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June’16 Financial and Banking Features Newsletter


Central Banking

Brexit Fervour Underscores the Weakness of Economic Forecasting.

Increasingly Outlandish Economic Arguments on Both Sides of the Brexit Debate. The Bank of England’s intervention is questionable.

As apolitical neutral observers, your authors seek to draw attention to bogus economic arguments advanced by both sides. Remain is of course the UK Government, and in recent weeks chose to make the economy the centrepiece of their campaign. With two weeks to go Leave are fighting back hard, pointing out the hidden costs of the EU, most recently that a £19bn EU accounting “black hole” exposes British taxpayers to a £2.4bn bill.

This plausible argument seems to have had an impact. But many arguments on both sides are far from credible. Our view is that the exaggerations by Remain are more extreme than those by Leave, and have likely nudged more ‘undecided’ voters into the Leave camp than the other way around. This effect stems not only from the absurdity of the arguments, but also from the aggression with which they are being advanced.

We present three strange economic arguments made by each side, and our reasoning why each side should not have made them.


a) Leave the EU to save the National Health Service. Leave’s point is that the £10bn per annum net cost to UK taxpayers of EU membership could be redirected to bail out Britain’s Primary Care Trusts, which fund the UK’s free healthcare system. Many PCTs are on the verge of insolvency. WE SAY: UK voters are unimpressed with this argument. The NHS is perceived as immune from financial problems and believed to be first in line for bailouts – EU membership is irrelevant to this issue.
b) Britain will be economically stronger outside the EU. Britain would be better off negotiating bilateral trade deals with all trading counterparties/ blocs/ customs unions including the EU. WE SAY: Remain have quite successfully jumped on this claim on the ground that it is absurd to predict what kind of tariff arrangements will be negotiated with so many counterparties over several years. The outlook looks so vague that the official Leave campaigns have declined to predict likely tariff arrangements, preferring to campaign on the drawbacks of the status quo. Leave would have been more effective by declaring that economics has no track record as a predictive science, the referendum will likely have little economic impact, and voters should concentrate more on matters such as migration and democratic control.
c) Leave quotes the gross price of Britain’s membership (£350 mm per week) rather than this figure net of the 40% rebate. WE SAY: Leave’s attempt to justify this on the ground that the EU has control of the rebate, that it is somehow not money which the UK can rely on receiving, has undermined Leave’s integrity.


a) According to the UK Treasury, leaving will cost every household £4000[[http://www.independent.co.uk/news/uk/politics/eu-referendum-vote-to-leave-europe-would-make-british-households-4300-worse-off-according-to-a6988786.html]] per year, 820,000[[http://www.bbc.co.uk/news/uk-politics-eu-referendum-36355564]] jobs will be lost, and each pensioner would be worse off to the tune of £137[[http://www.zerohedge.com/news/2016-06-01/what-carve-economists-fake-panic-over-brexit]] per annum. WE SAY: Even though the majority of accredited economists back Remain, the precision of these predictions is transparently arrogant and has inflamed economists in the Leave camp. Ordinary citizens may not have read Mises, but the absurdity of these predictions, combined with multiple references by Remain to the benefits of ‘economic certainty’ of EU membership have inspired commentators to quote from Human Action: “The paradox of “planning” is that it cannot plan, because of the absence of economic calculation. What is called a planned economy is no economy at all. It is just a system of groping about in the dark.

b) If Britain leaves, sterling will fall, import prices and inflation rise, and house prices fall. WE SAY: although the Bank of England’s decisions to maintain interest rates at near zero levels has been expressed more as boosting jobs rather than inflation; it is broadly similar policy to that of the ECB who are fixated with boosting inflation. If inflation is good for Europe, how can it be bad for Britain? As for house prices, these have risen clearly much higher than the Bank of England expected. The Bank has previously warned about the risks of much higher prices[[http://www.bbc.co.uk/news/business-28140588]]. How can they now suggest that a dip in prices would harm the economy?

c) Being in the EU but out of the euro is the ‘best of both worlds’. WE SAY: As the Eurozone crisis grinds on with no signs of economic improvement, Britain’s half-in-half-out status does not help the process of further federalisation which may be needed to resolve sovereign and bank insolvencies. Perhaps too complex for the public, but Cameron’s boasting appears insensitive to Europe.

British voters know that the referendum is at heart a constitutional issue; should the UK be governed solely by its national Parliament or continue to sacrifice a degree of democratic power to the EU? But Remain recently chose to argue that the economic benefits trump all else. Leave are far from squeaky clean, but Remain’s position, that the economy and therefore tax receipts will shrink so much, that everything will suffer, appears increasingly as a manufactured position, which is perhaps why the polls have recently narrowed.

The truth is that nobody knows whether the UK economy would be stronger or weaker outside the EU. Ordinary citizens increasingly sense this and agree with the verdict of Tyler Durden:

We do not know precisely what might happen if the UK were to vote to leave the EU. It is intellectually and morally unacceptable for economists to pretend that they do.

Perhaps this is why Europe’s elite and the ECB desperately hope that Remain wins. They are surely worried that if Britain were to Leave and prosper, their credibility would suffer. So too would the credibility of supranationals like the IMF who prophesise a Brexit slump . Like the ECB, the IMF has a prominent role co-managing the European sovereign rescue programmes.


Concerns from US regulator that large US banks are undercapitalised add to European concerns that banks are struggling to survive. New Fintech companies challenge the role of banks’ core deposit taking business.

News recently broke that the Federal Reserve is likely to increase capital requirements for the eight largest US banks. Although unlikely to take effect before 2018, Federal Reserve governor Tarullo considers such increases a necessary buffer against future financial shocks. Predictably, the response from US banks was that using less leverage is bad news for banks, a response which only increases our concerns that banking is in worse shape than most commentators believe.

In Europe, little progress is being made toward full banking union and there is little evidence of systemic recovery. German resistance to a common deposit fund seems firm. Furthermore, the Basel Committee on Banking supervision is taking its time on reviewing the much criticised zero risk weights for sovereign debt.

While banks continue openly to adjust their business models in search of stability and profit, even the mainstream media are questioning whether senior managers of many banks really know what they are trying to achieve. As we wrote last month, there has been a raft of investments in new financial technology companies seeking to compete with specific areas of business previously considered to be the exclusive domain of banking. This begs the question as to which, if any areas of traditional banking can traditional banks hope to retain as their exclusive territory? One not so new technology company, Germany’s FIDOR – established 2009 – has a model which challenges the indisputable core business of banks.

Stripped to its essence, a bank is simply a regulated deposit taking institution. It need not perform any other services, not even lending. FIDOR is perhaps the first of many future “No Stack” banks. It uses technology for everything, even customer identification and accreditation at account opening. Its cost base per customer is a fraction of that of a traditional bank.

FIDOR merely takes deposits and operates current accounts and enables its customer to make payments. It is purely an online bank with no branches. But it is a bank, regulated by German authorities. It invites other providers of various banking services, to market to its customer base by placing their “apps” on FIDOR’s customer interfaces. If a FIDOR customer wishes to lend his funds, or buy bonds, shares or invest in any kind of fund, he/she can choose from a range of regulated providers of such services. FIDOR’s success also demonstrates the simplicity true low market cost of such core banking business. This may have further negatively impact public opinion regarding banks.

We are presently witnessing a tussle between technological innovation and regulators determined to prevent the process of creative destruction taking place. The story so far is that banks deserve continuing special treatment because of their systemic importance. However, public doubts as to the wisdom of continued special treatment are growing as large banks increasingly struggle to convince anyone of their commercial viability. To the extent that new companies with simple business models are seen successfully to outcompete banks for basic banking services, the doubts will increase.

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