predictions of post-referendum gloom — services, manufacturing, and construction sectors are all growing strongly, and the benchmark FTSE-100 share index is hitting record highs.

In light of this, currency speculators’ pessimism seems somewhat premature. The unhappy Brexit their sterling sell-off implies is certainly a possibility, but it’s not the most likely one. So let’s step back and look at how things might play out over the months and years ahead.

The British government is awaiting a Supreme Court decision on whether it can unilaterally trigger Article 50 — the legislative clause formally signaling Britain’s intention to leave the EU, which would begin the two-year period of UK-EU negotiation — or whether parliament must have a vote. The Court is expected to rule in favor of a parliamentary vote sometime in January. Continue reading

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Financial Deregulation? Don’t Bank on Brexit

On June 23, Britain voted by a margin of 52 to 48 percent to leave the European Union (EU). Much ink has already been spilled on the policy implications of that vote and, indeed, its long-run consequences may prove quite profound. When it comes to financial regulation, however, it is difficult to see any significant changes emerging in the short- to medium-term. There are a couple of fundamental reasons for this.

The first stems from the fact that the British financial sector is desperate to maintain its current access to the European Economic Area (EEA), also known as the “single market.” As things stand, a process known as “passporting” allows British financial firms to do business throughout the single market, whether on a cross-border basis or by establishing branches, without having to get separate regulatory approval in every jurisdiction. This arrangement is important to the industry and — given that financial services produce 8 percent of the UK’s output — the British government is likely to make its continuation after Brexit a priority.

But how can they bring that about? The most straightforward path is for Britain to leave the EU, but remain a member of the EEA. This approach, often referred to as the “Norway option,” would see Britain exit the EU’s centralized political institutions, while still participating fully in its “four freedoms” — that is, the free movement of goods, services, capital, and people. There is much to commend such a settlement, as I’ve written before. But if it did come to pass, Britain’s financial sector would clearly be subject to EU rules in much the same way as it is now.

There’s also a political problem with EEA membership: namely, it wouldn’t allow the British government to pursue its stated aim of controlling immigration from the EU. That suggests that the obvious alternative — a bilateral, post-Brexit trade treaty — might be the more likely outcome of Britain’s eventual withdrawal. Such a treaty could, theoretically, protect the British financial sector’s passporting rights. However, the quid pro quo for market access of that sort would undoubtedly be regulatory equivalence — that is, the European Commission would have to deem British regulation equivalent to EU rules before any passporting could take place. The handful of existing EU directives that provide “third country” financial firms access to the single market work in precisely this way. Ultimately, then, there are unlikely to be any major reforms to British financial regulation so long as the British financial services industry maintains access to the single market. Continue reading

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What’s at Stake in Britain’s EU Referendum?

On Thursday, Britain will vote on whether or not to leave the European Union (EU). As things stand, the race is too close to call: a week ago, “Leave” were surging in the polls; this week, things have swung back towards “Remain.” But neither side has managed to build a lead beyond the pollsters’ margin for error, and veteran political campaigners suggest it will all come down to turnout. So what is really at stake as Britons submit their “Brexit” ballot papers?

To me, the case for Brexit is rooted in the idea of self-government, and the democratic accountability that goes along with that. The question facing British voters is, fundamentally, whether their parliament should be sovereign and their laws supreme, or whether such powers should continue to be pooled at the European level.

In other words, this is a constitutional referendum. It is not a choice between rival political platforms, or between rival sets of politicians; nor, indeed, does the result of the referendum have any immediate legal consequences. Rather, this is an opportunity for British voters to decide how they should be governed in future. Once the result is in, it will be up to the British government, and to parliament, to determine policy going forward.

This point is important, because it undercuts a lot of the fears people have about Britain leaving the EU. There is no denying, for example, that the Leave campaign has taken some unsavory positions on immigration, and promised unrealistic “bread and circuses” once Britain leaves the EU. But Leave are, emphatically, not a government in waiting.

Then there’s the government-backed Remain campaign, who have scarcely let an opportunity to scaremonger about the economic consequences of Brexit pass them by. From their increasingly shrill and outlandish claims, you would think that a vote for Brexit meant surrounding Britain with naval mines and never letting anything—whether goods, services, capital, or people—cross the border again. Continue reading

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Cato Journal: Revisiting Three Intellectual Pillars of Monetary Wisdom

A new issue of the Cato Journal, which collects the proceedings of last year’s Annual Monetary Conference, was released last week.  Those proceedings include a paper by Claudio Borio, head of the Bank for International Settlement’s monetary and economic department, which Alt-M readers may find particularly interesting. Continue reading

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Competition in (British) Banking

Writing for FT.com’s “The Exchange” blog, economists Diane Coyle and Jonathan Haskel suggest that Britain’s regulators — namely, the Competition and Markets Authority and the Bank of England — have got it wrong on competition in banking.  The authors argue that “the CMA and the BoE” have overlooked “the ruinous effect on competition of the ‘too big to fail’ subsidy” in their recent reports and policy announcements, and that, if anything, it is becoming “harder than ever for new entrants to gain a foothold” in the banking market.

In my view, Coyle and Haskel are right, but their argument doesn’t go far enough.

Let’s start with the basics: what is the too-big-to-fail subsidy, and how does it affect competition in banking?  The fundamental idea is that the bigger a bank is, the more likely it is to be bailed out if it runs into trouble.  The events of the 2008 financial crisis seem to confirm this, as do the assumptions of government assistance that some rating agencies build into their “support” ratings.  And as the 2011 report of Britain’s Independent Commission on Banking points out:

If one bank is seen as more likely to receive government support than another this will give it an unwarranted competitive advantage.  As creditors are assumed to be less likely to take losses, the bank will be able to fund itself more cheaply and so will have a lower cost base than its rival for a reason nothing to do with superior underlying efficiency.

The result is that small banks struggle to compete against larger rivals, while market entrants have difficulty establishing themselves against privileged incumbents.  All of this makes the banking sector less dynamic — and more comprehensively dominated by large, established firms — than it might otherwise be.

As Coyle and Haskel see it, however, Britain’s CMA thinks the problem has already been solved: that the competitive playing field has been leveled by the Bank of England’s proposed “systemic risk buffer,” according to which larger banks must hold more equity capital against their risk-weighted assets than smaller competitors.  In consequence, the CMA’s October 2015 provisional report on Britain’s retail banking market mostly ignored the too-big-to-fail problem, focusing instead on the rather more mundane question of how consumers can be encouraged to switch bank accounts more often.

Yet the CMA’s position is mistaken, say Coyle and Haskel, for three reasons.  First, switching bank accounts doesn’t always make sense for consumers: in the UK, at least, one bank account is pretty much the same as another, so consumers’ status quo bias is often quite rational.  Second, the level of additional capital big banks must hold as a systemic risk buffer is not high enough to outweigh the funding benefits that accrue from being too-big-to-fail.  Third, the stepped schedule of systemic risk buffer requirements outlined by the Bank of England might make big banks less likely to compete with each other, by effectively creating high marginal tax rates when banks move from one “systemic risk buffer” tier to another.  As Coyle and Haskel say, “This might restrain the emergence of gargantuan banks, but the purpose of competition is to promote rivalry, not hold up expansion at arbitrary regulator-determined thresholds.”

So far, so good.  But there’s a bigger picture here that Coyle and Haskel don’t see, or at least fail to mention.  For one thing, it isn’t just lower funding costs that make too-big-to-fail such an anti-competitive doctrine.  In fact, the very act of bailing out a failing institution itself constitutes a powerful strike against market competition.  As Europe Economics’ Andrew Lilico has put it, “company failure is an essential and ineliminable part of the competition process.  One of the most important obstacles to new entry in the banking sector, impeding competition, is that failing banks are saved by the government.”  If you want smaller banks to grow, and new banks to prosper, in other words, you can’t keep saving their bigger rivals from the consequences of bad investments.

More important still are the grounds upon which banks compete.  And it’s here that our financial regulatory authorities have the most to answer for.  Yes—of course—banks should compete with one another to provide the best possible service at the best possible price.  In an ideal world, however, banks would compete on something else as well: namely, their safety, stability, and reliability.  That banks do not tend to compete on these grounds today is testament to the fact that their depositors, bondholders, and shareholders do not see the need to pay attention to such things.  “Regulatory badging,” that illusory sense that banks must be safe because they are subject to regulators’ oversight, means that people seldom ask how highly-leveraged their banks really are.  Deposit insurance means they might not care about the answer, even if they ask the question.  And too-big-to-fail compounds the problem: if your bank is going to be bailed out, why worry about its risk profile?  No amount of regulatory oversight can compensate for this loss of competitive market discipline.

Ultimately, then, Coyle and Haskel are right to stress the importance of competition: if financial stability is the goal, then competition must be central to any banking reform agenda worthy of the name.  But before regulators can be part of the solution, they must understand the ways in which they are part of the problem.  And that, alas, has yet to happen.

Originally published at Alt-M.org.

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Obama v. Brexit

http://www.cato.org/longtail-iframe/node/64040/field_longtail_player/0

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The Battle Lines over “Brexit”

http://www.cato.org/longtail-iframe/node/63486/field_longtail_player/0

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