The fatal attraction of a no-deal Brexit

A bitter rift between Brussels and London would be geopolitical madness

Gideon Rachman




Shortages of medicine; the garden of England turned into a lorry park; a surge in red-tape; new tariffs on cars and food; factories halted for lack of parts. Those are the grim scenarios conjured up by planning for a “ no-deal Brexit”. Who in the world would volunteer for that kind of chaos? Quite a few people, as it happens.

There are hardline Brexiters who regard the British government’s current proposals for Brexit as a betrayal — and so would prefer no deal. There are ardent Remainers who hope that the spectre of no deal could provoke a political crisis that stops Brexit altogether. And there is the European Commission, which sees no deal as preferable to compromising on the basic principles of the single market.

Together, these three groups could lead the UK and the EU into no-deal territory. But they are all deluded in their own way. In their refusal to compromise they risk jointly unleashing a dangerous crisis, whose endgame they can neither predict nor control.

The motivations of the hardline Brexiters are, in some ways, easiest to understand. They believe that the proposal of Theresa May’s government would be the worst of all worlds: leaving Britain with the obligations of EU membership, without the supposed benefits of Brexit. But their argument that Britain should hold out for something better depends on dismissing all the warnings about no-deal as scare stories or “Project Fear”.

So what are the hardliners really thinking? Perhaps they believe their own propaganda and simply do not accept or comprehend the legal and regulatory consequences that flow from no deal. Maybe their reverence for Britain’s “finest hour” in 1940 has created a certain nostalgia for rationing and the “blitz spirit”?

But the Brexiters are surely mistaken if they believe that the chaos unleashed by crashing out of the EU would create national unity. It is more likely that Leavers and Remainers would round on each other with renewed fury, and that the political careers of many prominent Brexiters would come to an end.

It is this last prospect that leads one school of Remainers quietly to embrace the idea of no deal. They argue that the only way of finally discrediting Brexit and politicians like Boris Johnson and Jacob Rees-Mogg is to let them have their way, and to force them to take responsibility for the results.

But that argument is uncomfortably close to a Marxist embrace of the immiseration of the people as a necessary condition for political progress. It also rests on the questionable assumption that an economic and social crisis would strengthen the centre ground in politics. In the real world, it is more likely to empower the political extremes.

There is also a milder version of the Remain case for no deal that, I admit, I have been attracted to. This rests on the hope that the May government is simply unable to negotiate a deal, or cannot get a hard-won agreement through the House of Commons. Under those circumstances, the Remainers hope that parliament would call a halt to proceedings and ask the EU for extra time to negotiate. The passage of time would make it possible to call a second referendum and Brexit might actually be stopped altogether.

But, alluring as that option sounds to Remainers, it is actually a very hazardous long-odds bet. There is no guarantee that the EU would be willing or able to stop the Brexit clock. And there is no guarantee that a second referendum would be won.

For Remainers, the more pragmatic, if depressing, option is to accept that Brexit will go ahead and to push the UK government to embrace the least-damaging version. After Brexit, economic and political logic is likely to lead Britain and the EU gradually to rebuild ties. The EU is evolving and Britain might eventually rejoin a second tier of the club focused mainly on trade and the single market.

But where do the EU’s interests lie? While there might be a certain schadenfreude in Brussels at the sight of the British hoarding food and stuck in massive traffic jams, chaos in the UK is not ultimately in the interests of the rest of Europe. For while the hardest economic blows would fall on Britain, there would also be serious consequences inside the EU, particularly in economically vulnerable areas like northern France.

A bitter rift between the EU and the UK would also be geopolitical madness at a time when Europe is under mounting pressure from Russia, China and the Trump administration in Washington.

The EU cannot micromanage British politics from Brussels. Nonetheless, it is clear that if the EU side forcibly and explicitly rejects the May government’s proposal — essentially that the UK stay inside the internal market for goods, but not for services — it will make a no-deal Brexit much more likely.

The European Commission has consistently argued that the “four freedoms” of the single market can never be divided, and that Britain must therefore choose something like the deals offered to Canada or Norway. But given the unique political, strategic and economic ties between the EU and the UK, it is not unreasonable to accept that the post-Brexit relationship should also have its own unique characteristics.All sides need to re-learn the art of compromise. And they do not have long to do it.

What Next for the US Stock Market?

Martin Feldstein




CAMBRIDGE – The US stock market achieved its longest rise in its history on August 22, with the Standard and Poor’s 500 index up by 230% since 2009. Although this wasn’t the biggest increase in a bull market, it marked the longest period of increasing share prices.

Several forces contributed to this impressive nine-year run. The primary driver has been the extremely low interest rates maintained by the Federal Reserve. The Fed cut its short-term federal funds rate to near-zero in 2008 and did not begin to increase it above 1% until 2017. Even now, the federal funds rate is lower than the annual inflation rate. The Fed also promised to keep the short rate low for a long period of time, causing long-term rates to remain low as well. With interest rates so low for so long, investors seeking higher returns bought shares, driving up their prices.

A rational model of share prices sets them equal to the present value of future profits. Low interest rates raised the present value of future profits, and the corporate tax reform enacted at the end of 2017, together with deregulation in several industries, has raised both current profits and expected future profits, contributing to the present value of future profits.

But even with rising profits, low interest rates have caused share prices to increase faster than profits. As a result, the S&P price-earnings ratio is now more than 50% higher than its historic average.

With real (inflation-adjusted) GDP rising at more than 3% this year, the strength of the US economy has induced foreign investors to shift their holdings to US equities. And in recent months, US households that had not owned stocks in the past, fearful of missing out on the bull market, have joined the equity bandwagon.

But what of the future? Stock-market booms don’t die of old age; they are generally killed by higher interest rates. That often happens when the Fed raises the short-term interest rate to stop or reverse rising inflation. Although the Fed’s preferred rate of inflation – the price of consumer expenditures – has just reached its target of 2%, other measures of price growth are rising more rapidly. The overall Consumer Price Index (CPI) is now 2.9% higher than it was a year ago. Even “core” consumer inflation, which strips out more volatile food and energy prices, has increased by 2.4% over the past year.

The Fed’s short-term interest rate is now just 1.75%, implying that the real rate is still negative. The Fed’s Open Market Committee has now projected that it will raise the federal funds rate to 2.4% by the end of 2018, to 3.1% by the end of 2019, and to 3.4% by the end of 2020.

My judgment is that the greatest risk to the stock market is the future increase in long-term interest rates. The interest rate on ten-year Treasury bonds is now about 2.9%, implying a zero real rate when compared to the current level of the CPI. Historically, the real ten-year Treasury rate has been about 2%, implying that the ten-year rate might rise to 5%.

Three factors will contribute to the rise in the long-term rate. The Fed’s projected increase in the federal funds rate will put upward pressure on the ten-year interest rate. With the unemployment rate at 3.9% and likely to decline further in the year ahead, the rate of inflation should continue to increase. And even if that does not cause the Fed to raise the federal funds rate at a faster pace, higher inflation by itself will cause investors to demand higher long-term rates to compensate for the loss of their funds’ real value.

But the major cause of the rise in the ten-year rate is likely to be the massive fiscal deficit. The federal government is scheduled to borrow more than $1 trillion in 2019 and subsequent years. The Congressional Budget Office projects that the federal debt held by the public will grow from 78% of GDP now to nearly 100% over the next decade. Although foreigners now own about 50% of US government debt, recent reports indicate that foreign buyers are remaining on the sidelines and domestic investors are currently buying all of the new government debt. As the total amount of debt increases, investors will demand higher long-term interest rates to purchase it.

The long-term interest rate will therefore be driven higher by rising short-term rates as the Fed normalizes monetary policy, higher inflation in response to tighter labor and product markets, and the explosion of the federal debt that needs to be absorbed by investors. The rise in long-term rates will reduce the present value of future corporate profits and provide investors with an alternative to equities. The result will be a decline in share prices. I don’t know when that will happen, but I am confident that it Will.


Martin Feldstein, Professor of Economics at Harvard University and President Emeritus of the National Bureau of Economic Research, chaired President Ronald Reagan’s Council of Economic Advisers from 1982 to 1984. In 2006, he was appointed to President Bush's Foreign Intelligence Advisory Board, and, in 2009, was appointed to President Obama's Economic Recovery Advisory Board. Currently, he is on the board of directors of the Council on Foreign Relations, the Trilateral Commission, and the Group of 30, a non-profit, international body that seeks greater understanding of global economic issues.

Tough Times Ahead for Housing

Rising rates, higher costs and taxes are already squeezing housing and the pressure will likely increase

By Justin Lahart

Single-family housing starts rose by a modest 1.9% last month, while single-family permits fell to their lowest level in a year. Photo: erik s. lesser/EPA/Shutterstock


The slowdown in housing can be blamed on a number of factors, and the bad news is they are all likely to get worse.

On Wednesday, the Commerce Department reported that single-family housing starts increased by a modest 1.9% last month from July, leaving them below the levels they registered in the spring. Single-family permits, which measure how much construction is in the pipeline, fell to their lowest level in a year. Other housing measures, including existing and new home sales, have also been slowing in recent months.

Is the US Supporting Kurdish Insurgents Against Iran?

An uptick in attacks coincided with the U.S. withdrawal from the nuclear deal and a conspicuous meeting.

By Xander Snyder        

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When Diversification Doesn’t Spread Your Risks

A lesson from 2008 that’s relevant again: Things go wrong when everyone diversifies in the same way

By Paul J. Davies