Why the Eurozone’s fate makes an immediate Brexit vital

Why the Eurozone’s fate makes an immediate Brexit vital

The huge financial liabilities associated with EU membership require a quick clean Brexit.

From research using publicly available figures, I have prepared a 40-page report published today by Global Britain that demonstrates the huge financial risk that the UK Government has thus far ignored in its efforts to deliver the EU’s Withdrawal Agreement that keeps Britain still on the hook. Never mind the £39 billion divorce bill, it is practically petty cash compared to the UK’s maximum possible liability now of €207 billion that could be escalated to €441 billion – or even more if our exit is drawn out into the period of the next EU Multiannual Financial Framework.

The Eurozone financial system is teetering on the edge of a renewed crisis but, unlike the one in 2013/14, this one can only be solved by the large and solvent EU Member States borrowing themselves and paying to reduce the liabilities of others. To avoid this scenario the UK needs to both leave the EU and sever its contractual connections with the EU in order not to be caught up in this “re-set”.

The UK’s likely share of such a “re-set” exceeds €200 billion, a horrendous outcome that would set the country back many years in its efforts to escape from austerity. This would be all the more unacceptable when we voted to leave the EU three years ago, and the best our negotiators have managed is a half-baked agreement that leaves us exposed to risk for at least twenty years.

The Eurozone financial system is drinking in the last chance saloon, a saloon that is a hall of mirrors in which each participant appears solvent only because it accounts for its claims on the other participants at face value. Behind this pacific façade lies a black hole of €1 trillion – the financial hangover built up over 20 years from banks and investors acquiring assets in the “Club Med” countries and Ireland for far more than they are worth now.

The apparent recovery of the Eurozone since 2012/13 is an illusion, kept intact by the European Central Bank (ECB) and the other Eurozone national central banks buying up government bonds in €trillions, reducing yields and enabling their owners – Eurozone governments – to issue new debt at subsidised rates of interest, as well as flooding financial markets with cheap money.

In turn this enables bankrupt borrowers – “zombies” – to remain alive, and for lenders into these “zombies” to rank their loans as “Performing” when the borrower cannot repay the capital or sustain a rise in interest rates. The lenders are zombies themselves, kept animate by ECB money and creative accounting. 

Lending banks continue to be allowed to under-assess the risks in their businesses via “Internal Risk-Based” methodologies, and in turn to claim that they are well-capitalised when they are not. Non-Performing Loans are either massaged back into “Performing” status without borrowers paying any debt service, or are sold off in bogus securitisations where the bank continues to carry a high risk of loss.

Financial markets recognise the size of the problems in the Eurozone’s banks by valuing bank shares at a considerable discount to their book value – in Deutsche Bank’s case by 80% – and the ECB bank supervision department has quantified bad loans as being 3.6% of all loans that banks still hold on their balance sheet: both these indicators point towards a Eurozone-wide “black hole” of €1 trillion.

A meltdown could be triggered in any number of ways, but the “longstop” is a realisation in 2020/21 that it is economically and politically impossible to achieve compliance with the EU Fiscal Stability Treaty by 2030: not only Greece, Italy and Portugal, but Cyprus, Spain, France and Belgium have Debt-to-GDP ratios over 90% and only Greece’s ratio is falling.

This is the treaty that was meant to demonstrate that the Euro is a single currency and not a synthetic one, and that the countries using it are converging economically and not diverging.

Only a debt transfer from the over-indebted countries onto the stronger ones – to initially achieve a consistent 87% Debt-to-GDP ratio across the Eurozone and EU – can keep the façade intact. Even then, all countries would have to run an annual budget surplus of 2.5% consistently for 11 years to reach the Fiscal Stability Treaty target of 60% from the startpoint of 87%. This is scarcely credible but at least the initial debt transfer would enable a gentler glide path and put off the day of reckoning. The amount of debt to be transferred is again of the order of €1 trillion.

The UK must not become embroiled in this “re-set”, and needs urgently to distance itself from involvement. The way to do that is to leave the EU as soon as possible and without a “deal” – and certainly nothing based on the Withdrawal Agreement and Political Declaration.