Streetwise Professor

June 25, 2016

Brexit: Epater les Eurogarchs

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.

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  1. As the people slowly realize that such things as the EU, slowly but surely, reduce the sovereignty of the nation members, these organizations will become less desirable and the collapse of the organizations will accelerate. Sovereignty is a prized possession, and will be proteected by the holders!

    Comment by Donald Edwin Michel — June 25, 2016 @ 1:45 pm

  2. Great post. I feel like Friday had people thinking it was like Fall 2008 or something. I’m far from convinced that there will be a negative long-term economic impact from Brexit. It seems very silly for the EU to try to take a very negative attitude in future trade negotiations with the U.K. For instance, Ireland and Netherlands have very strong trade ties with the UK. They would be immensely hurt if the status quo is changed significantly. Moreover, Scotland is increasingly likely to exit the UK after the vote. Trade and financial connections are too strong for the EU to take an overly negative attitude in negotiations. If anything, Scotland as EU member would probably mean a more favorable result from trade negotiations for the UK. The downside is that I think these negotiations will take an extended period of time. Of course, while the UK technically remains a part of the EU, trade agreements are in place. But I suspect that markets will move strongly at any hint of changes.

    Comment by John Hall — June 25, 2016 @ 8:27 pm

  3. Yet another decomposition of civilization started by rotting of the elites. Has happened before, will happen again. The barbarians are at the gate and will repurpose the Forum for a corral, ensuring optimal use of scarce resources. Move along, nothing to see here for the duration of the Dark Ages.

    Comment by Ivan — June 26, 2016 @ 2:58 am

  4. I recall first learning of the Mandate from Heaven in fifth grade. The supporters of Remain (and associated policies) appear not to have.

    Comment by FTR — June 26, 2016 @ 8:56 am

  5. Despite not recognizing at least one word per paragraph (this may be a tell for being non-elite and self-admission) it was well worth the read.

    Although more caustic in his opinion, Mike Sheuer’s blog echoes of the same warnings: “These hubristic elites just knew that the citizens they despise would never reach out to either depose them and their ways, or to simply choke them to death. Well, it happened last Thursday – peacefully this time – and so the very well-educated elites are scrambling in shock over the power of men and nations to want liberty, tradition, and history on their own terms, and not on the terms of those who see the world as their exclusive possession and who have so thoroughly cocked it up” (

    Comment by Dizzy — June 26, 2016 @ 11:05 am

  6. I’m strugglinb to see how Scotland stays in the EU. Either Scotland stays in Britain and Britain leaves the EU or Scotland leaves Britain menainbg she’s left rhe country that had the EU membership. As was established in 2014 Scotland wouldn’t be allowed to use the pound and is also constructively insolvent because its economy barely breaks even when oil’s at $115.

    Personally I’d love to Scotland go, Scotland is Britain’s very own Greece. I would laugh if the only part of the UK that stayed in the EU was Scotland. The EU would then have two Greeces.

    Comment by Green As Grass — June 27, 2016 @ 2:31 am

  7. Why does everybody see the EU as this huge evil beast? Yes, it does cost money. Yes, they do make some stupid laws (though they are trying to improve this). But the value of the co-ordination it provides is plain to see: Just look at how some countries who were quite poor on joining (such as the UK!) have become wealthy as part of the EU.

    As for the campaign of fear that everybody accuses the Remain campaign of running: They may turn out to be right – we will see what happens next. Contrary to much opinion, I doubt the EU will seek to punish the UK. They’ll offer up the Norway deal and the UK can then take it or leave it. They will surely leave it, since to accept it would go against the spirit of the referendum result in an untenable way (Norway accepts free movement of labour, accepts almost all EU regulations and contributes 85% as much to the EU budget as the UK does – the victorious Brexiteers will certainly not want this).

    So that leaves WTO-rules trade (with tariffs – surely a huge economic blow (e.g. auto industry)) or to negotiate the sort of free-trade deal that the EU has with countries like South Korea. I’d really like to hear the Prof’s opinion on how the Korean deal compares with the Norwegian deal.

    PS – The EU is undemocratic for sure, so maybe some good will come from Brexit in the form of a less dictatorial EU… But I fear that the Prof is right that they will not. Then they will have the same result elsewhere until they learn that the pitchforks will eventually win…

    PPS – Scotland is hardly Greece. The Greeks chose to abandon notions of organised society by not paying any tax at all and having an economy based on little more than rent-seeking. An independent Scotland would suffer economically for sure, but they have not abandoned their society’s interests wholesale, and could enact useful reform through a decent civil service that they would inherit from the UK.

    Comment by Hiberno Frog — June 27, 2016 @ 7:18 am

  8. @ Hiberno Frog

    Net, Scotland is a tax taker. Only two regions of the UK are net payers of tax: London and the south-east. Scotland would be running something like a £14 billion deficit the day of departure. Expressed in USD and adjusted per capita, this is like the USA running a deficit of $1.1 trillion. The USA probably could afford that for a while, because it has industries and a diversified economy. Scotland basically has a dwindling oil and gas sector, several world-class universities, and that’s it. Everything else is public sector. Reportedly only 3% of Scots are net taxpayers; the other 97% are net takers.

    The issue with the EU is that Britain joined the EEC, which became the EC, which became the EU. At no point was the electorate consulted on whether it wanted to be carried along in all this. At every election since 1983 both main parties have been pro-EU; that’s not a choice. What is noticeable is that at elections that don’t matter, such as the European Parliament elections, where it is safe for voters to send a signal, they have been doing so. The UK has been sending more and more separatist MEPs to that assembly to the point where in the last round of eelctions the biggest UK contingent was UKIP, the party that wants to secede. That was a whole field of straws in the wind.

    What you have described is the EEC. Most Britons would be perfectly happy to be in that. Unfortunately it’s not on offer.

    If the EU is not thoroughly thoroughly vengeful and nasty toward a seceding Britain, it risks Swexit, Spexit, Hexit, Dexit, and even Frexit. So it’s going to be ugly.

    It’s possible it may not happen. Parliament needs to pass a motion to notify under Article 50. That may be a hard vote to win as there are only a handful of MPs who are actually Leavers. But that starts to look like a coup d’etat by the establishment against the people.

    Comment by Green As Grass — June 27, 2016 @ 9:03 am

  9. Juat to add that in the wake of Swexit, Spexit, Hexit, Dexit, and Frexit (and I forgot Nexit), you’d likely have the makings of a new EEC – a rival to the EU based on its own founding principles. That’s an existential threat the EU cannot afford to allow to develop.

    Comment by Green As Grass — June 27, 2016 @ 9:06 am

  10. I am optimistic that there will be little disruption in the financial centre. The key to clearing recognition is adherence to supranational principles and these are implemented at a jurisdictional level. There is a reason that European central banks continue to exist notwithstanding a common currency. Agreements between European clearing houses (and their regulators) with LCH (and its U.K. regulators) should be unaffected.

    Comment by noir — June 27, 2016 @ 9:56 am

  11. This is the best article on Brexit I have read so far

    Comment by Aynuck — June 28, 2016 @ 1:00 am

  12. The EEC is just the EU, minus control. For the UK to swap being in the EU for being in the EEC would suggest stupidity. It would have to accept immigration from the EU on the same terms as now. Also, if we are happy that ‘the elites’ have nothing to do with leaving the EU, will you apportion responsibility for the negative outcomes of leaving the EU on the true culprits?

    Comment by Person_XYZ — June 28, 2016 @ 1:08 am

  13. The reason the London stock exchange sold off less than the European exchanges is because most large UK companies generate the bulk of their profits in €s and $s. The right way to think about their value is, therefore, in €s and $s and if you did that you’d find that the plunge has been larger than for continental European companies.

    Comment by Tom DW — June 28, 2016 @ 1:32 am

  14. The main problem with the EU is the euro. The single currency demands ever further integration – can’t have monetary union without fiscal and politcal union. The problem is that none of the people – not in Germany, not in France, Italy, Spain, etc – actually want more power handed to the EU. This is a massive problem and there is no solution. Any referendum in any country on more integration will fail. But you cant have a single currency without it – the current absence of transfer payments (no political union) coupled with inability to devalue (single currency) is destroying the periphery. Since you can’t unravel the euro (can you?), and since there is no democratic mandate for political union, the elites will force the unioin against the will of the people. The ECB is already on this path. And then there will be trouble. And possibly blood on the street.

    Comment by exBanker — June 28, 2016 @ 2:57 am

  15. The UK has always been the annoying member of the EU, negotiating exceptions and slowing down stuff.
    It also has a social model closer to the US one, while continental Europe, including Denmark and France, have more emphasis on a social model.
    Europe without the UK is now more coherent from a political perspective.
    The debate about France leaving the EU doesn’t really exist.
    the UK will move its own way, probably getting closer to the US, and Europe will move its own way too.

    Comment by lbc — June 28, 2016 @ 8:01 am

  16. @exBanker “can’t have monetary union without fiscal and politcal union” – I know the arguments as to why you may want to have fiscal union, but I’m a bit puzzled about the “can’t have”. There was no fiscal union when there was de facto bimetallic monetary union. “Can’t have governments living beyond their means” maybe?

    Comment by Ivan — June 28, 2016 @ 12:21 pm

  17. As soon as one reads that the british stock exchange crashed less than its european counterparts (neglecting the additional GBP dive) it’s obvious that we are reading the 1000th version of the “dense fog in the channel / europe isolated” story. Precious time it saved me

    Comment by Buiça — June 28, 2016 @ 12:36 pm

  18. @Ivan @exBanker-It’s all about bailouts and the doom loop between banks and governments. When the EU bails out–or there is even a perception that that the EU will bail out–countries facing fiscal crises (perhaps due to banking crises in those countries) a moral hazard is created. Governments with shaky finances then have an incentive to spend/no incentive to impose austerity measures. So whenever there is an explicit or implicit guarantee the inexorable logic of moral hazard leads those who are providing the bailout/insurance to demand that individual governments be stripped of their fiscal sovereignty.

    The US was able to allow states to have considerable fiscal independence in the 19th and early-20th centuries because there was no way the federal government was going to bail them out.

    The demand for political union is the result of never step back logic. Rather than re-thinking the advisability of bailouts, the elimination of which would make political union unnecessary, they plunge ahead.

    This is also convenient for those who want to create a Fourth Reich and think political union is a desirable end in itself.

    The ProfessorComment by The Professor — June 28, 2016 @ 6:26 pm

  19. @lbc
    “and Europe will move its own way too.”-yep, a few different of them (ways). Unless, of course, the US is too busy building da Wall and Europe gets united by the Kremlin. Then it will be one way indeed.

    Comment by Ivan — June 29, 2016 @ 11:02 am

  20. Schroeder/Steinmeier etc surely won’t mind

    Comment by Ivan — June 29, 2016 @ 11:03 am

  21. @Ivan–swirling down the toilet is moving.

    The ProfessorComment by The Professor — June 29, 2016 @ 5:50 pm

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