The Beginning of the End of Uncertainty for the UK

The Beginning of the End of Uncertainty for the UK

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Macro Letter – No 124 – 20-12-2019

The Beginning of the End of Uncertainty for the UK

  • The UK election result was a clear mandate for Brexit
  • A UK/EU free-trade agreement may not be ready by December 2020
  • Uncertainty remains but real economic progress can now begin

For traders and investors in financial markets, risk and reward are two sides of a single coin. There are, of course, exceptions and geopolitical risk is one of them. The difficulty with geopolitical risk is that it is really geopolitical uncertainty. As Frank Knight observed back in 1921 in Risk, Uncertainty and Profitrisk is can be measured and forecast, uncertainty, cannot: –

Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from which it has never been properly separated…. The essential fact is that ‘risk’ means in some cases a quantity susceptible of measurement, while at other times it is something distinctly not of this character; and there are far-reaching and crucial differences in the bearings of the phenomena depending on which of the two is really present and operating…. It will appear that a measurable uncertainty, or ‘risk’ proper, as we shall use the term, is so far different from an unmeasurable one that it is not in effect an uncertainty at all.

I have kept this in mind throughout my investing career and it is for this reason that I have avoided investing in the UK stock market since the Brexit referendum. The uncertainty surrounding Brexit has not disappeared, but I now have sufficient confidence in the decisiveness of the incumbent administration to believe that progress can at last be made. To judge by the immediate reaction of financial markets in the wake of the UK election result, I am not alone in my optimism.

To begin, here is a chart of G7 GDP since Q2 2016: –

GDP comparison since 2016

Source: OECD

The UK has fared better than Japan and Italy but its momentum has diminished relative to the remainder of G7.

A more nuanced view of the relative underperformance of the UK is revealed by comparison with Eurozone growth. The chart below, which starts in 2014, shows the switch from UK outperformance to underperformance which began even before the Brexit referendum in mid-2016: –


Source: Eurostat, Full Fact

Whilst there are many factors which have contributed to this change in the UK growth rate, the principal factor has been uncertainty relating to Brexit.

Of course, the direct impact of the Brexit referendum was felt by Sterling. The chart below shows the (Trade-weighted) Sterling Effective Exchange Rate since 2016: –

Sterling Effective Exchange Rate since 2016

Source: Bank of England

The rise since August 2019 appears to predict the outcome of the election, but the currency still has far to rise if it is to return to pre-financial crisis levels, as this 20 year chart reveals: –

Sterling Effective Exchange Rate since 2000

Source: Bank of England

The strong upward momentum which began in 2012 was swiftly terminated by the political morass which culminated in the UK referendum. The unexpected outcome of the 2016 Brexit vote only served to exacerbate the malaise.

The weakness of Sterling merely accelerated the deterioration in the UK terms of trade. The UK has run a continuous trade deficit since 1998 but, as the chart below reveals, the deficit has become structural: –

UK Trade Balance

Source: ONS

Any significant imbalance in trade makes an economy sensitive to changes in the value of its currency. The fall in Sterling since 2016 has had a knock on effect on the rate of UK inflation: –

united-kingdom-inflation-cpi since 2016

Source: ONS, Trading Economics

Viewed from a 10 year perspective, the reversal is even more pronounced. UK interest rates would probably have been substantially lower during the last four years had it not been for the uncertainty surrounding Brexit: –

united-kingdom-inflation-cpi since 2010

Source: ONS, Trading Economics

Is optimism now justified?

Aside from the trade balance, the charts above are a reflection of the discount financial markets have imposed on the UK. This month’s election justifies a rerating. Whilst the markets have not been overly enamoured with the latest Tory Brexit deal they have been craving certainty. A working majority of 80 allows room for any Conservative dissenters to be quashed. Then there is the ‘Corbyn Factor.’ Promises of widespread nationalisation, without clarity about the price with which private investors would be compensated, did not sit well. Neither did the proposed tax increases required to fuel the £80bln increase in fiscal spending. That threat has now passed.

Finally there was clarification of the nation’s opinion on Brexit itself. Labour lost ground almost everywhere; to Tories and the Brexit party in England and Wales, whilst in Scotland they ceded ground to the SNP.

This summation of the UK situation is an over-simplification, but from a financial market perspective the UK political landscape has improved. Suffice to say, there remain many challenges ahead, not least the Brexit transition period (end 2020) during which a free-trade agreement (FTA) needs to be agreed to avert unnecessary trade disruption. After four years, one might hope there has been behind the scenes preparation and that much of the deal will be a slight amendment to current access arrangements. In reality to complete a deal by year-end 2020 it will have to be an ‘FTA-lite’ affair, which may prove less than satisfactory. A swift trade deal should, nonetheless, reduce uncertainty which is also in the interests of the EU. I remain sceptical, there may be many a slip twixt cup and lip.

Conclusions and Investment Opportunities

Four years of deferred investment and consumption will now gradually be unleashed. This should bolster Sterling. As the Pound rises inflation should fall. Assuming they do not give up on their inflation target, currency strength should prompt the Bank of England to ease monetary conditions. Gilt yields will decline, forcing investors to seek longer duration bonds or higher credit risk to compensate for the shortfall in returns. Companies will find it easier to issue debt in order to fuel capital expenditure: although I expect it may lead to more share buybacks too. UK equity markets will rise, driven by an improved outlook for inflation, a lowering of interest rates and expectations of stronger economic growth.

For equity investors, this rising tide will float most ships, but not all companies will benefit equally. Those firms which were at risk of nationalisation have been immediate beneficiaries. The chart below tracks their relative underperformance: –

UK Nationalisation Tragets v FTSE 350

Source: Bloomberg, The Economist

A longer term investment opportunity should be found in the FTSE 250. The four year picture is found below (FTSE 100 in blue, FTSE 250 in red): –

FTSE 100 vs 250 - 4yr

Source: AJ Bell

It might appear as if the FTSE 250 has already caught up with the FTSE 100, but this next chart reveals a rather different picture: –

FTSE 100 vs 250 10yr

Source: AJ Bell

The FTSE 250 is much more closely entwined with the fortunes of the domestic UK economy. For the past four years many business plans in the UK have been on hold, awaiting clarity on Brexit. Now that a deal will be done and an FTA with the EU will follow, we may have finally reached the beginning of the end of uncertainty.

UK Financial Services – Opportunities and Threats Post-Brexit – Short-term Pain, Long-term Gain?

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Macro Letter – No 102 – 28-09-2018

UK Financial Services – Opportunities and Threats Post-Brexit – Short-term Pain, Long-term Gain?

  • A Brexit deal is still no closer, but trade will not cease even if the March deadline passes
  • In the short-term UK and EU economic growth will suffer
  • Medium-term new arrangements will hold back capital investment
  • Long-term, there are a host of opportunities, in time they will eclipse the threats

In a departure from the my usual format this Macro Letter is the transcript of a speech I gave earlier this week at the UK law firm, Collyer Bristow; Thomas Carlisle may have dubbed Economics ‘the dismal science,’ but I remain an optimist.

Setting aside the vexed question of whether Brexit will be hard, soft or stalled, the impact on financial services (and, indeed, the majority of UK trade in goods and services) will be dramatic.

Financial markets (and businesses in general) loathe uncertainty. Ever since the referendum result, investment decisions have been postponed or cancelled. When investment is being made it is generally tentative and defensive. Exporters and importers alike are striving to develop alternative strategies to maintain and protect their franchises.

As a long-term economic commentator, I try to look beyond the immediate impact of events, since near-term expectations are usually reflected in the valuation of an asset or currency. Brexit, however, is a particular challenge, not only due to near-term uncertainty but because policy decisions taken now and in the wake of the March 2019 deadline could set the UK economy on an unusually wide array of possible trajectories.


To begin an analysis of the impact post-Brexit on financial services, there are several near-term threats; here are a selection: –

  1. House Prices

Earlier this month Mark Carney, the Governor of the Bank of England, warned cabinet ministers that a ‘no-deal’ on Brexit could see house prices decline by as much as one third and a rapid rise in defaults. The subsequent impact on financial institutions balance sheets and the inevitable curtailment of bank lending could be severe. Jacob Rees-Mogg even dubbed him, ‘The High Priest of Project Fear.’

  1. Passporting

Assuming no deal is agreed, the access which financial services providers in the UK have had to the EU27 will not be available after March 2019. Many existing contracts and licensing agreements will need to be rewritten.

  1. Regulatory equivalence

Divergence between the regulatory regime in the UK and Europe remains a distinct risk. The types of legal issues surrounding, for example, ISDA Master agreements (Deutsche Bank AG v Comune di Savona) will inevitably become more widespread.

  1. Systemic Risks to the Euro

The ECB is vocal in its mission to maintain control over the clearing and settlement of Euro denominated transactions. Many financial services activities which currently take place in the UK may need to be transferred to another EU country.

In the near-term, these types of factors will reduce trade and economic growth, both in the UK and, to a lesser degree, in Europe. In May 2017 I wrote an essay entitled ‘Hard Brexit Maths – Walking Away’ in which I estimated the negative impact a no-deal Brexit would have on the EU. The UK’s NIESR estimated the bill for a Hard Brexit to the UK at EUR66bln/annum. I guesstimated the cost of Hard Brexit to the EU at EUR 62bln/annum. Both forecasts will probably prove inaccurate.

The reduced free movement of workers from the EU is another significant factor. It will lead to a rise in a toxic combination of skill shortages (due to new immigration controls) and unemployment, as companies are forced to conserve capital to weather the inevitable economic slowdown.

There are, however, several near-term opportunities, here are a small selection: –

  1. Sterling weakness

The currency has already weakened. Whilst this may be inflationary it makes UK exports more competitive. Whether the UK can take advantage of currency weakness remains to be seen, history is not on our side in this respect.

  1. A US boom

Aided by a lavish tax cut, the US economy is growing faster than at any-time since the financial crisis, underpinning its currency. Its trade deficit is growing despite tariff barriers.

  1. US Trade policy

The Trump administration appears to have focused its ire on trade surplus countries, of which Germany is the largest European example. The UK is not under the White House microscope to the same degree.

Seizing the opportunity presented by these financial and geopolitical shifts is easier to speak of than to grasp. Nonetheless, just this month Absa Bank of South Africa (recently spun-off from Barclays) announced plans to open a London office to capitalise on post-Brexit opportunities connected with the fast-growing economies of Africa.


The medium-term risks will mostly be borne out of inertia. Until the shape of Brexit is clear, decisions will continue to be postponed. Once Brexit occurs there will be inevitable technical problems, stemming from systems issues and new procedures. Growth will slow further, business operating costs will need to be cut, employment in financial services (and elsewhere) will decline at exactly the moment when greater investment should be undertaken.

But, new trade deals will be negotiated, not just with Europe and the US, but also with the countries of the British Commonwealth, notably (but not just) India. Many of these countries are among the fastest growing economies in the world, often imbued with benign demographics. Here is a rapidly expanding working age population in need of capital investment and financial services. Ruth Lea, Chief Economist at Arbuthnot Latham has commentated on this subject at length during the last two years. In April she wrote: –

Commonwealth countries, taken together, have buoyant economic prospects and their share of global output continues to increase (especially in PPP terms). The EU28 share, in contrast continues to decline.

UK exports to the top eight Commonwealth countries rose by over 31% between 2006 and 2016, but total exports rose by 40%. And the share of UK exports going to the top eight Commonwealth countries fell from 7.5% in 2006 to 7.0% in 2016…

There is little doubt that Commonwealth countries have the potential to be significant growth markets for the UK’s exports, given their favourable growth prospects and demographics. This is all the more likely given the probability of trade deals with individual Commonwealth countries after Brexit.


David Riccardo defined the law of comparative advantage just over two hundred years ago. Perhaps one of the best examples of the continuance of the phenomenon is Switzerland, which has seen its currency appreciate against the US$ by approximately 3% per year, every year since fiat currencies were freed from their shackles after the collapse of the Bretton Woods agreement in 1971. Here is a chart of the US$/CHF exchange rate over the period: –

USDCHF 1970 to 2018


The Swiss turned to pharmaceuticals and other value-added businesses. The success of this strategy, despite a constantly appreciating currency, has spawned an entire industrial region – the Rhone-Alp economic area, which incorporates German, French, Italian and Austrian companies bordering Switzerland. This region is among the most economically productive in the EU.

The UK has an opportunity, post-Brexit, to focus on economic growth. As a trading nation, we should concentrate our efforts on re-forging links with the fast-growing countries of the Commonwealth, where the advantages of a common language and legal system favour the UK over other developed nations.

An example of this opportunity is in education. We have a world class reputation for education and training. Combine this redoubtable capability with the abundance of new technologies, which permit the delivery of content globally via the internet, and we can provide the full gamut of instruction, ranging from primary to tertiary and professional via a combination of video content, on-line examination and tailored digital collateral.

A recent MOOC (Mass Open On-line Course) In which I enrolled, attracted students from across the world. The course was dedicated to finance and among the students with whom I interacted was a Masi tribesman from Kenya who hoped to develop micro-finance solutions for the local farming community. The world is our veritable oyster.

Conclusion – The Bigger Picture

The economies of the developed world are growing more slowly than those of developing nations. Providing goods and services to the fastest growing economies makes economic sense. Many of the largest companies listed on the UK stock market have been oriented to take advantage of this dynamic for decades. Brexit is proving to be cathartic, we should embrace change: the sooner the better.

The Austrian economist, Joseph Schumpter, described the cycle of economic development as including a period of ‘creative destruction’. Brexit could be an extreme version of this process. The patterns of trade which have developed since the end of WW2 have been concerned with promoting cohesion between European nations, but, as Hyman Minsky famously noted, ‘stability creates the seeds of instability.’ I believe the political polarisation seen in Europe and elsewhere is a reaction against the success of the global financial and economic system and the institutions and alliances created to insure its success. We are entering an era of change and Brexit is but one personification of a growing trend. Technology has shrunk the world, empowered the individual and (in the process) undermined the influence of nation states and international institutions. Individual freedom is ascendant but with freedom comes responsibility.

One of the greatest challenges facing the UK and other developed nations, in the long run, is the provision of pensions and health insurance to an increasingly ageing population. Many of the financial products required by these ageing consumers are ones in which the UK is a world leader. The developing world is rapidly growing richer too. Their citizens will require these self-same products and services. Brexit is an opportunity to look forward rather than back. If we embrace change we will thrive, if not change will occur regardless. Post-Brexit there will be considerably pain but, if we manage to learn from history, there can also be long-term gain.

What’s right with the Trans-Pacific Partnership?


Macro Letter – No 44 – 23-10-2015

What’s right with the Trans-Pacific Partnership?

  • The TPP may boost real-incomes by $285bln by 2025
  • US Congress should approve the TPP to avoid international political embarrassment
  • The TPP may be expanded to include South Korea, Taiwan and maybe even China
  • Many companies involved in auto, pharma, IT and agricultural should benefit

For Asia-Pacific, the Trans-Pacific Partnership (TPP) is the most substantial trade agreement in history. In this video Cato Institute – Putting the TPP in Perspective: 150 Years of U.S. Trade Policy in Less than 4 Minutes – remind us that this is a “Managed Trade Agreement” rather than a “Free Trade Agreement” (FTA).

The 12 TPP participating countries – Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, USA and Vietnam – represent almost 40% of output and 25% of exports of goods and services globally. This makes it the largest regional trade agreement in history.

After five years of “horse-trading” and “turf-wars” the agreement was finally signed on 5th October, yet, with US Congressional enactment still awaited in December, much media commentary has focussed on the weaknesses of the agreement. These include:-

  • Agriculture – Japanese resistance to the elimination of tariffs on agricultural imports, including rice, beef, pork, dairy, wheat, barley, and sugar. Japan’s average most-favoured nation (MFN) tariff for agricultural products is 16.6% – although some tariffs are as high as 700%. The US accounts for 25% of agricultural imports to Japan.
  • Intellectual property rights – Whilst all TPP members agree on high IP standards, the devil is in the detail. The period of data exclusivity for drug tests, protection of trade secrets, and liability of ISPs for transmitting illegal/pirated material all remain contentious.
  • State-owned enterprises – TPP members are committed to levelling the playing field in respect of preferential access to finance or new markets. Problems arise over the length of the transition period before the new rules must be adopted, standardisation of accounting practices, board governance and unbiased procurement processes.
  • Labour – Issues remain around the adoption of ILO Fundamental Principles, prohibiting workplace discrimination and upholding consistent child labour practices.
  • Investor-State Dispute Settlement – Investor-State Dispute Settlement provisions allow international investors to use dispute settlement proceedings against host governments if they believe their property has been expropriated without compensation or regulated in a discriminatory manner. TPP members disagree about the extent of carve-outs from Investor-State Dispute Settlements for health, safety, and environmental regulations.

According to the Independent – TPP trade agreement text won’t be made public for four years – so in the interim here is the USTR Summary.

The Guardian – Wikileaks release of TPP deal text stokes ‘freedom of expression’ fears – provides more details about Chapter 12, covering IP, yet it is not clear whether this is the final version of the document or not.

In attempting to assess the initial deal The Economist – Every silver lining has a cloud – said:-

First, there is the fact that the agreement has been so hard to sell in America. It took months, and several legislative setbacks, before Barack Obama won the authority to fast-track a congressional vote on TPP. The deal may still be voted down, in America or elsewhere. Those who would succeed Mr Obama as president know that TPP holds few votes. This week Hillary Clinton, the Democratic front-runner and once a promoter of TPP, came out against it. The beneficiaries of TPP—consumers, as well as exporters—are numerous, but their potential gains diffuse. By contrast, inefficient firms and farms, about to be exposed to greater foreign competition, are obvious and vocal. Canada, for example, limited the threat to its dairy farmers and doled out a big new subsidy. The saga is a reminder of how hard free trade is to champion.

Second, the TPP deal underscores the shift away from global agreements. The World Trade Organisation, which is responsible for global deals, has been trying, and largely failing, to negotiate one since 2001. Reaching agreement among its 161 members, especially now that average tariffs around the world are relatively low and talks are focused on more contentious obstacles to trade, has proved almost impossible. Regional deals are the next best thing, but, by definition, they exclude some countries, and so may steer custom away from the most efficient producer. In the case of TPP, the glaring outcast is China, the linchpin of most global supply chains.

Third, good news on TPP stands in contrast to bad news elsewhere. Cross-border trade today is as much about the exchange of data as it is the flow of goods and services: this week saw the annulment by a European court of a deal that had enabled American firms to transfer customer data across the Atlantic. Conventional trade faces even stronger headwinds. The volume of goods shipped in the first half of this year was just 1.9% higher than in the same period of 2014, far below its long-term average growth of 5%. This reflects not only China’s soggy demand for imports—a threat to the developing economies that supply it—but also the accumulation of minor measures that silt up global trade.

Deals like TPP are the most effective way to reverse this sorry trend, by reducing tariffs and other obstacles to trade. Optimists hope it can now be expanded, to include China and others. Sadly, experience suggests that will be hard.

Looked at from a more positive perspective, the TPP tops the US trade policy agenda, incorporating President Obama’s “Asia Pivot”. Signatory countries account for 36% of US trade in goods and services. US ratification of this agreement will upgrade a range of existing FTAs stretching back to NAFTA (1994).

With some exceptions – mostly in agriculture – the TPP aims to remove tariff barriers for goods and services. It will also address some “access” issues in areas such as competition policy, direct investment, labour and environmental standards.

Japan and the US will be the principal beneficiaries of the TPP (64% of GDP gains) but it has been estimated that the agreement could boost real incomes of member countries by $285bln by 2025, with exports increasing by $440 billion (+7%) assuming full-adoption.

The TPP could achieve even more since is allows for the future accession of new members. South Korea, possibly regretting its decision not to take part in the initial negotiations, has announced its interest, while Indonesia, the Philippines, Thailand, and Taiwan are evaluating the benefits. It might even form the framework for a bilateral FTA between the US and China. The chart below shows the potential benefit in GDP terms:-


Source: Economist and Peterson Institute

A brief history of free-trade



The liberal idea of free trade sprang from the earliest discoveries in the field of economics. It is the embodiment of the spirit of “comparative advantage” – David Riccardo’s observation that specialisation makes economic sense and that those agents with a natural economic advantage should specialise and trade, rather than attempting to produce all goods to meet their own needs.

There are difficulties in achieving genuine free trade. Consumer organisations are relatively weak in comparison with trade organisations: this iniquity is the flaw at the heart of so many FTAs. Consumers, if consulted, would vote unanimously in favour of cheaper goods. Inflation targeting might prove difficult for central banks but people’s standard of living would improve, all other things equal. This is the benign face of deflation; it is also the reason why productivity growth is critical to economic progress.

Since the time of Sumer, empire building has involved conquest, assimilation and trade. Artefacts of North African and Middle-Eastern origin uncovered at Roman archaeological sites in Britain, bears testament to the wide-spread distribution of goods throughout the Roman Empire.

The Spanish theologian, philosopher and jurist Francisco de Vitoria (1483 – 1546) developed the first ideas about freedom of commerce and freedom of the seas. A forerunner to FTAs, were the “most favoured nation” (MFN) clauses attached to international treaties during the European colonial era – many of these MFN clauses are still in use today – but it was the philosopher Adam Smith, along with Ricardo, who articulated what we would recognise as free-trade theory today.

William Huskisson (1770 – 1830) was appointed President of the Board of Trade and Treasurer of the Navy in 1823. He was part of the Canningite faction of the Tory party, led by George Canning, which formed a brief coalition government in 1827. Perhaps Huskisson’s greatest contribution to free-trade was his reform the Navigation Acts. This allowed other nations full equality and reciprocity of shipping duties, it repealed the labour laws, introduced a new sinking fund, reduced duties on manufactures and foreign imports, and repealed quarantine duties.

Huskisson had also been a member of the committee appointed to inquire into the causes of the agricultural distress of 1821 – this committee proposed a relaxation of the Corn Laws chiefly due to his strenuous advocacy. Sadly it was the potato famine in Ireland that eventually saw their repeal in 1846. It was the campaign to repeal the Corn Laws which eventually led to the next great clarion for free trade, the Cobden-Chevalier Treaty of 1860. The treaty reduced French duties on most British manufactured goods to around 30% and reduced British duties on French wines and brandy. During the next decade the value of British exports to France more than doubled whilst French wine imports increased by 100%.

Richard Cobden (1804 – 1865) had founded the Anti-Corn Law league in 1838. That the current TPP has taken just five years is therefore encouraging. Cobden is a giant in the annals of free-trade, to find out more about this extraordinary man and the relevance of his ideas today please visit The Cobden Centre. A recent post – No more “Free-Trade” treaties: it’s time for genuine free trade – is an excellent example of their important work:-

Murray Rothbard opposed NAFTA and showed that what the Orwellians were calling a “free trade” agreement was in reality a means to cartelize and increase government control over the economy. Several clues lead us to the conclusion that protectionist policies often hide behind free trade agreements, for as Rothbard said, “genuine free trade doesn’t require a treaty.”

The Cobden-Chevalier Treaty spawned a cascade of bilateral FTAs across Europe. By some estimates these agreements reduced tariffs in Europe by 50%. Sadly as the world economy entered a recession in 1873 the enthusiasm for free trade began to wane. The First World War saw the situation deteriorate further, whilst the great depression of the 1930’s heralded an increase in nationalism which went hand in hand with protectionism.

According to the World Trade Organisation (WTO) – established in 1995 in the wake of the NAFTA agreement of 1994 – the General Agreement on Tariffs and Trade (GATT) of 1947 was the starting point for multilateral FTAs, although it was originally agreed between just 23 countries. This followed in the wake of the 1944 Bretton Woods Agreement which had established the IMF, World Bank and Bank for Reconstruction and Development. By 1951 the European Coal and Steel Community had been founded – later to become the EEC (1957).

Many other bilateral and multilateral agreements followed. For a more detailed investigation of the history of free trade, this WTO – Historical background and current trends 2011 – article is worth investigating. One point the WTO make in conclusion is:-

…despite the explosion of PTAs in recent years, 84 per cent of world merchandise trade still takes place on an MFN (Most Favoured Nation) basis (70 per cent if intra-EU trade is included).

Viewed from this perspective, the ideal of “Free Trade” still has far to go.

Other perspectives on the TPP

In this recent article Bruegal – Trans-Pacific Partnership: Should the key losers – China and Europe – join forces? the authors anticipate a Chinese response which could benefit the EU-

The winners are obvious: Obama and Shinzo Abe, arguably also the US and Japanese economies. Obama can leave office with a strong demonstration of the US pivot to Asia, and Abe can finally argue that the third arrow of his Abenomics program is not empty.

The losers are also obvious: China and Europe. China not only has been left out of the deal, but it has been left out on purpose. If anybody had any doubt (at some point China was invited into the negotiations and some still expect China to continue discussing membership in the future), Obama’s official statement on TPP yesterday makes it very clear: “when more than 95 percent of our potential customers live outside our borders, we can’t let countries like China write the rules of the global economy”. For China the issue is not only losing access to the US market but also the fact that its most important trading partners are in the deal, with the notable exception of Europe.

The fact that TPP has not yet being ratified by national parliaments still offers room for doubt as to TPP’s actual economic significance (exemptions from its coverage could spring out in every jurisdiction) but there is no doubt that it will be economically relevant. TPP covers 40 per cent of global trade and spans 800 million people. Not only will trade barriers be reduced to the minimum in virtually every sector (including generally protected ones such as agriculture) but also common standards will need to be used by all participants, be it for investment, environment or labour. In this regard, the primacy of the protection of brand names over the protection of geographical indications of agricultural products, or the priority of the protection of trade secrets over press freedom are cornerstones of the US success in its negotiations with TPP partners, which also shows the price that a country like Japan are willing to pay for US-led security. In the same vein, the high price to pay (in terms of US supremacy on the negotiation table) makes it all the more unlikely for China to seriously consider joining the bloc in the near future: the treatment of state-owned enterprises and data protection are two stumbling blocks. The latter is also a key deterrent for Europe’s TTIP negotiations.

They see a window of opportunity to the EU to negotiate a deal with China.

From a geo-political standpoint Chatham House – For the West, the Trans-Pacific Partnership Must Not Falter – see the TPP providing benefits which go well beyond economics:-

But the economic benefits are only one upside of the deal. While it is by no means assured, there could also be a significant geostrategic impact. The TPP was not the only Asian trade agreement of choice. China, for example, had been supporting an alternative Regional Comprehensive Economic Partnership. But the 12 TPP participants – the US, Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam –  sent a clear message regarding the kind of standards and rules they believe are best placed to provide the greatest benefit to their populations – from greater transparency and anticorruption to more free and open markets.

Western leadership

The TPP now sets the bar. If successful, in time other states will hopefully join including, most significantly, India, China and South Korea. But this will take time and the TPP has to prove itself first. Prospective member states will have to make extremely tough political choices in order to join and they and their populations will need to see meaningful tangible benefits first. But the door has been left open and if the TPP turns out to realize some of its potential, others could come knocking on the door.

This podcast from CFR – Trans-Pacific Partnership Trade Deal – gives a good global overview from both an economic and political perspective:-

…If you look at the U.S. negotiations with Europe—the Transatlantic Trade and Investment Partnership—if those come to fruition—and they’re on a somewhat slower track—you’re going to reach a position for the United States where two-thirds of its trade is covered under free trade arrangements of some sort of another.

…you’ve had a stalemate in the Doha Round for more than a decade now between the advanced economies—primarily the United States, Europe, Japan to some extent—and the big emerging economies—China, India, and Brazil. And they’re just at loggerheads over a whole series of issues, from, you know, farm subsidies in the U.S. and Europe to the pace of opening up manufacturing markets in the developing countries.

…The Europeans are always very conscious about not losing their relative trade advantages, and the possibility of Japan, and then if Korea docks on to the TPP as well—the possibility of those countries having better access to the U.S. market than European companies would enjoy, I think that will be a spur to action at the—at the U.N.

…Peterson Institute, for example, thinks that Japan is going to gain upwards of $119 billion in absolute gains from TPP.

…TPP is an instrument of Abenomics, the broader structural reorganization inside Japan, and it leverages for Abe all kinds of transformations that would be difficult to accomplish by a Japanese government on its own.

…There’s some loud minority voices of criticism. But overall, the opinion polling in Japan has really embraced this notion of TPP participation.

…The LDP has long been the protector and party that has advocated on behalf of Japan’s farmers. It is now leading this agricultural reform, largely because Japan’s farmers are aging. They’re getting older. And there’s a demand from within the agricultural sector for these reforms and a more competitive-oriented agricultural policy.

Nonetheless, in some parts of Japan Abe’s party still is seen as betraying some of the core interests of its postwar conservative protections, and so he’ll have to tread a little bit carefully to make sure that he can pay off or make sure that the farmers will not be mistreated.

…Initially the rhetoric out of the Chinese government was reasonably hostile to TPP. That has softened in recent months. But clearly, to make the sorts of reforms that would be necessary to join the TPP would be a very big lift for China.

…if Congress rejects the TPP, that’s a slap in the face to 11 other countries, including close allies like Mexico, Canada, Japan, Australia, and New Zealand that have made difficult decisions domestically in order to be able to conclude the deal. So the thinking has always been, at the end of the day, Congress is going to be very reluctant to do that.

Countering the enthusiasm of Chatham House, The Diplomat – Could the TPP Actually Divide Asia? – cautions that there are geopolitical risks that the TPP will increase tensions in the region.

Firstly, South Korea:-

U.S.-Korea free trade agreement (KORUS) came into effect in March 2012. South Korea is undoubtedly a strong candidate to join the group, given that KORUS is seen as a gold standard for free trade deals. Nevertheless, the U.S.-Korea free trade pact largely exempted the politically sensitive Korean rice market. That alone will undoubtedly be a major political issue for all member countries should Korea negotiate entry into the pact, and it will certainly be a source of contention with Japan, a founding member of the TPP that was forced to make concessions on its equally politically sensitive rice market. 

Then, Taiwan:-

The Taiwanese government has made clear that it hopes to be one of the first entrants to the TPP, not only to further its position as a global exporter, but also to encourage domestic reform that is critical if Taiwan is to remain competitive. Given its experience in joining the World Trade Organization, whereby it had to wait until China was ready for accession in 2001 so that it could join at the same time, there is growing concern that Taipei would have to wait again for Beijing to be ready. The frustration of being unable to join a group that is seen as key to Taiwan’s growth will undoubtedly strain cross-Strait relations.

And finally, the undermining of existing agreements:-

The Regional Comprehensive Economic Partnership (RCEP) includes not only all 10 ASEAN countries, but also China, Japan, South Korea, India, Australia, and New Zealand. Critics of the RCEP have been quick to dismiss the pact as aiming at lower standards compared to the TPP, and as focused too heavily on relatively unambitious tariff barrier reductions. Moreover, it is seen as a Chinese-led initiative that does not include the United States. Yet the fact that RCEP brings hitherto unlikely partners such as Burma and Cambodia into the fold of regional trade agreements in itself should be heralded as a significant development that has already achieved what is one of the major longer-term goals of TPP, namely to encourage nations to adopt internationally developed rules and standards. 

To round off the arguments for and against here is Mish Shedlock – Hillary Clinton, Dead Rats, Toilet Paper Politics – he’s definitively unimpressed:-

Every country is a firm believer in free trade for exports, but no country wants free trade for imports. Obviously, that cannot work mathematically, which is precisely why the deal had to be negotiated in secret and has taken five years to produce questionable results. …The New York Times reports “Trans-Pacific Partnership Seen as Door for Foreign Suits Against U.S.“. WikiLeaks analysis explains that this lets firms “sue” governments to obtain taxpayer compensation for loss of “expected future profits.” This agreement is a lawyer’s fantasyland dream come true. Corporations will be suing governments left and right over “expected future profits.” For example, Australia would not sign the deal unless it obtained a waiver for health warnings on cigarette packages that are more stringent than elsewhere. Apparently, all other lawsuits are fair game. And it will be taxpayers who pay the bill. Imagine the lawsuits over GMOs (genetically modified organisms). Monsanto will be suing every country that blocks its GMO products.

…I propose TPP will create a nightmare of worldwide lawsuits at taxpayer expense, while doing nothing that will genuinely advance free trade. Mish Free Trade Proposal As I have stated numerous times, I am in favor of free trade. An excellent free trade agreement would consist of precisely one line of text: “All tariffs and all government subsidies on all goods and services will be eliminated effective immediately”. I maintain that the first country that does that will be the beneficiary, regardless of what any other country does!

Conclusions and investment opportunities

The TPP has 30 chapters to be analysed. It will probably under-deliver as Shedlock indicates, however, perception that large scale, multilateral free-trade negotiation is back on the agenda, after such a long absence – NAFTA was back in 1994 – is likely to be supportive for markets

Country level benefit to financial markets

  • Japan will benefit from the external assistance it lends to the policies of Abenomics. Japanese agriculture will be negatively affected but internal subsidies will mitigate its impact. The TPP should have a strong positive influence on the Nikkei. This will help support JGB yields but is unlikely to cause a significant increase in the JPY if the BoJ continues with its QQE policy..
  • Singapore should benefit, providing goods and services to its Asian neighbours. The Straits Times Index should be supported and the SGD is likely to appreciate.

Sectoral stock market effects

  • US, Canadian, Australian and New Zealand agricultural businesses should reap significant benefits over time – especially Australian sugar refineries – whilst agro-business in Japan will be impaired.
  • Vietnam’s apparel manufactures should have improved terms of trade, as will Malaysian Palm Oil producers.
  • Companies in the Japanese and US auto-industry will benefit.
  • US pharmaceutical companies will benefit.
  • IT companies, especially from the US but also Japan, will benefit.

In the long run, other countries, including South Korea, Taiwan and perhaps even China, may join the TPP. Uncertainty still revolves around final approval of the treaty by the US, but, as more information begins to emerge, investment flows will start to influence equity prices across certain sectors and, more broadly, on a country specific basis.