The democratic case for stopping Brexit  
The question is whether the British public would support a second referendum
by: Gideon Rachman

The campaign to stop Brexit is gathering pace. The most obvious sign is the increasing chatter about a second referendum. At the moment it is still mainly former politicians, such as Tony Blair and Nick Clegg, who are explicit about their desire to prevent the UK leaving the EU. Active politicians tend to talk about a “soft Brexit”. For some, this is simply a convenient code, or a staging post, for their real goal — stopping Brexit altogether.

The reasons that Remainer politicians are still so cautious about explicitly rejecting Brexit is that they are worried about sounding undemocratic. As the evidence mounts that Brexit is going to be bad news for the economy, so Leavers are increasingly falling back on one main argument: “the people have spoken”. Whatever the economic costs may be, Brexit must roll forward. Anything less would be an insult to democracy. This argument is sometimes accompanied by dire predictions of social turmoil if the will of the people is thwarted by “the establishment”.

If Remainers are to have any chance of blocking Brexit, they have to find a response to the democracy argument. But that will become increasingly easy, as the contradictions in the Brexit project become evident.

The key lies with Theresa May’s most famous and fatuous sound bite: “Brexit means Brexit”. This statement was meant to signal resolution and clarity. In reality, it was a meaningless tautology that underlined the fact that “Brexit” could mean a great many things.

The 52 per cent majority of voters who chose Brexit were actually two minorities, voting for two incompatible ideas. The largest minority seem to be in favour of “hard Brexit”, which prioritises control of immigration over access to the single market. But a substantial minority of the Brexit vote place a higher priority on free trade than on border controls. These two minorities were turned into a majority because the “Leave” campaign successfully convinced enough voters that there was no choice to be made. Britain could have frictionless trade with Europe, while ending free movement of people and stopping payments to the EU.

It is now obvious that this vision of a painfree Brexit was an illusion. As the real choices become clear, the slim pro-Brexit majority could easily fall apart. That is all the more likely because opinion polls have consistently suggested that a majority of voters are not prepared to pay a personal economic price to secure Brexit.

The more that it becomes apparent that the Brexiters’ original vision is collapsing, the more shrilly they will insist that a second referendum would be undemocratic. But the Leavers’ view of democracy is similar to that of a third-world dictator — “one man, one vote, one time”. In other words, once a decision has been taken by referendum, it cannot be revoked.

This is a principle that would never be applied to electoral democracy, where it is essential that consent is renewed every five years, at a minimum. Referendums, it is argued, are different. But are they? The only reason that Brexit is happening is because a referendum on EU membership held in 1975 has been reversed by a second referendum held in 2016.

The Brexiters argue that a new vote on EU membership was justified because the EU has changed fundamentally since 1975. Fair enough. But the Brexit that is going to be delivered to the British people is very different from the one that many people voted for. If new information justified a second vote on EU membership, why does new information not validate a second vote on Brexit?

Some opponents of a second referendum reject the idea not because it is undemocratic but because they fear a backlash from Leave voters. There is a violent nationalist fringe in Britain that could be stirred up by an effort to reverse Brexit. The murder of Jo Cox, a member of parliament who was a vocal supporter of immigration and the Remain campaign, is a reminder not to take that prospect lightly.

But if Brexit is stopped, it will be through a lawful, democratic process, not a coup d’état. And no law-governed society should allow itself to be intimidated by the threat of violence.

The real question is whether the British public can be persuaded that a second referendum is needed. As with Scottish independence, there is an understandable public reluctance to reopen a divisive issue. For Remainers, the biggest risk is that the true costs of Brexit do not become apparent until after the UK has left — and it is too late to reverse the decision.

That is certainly possible — maybe even probable. But it is also a distinct possibility that there will be revelatory moments in the next two years that create a clear demand for a second vote. A serious breakdown in negotiations with the risk of a “no deal Brexit” would be one such scenario. Another would be a series of concessions that made it clear the promises of Brexit, such as an extra £350m a week for the National Health Service, will not be delivered.

The sheer incompetence and infighting of the current May government can also be relied upon to undermine the case for Brexit on a weekly basis. At a certain stage, the British people might reach the obvious conclusion that the Brexiters have had their chance — and failed. Then it will be time to take back control.

Lies, Damned Lies, and Statistics

George Friedman
Editor, This Week in Geopolitics

Economics and finance are thought to be more predictable than other disciplines such as politics because they are quantifiable. This is debatable. The extent to which quantitative economic analysis is possible depends on the relationship between the number and reality. That there is a relationship is true, but the relationship is more tenuous than might be thought.

I am not talking about the possibility that economic statistics are manipulated for political reasons.

This is certainly the case in some countries like China but less so, in my opinion, in Europe and the United States. But I want to put aside that theory and examine the validity of data assuming that everyone, everywhere, was honest.

Before we begin, a question…

Do you know how to separate the signal from the noise? It’s one of the most useful abilities a person can possess. But it’s also one of the hardest to acquire in the age of big data, big media bias, and the Internet, the biggest communication platform we’ve ever had. Reality gets diluted by the surreal.

Cutting through the noise to find insight and value is what has made Warren Buffett one of the most successful investors the world has seen. It’s what we strive to do here at Geopolitical Futures as well.

Now you can learn how to cut through the noise to become a better investor and analyst of the world, too. Find out how right here.

Let’s get started with This Week in Geopolitics.

Gauging the Economy

Countries consist of millions of people who conduct trillions of economic transactions each year.

Countless products are produced, warehoused, sold, and consumed. Value is created and destroyed. The vastness of economic activity in even the smallest countries, let alone countries like the United States with over 300 million people, makes it impossible to count each economic transaction. And so it becomes necessary to find a more reliable method of measurement.

Consider employment figures in the US. The country boasts some 160 million workers. The method for measuring employment and unemployment is not to count them all but to use a sample. Sampling is a method that selects a small, representative sample to survey, and then generalizes from that sample. The Bureau of Labor Statistics maintains a list of 60,000 households it calls monthly to determine who is employed, who isn’t, who has gotten a job that month, who had their hours cut or increased, and so on. Each month one quarter of this sample group is replaced, and after eight months, those who were dropped return to the rotation. This is where employment and unemployment numbers come from.

I don’t mean to demonize the Bureau of Labor Statistics. It employs only about 2,500 people who must select a representative sample of the population, contact them directly, and develop and apply statistical analysis to get final numbers. It is a huge task for so few people. And even if they do their jobs perfectly, their findings still may not be all that reliable.

This is in part because it’s unclear just how accurately the sample group represents the rest of the country. The group needs to correspond to the US labor market, but it’s very difficult to find 60,000 households that actually do. Compare this with, say, presidential polling, which is a notably smaller sample group (about 1,500–2,000 people). With few exceptions, those polled have a binary choice.

Tracking the changes is simple. Employment appears to be binary but it’s not. Vacation, sick leave, maternity leave, post-graduate education—all these affect the yes-or-no question of “Are you employed?”

Another reason to question the accuracy of employment statistics comes down to inputs. The samples used are built only with people who are prepared to share their economic data with the government.

Samples obviously exclude the kinds of economic activity and employment meant to evade taxes.

This raises an important question: How do we know the variables that make up a statistically valid household? Anyone who has done survey research knows that the creation of the model against which the sample is managed, alongside screening for dishonesty from the respondents, is a nightmare. There is a (sometimes true) belief that larger sample sizes yield more accurate results, so there is a tendency to create larger samples. A larger group providing information that must be shaped into a binary from a multivariate data set can create chaos, especially for a staff that obviously doesn’t have time for intense questioning.

The Moment of Truth

One way to adjust for this is to compare the sample with the real-world outcome. In political polling, there is the moment of truth for pollsters: the election. But for statisticians calculating employment figures, there is no such moment when the truth is revealed and the method adjusted. Political pollsters generate numbers but they also generate a margin of error, between 2% and 5%. A three-point margin of error creates a six-point range. A seven-point lead might mean a lead of somewhere between 4% and 10%.

Employment figures are never published with a margin of error. This is not because statisticians at the Bureau of Labor Statistics believe they are spot on but because they don’t know what the margin of error is. They have not had the moment of truth at which they have found out the relationship between the sample and the whole, and in not being able to measure error rates empirically, they don’t know how to project rates. They are there but we don’t know what they are. The results are presented without mention of uncertainty, giving the impression that the error range doesn’t exist when in fact it’s simply unknown. But we know that the larger and more complex the sample and the more complex the question (however seemingly simple), the greater the range.

Unemployment is relatively simple, especially compared to measuring gross domestic product.

GDP is staggeringly difficult, and it draws from numerous sources to try to aggregate economic productivity for the entire United States. In all economic statistics, there is an inherent margin of error, which makes economic forecasting difficult. It is not impossible, and correctives can be undertaken, but the fact is that no nation, even a totally honest one, knows precisely how the economy is doing. The best measure is to ask a small-business man how it is doing, and he will say that it is steady, up a little, rocking, weak, or disastrous. Ask a few thousand and you will get a sense of the economy’s status, and a sense is the best we can do.

It reminds me of the old joke: What is the definition of a lie in economics? A decimal point. I may have made up that joke but I can’t remember.

Investors May Feel Left Out of Fed’s Plans

The Federal Reserve may hesitate to raise rates again, but still intends to shrink its bond holdings

By Justin Lahart

Federal Reserve Chairwoman Janet Yellen testifying before a Senate Committee in July. Photo: Ron Sachs/CNP/Zuma Press

Can the Federal Reserve take away the punchbowl from the stock market without taking it away from the economy?

The Fed left rates steady at the conclusion of its two-day policy meeting Wednesday and, given worries about low inflation, investors are doubtful whether another rate increase is coming this year. But the central bank doesn’t seem to have any qualms about starting to run down the massive stock of Treasury and mortgage securities that it accumulated in the wake of the financial crisis. It said it plans to do that “relatively soon”—a signal that it could start shrinking its portfolio following its September meeting.

It seems as if the Fed is making its future rate decisions contingent on what inflation does, but that it is happy to go forward with its balance sheet plan so long as the job market continues to do well, says J.P. Morgan Chase economist Michael Feroli. It is a bit of a mystery why.

One possibility is that it wants to get the balance-sheet process under way before Chairwoman Janet Yellen’s term ends in January, helping to make any successor’s move into the job smoother. But the Fed also may be mindful of differences in how rate increases and portfolio reductions might affect the economy.

When the Fed raises rates, it increases banks’ borrowing costs and can make them less willing to extend credit. But when it starts reducing its balance sheet, it will increase the supply of Treasury and mortgage securities on the market, placing upward pressure on their yields. That will make them more attractive relative to stocks and corporate bonds and could reverse an easing in financial market conditions that has come despite the Fed’s rate increases. This has the Fed worried. Indeed, minutes of the its June meeting showed that some policy makers were concerned that investor complacency amid high valuations “could lead to a buildup of risks to financial stability.”

For investors, whether or not financial markets are an element in the Fed’s thinking is beside the point: For whatever reason, it isn’t letting low inflation get in the way of its balance sheet plan. That could make markets more challenging.

Donald Trump is winning the currency cold war: Pimco


Donald Trump can’t point to much in the way of legislative victories over his first six months in office, but he might have something to crow about when it comes to a weaker U.S. dollar.

“Much of the world has been waging a cold currency war since the autumn of 2016, and so far the winner is Donald Trump,” wrote Joachim Fels, global economic adviser for asset manager Pimco, in a Wednesday blog post.

Trump regularly charged during the presidential campaign that other countries were taking advantage of the U.S. by manipulating their currencies, leaving U.S. exporters to suffer from an overvalued dollar. The Trump administration hasn’t followed through on a campaign pledge to declare China a currency manipulator, but has continued to at least talk tough on trade-related issues.

The dollar has weakened against major rivals in 2017, leaving the ICE U.S. dollar index DXY, -0.59% , a measure of the U.S. unit against a basket of six major rivals, down nearly 8% year-to-date. The dollar is down more than 4% versus the Japanese yen USDJPY, -0.61% , while a surging euro EURUSD, +0.7040% has risen more than 10% against the U.S. unit this year.

“While the U.S. administration and the Republican majority in Congress are yet to deliver on most of their policy goals, they have succeeded in making the dollar more competitive. How? By putting an end to the decadeslong official mantra that ‘a strong dollar is in our interest’ and by threatening other nations, implicitly and sometimes explicitly, with protectionist policies,” Fels wrote. “ In short, all this trade bullying has killed the dollar bull.”

Indeed, as MarketWatch wrote in January, Trump’s abandonment of the strong dollar mantra was seen as an important signal, even if a strong dollar policy had often received little more than lip service from previous U.S. administrations.

Fels argued last December that a currency cold war had taken hold in the second half of 2015 as the European Central Bank, the Bank of Japan, and the People’s Bank of China took “guarded actions” that contributed to the depreciation of their currencies versus the dollar.

Things started to shift earlier this year, he said, with China fixing its yuan stronger versus the dollar, the ECB signaling it is slowly moving toward winding down its own extraordinary monetary stimulus, and the Bank of Japan leaving policy on hold.

With the dollar sinking in response, “the Trump administration has had no reason to turn aggressively protectionist. Mission accomplished,” Fels said.

Of course, it could be argued that the dollar weakness has relatively little to do with Trump.

The ECB, for example, is seen responding to signs of improving economic growth and a number of other factors rather than complaints by administration officials over the value of the euro.

But a weaker dollar—and a stronger euro and yen—is a headache for the ECB and BOJ as they struggle to boost inflation. And Trump’s stance adds another layer of difficulty.

“Outright intervention in the [foreign exchange] market is a no-go as it would likely spark protectionist retaliation by the U.S. administration,” Fels wrote.

That means it would likely take an unexpectedly hawkish turn by the Fed or sudden progress toward implementing the administration’s agenda of aggressive tax cuts to turn the tide for the dollar. Both remain unlikely, Fels said.

Predicting the Unpredictable in Russian Agriculture

By Antonia Colibasanu

Russia became the world’s top grain exporter in 2016 with a record production of 120 million tons of wheat, according Russian statistics agency Rosstat. But poor weather conditions have affected this year’s production. Russia’s grain harvesting season normally starts in June, but this year, it started in July. Cold temperatures have delayed crop ripening and have slowed down field work. As a result, total output is expected to be 17 percent lower than was originally anticipated.

This is noteworthy for two reasons. First, grain, wheat in particular, is an important component of Russia’s food supply, and a shortage could lead to social instability. Second, the worsening conditions in the food sector and declining grain exports could have a detrimental effect on the economy.
Russia’s Agricultural “Rebirth”
The Russian agriculture sector experienced a remarkable boom after 2014. When Western countries imposed sanctions on Russia following Moscow’s annexation of Crimea, the Kremlin retaliated by banning food imports from these countries. Russia portrayed this as an opportunity for the sector’s “rebirth” – local businesses no longer had to compete with European producers. This may have been true to an extent, but the Kremlin can’t control the weather, and this year’s crop proves just how vulnerable the sector is.

More than half of Russia’s agriculture sector is dedicated to farming, 80 percent of which is grain production. Of this grain production, 60 percent is wheat. Wheat is cultivated on more than 48 percent of Russia’s total area dedicated to grain and oilseed crops. Russia relies on wheat more than any other foodstuff as an important component of its food supply. In fact, roughly 70 percent of wheat produced in Russia annually is consumed domestically. From Siberia to the westernmost regions bordering Europe, wheat is a staple in most parts of the country. Other food products like meat and vegetables are too perishable for the majority of Russians to rely on.

Weather is the most important factor that affects grain production and the agriculture industry as a whole. The government has invested in building storage facilities so that harvested crops can be stored for seasons with poor yields. It has approved a plan to expand its grain storage capacity to 130 million tons by 2030, particularly in an attempt to meet the needs of the eastern part of the country. Russia currently has a total storage capacity of 120 million tons – but most facilities need to be upgraded, and very few can effectively hold grain stocks, according to the Russian Grain Union. Russia’s most important storage facilities are located in the southwest, in the Ural region and close to the border with Kazakhstan. These facilities hold grains for export and domestic consumption, but poor infrastructure linking the facilities to the eastern parts of Russia has left these eastern regions vulnerable.

The state holds roughly 25 million tons of grain on reserve in case of poor harvests. Considering that Russians consume 75 million tons annually, the Kremlin believes a minimum of 50 million tons of grain needs to be harvested to supply the domestic market. When production gets close to this minimum level, as it did in 2010, the government considers introducing drastic measures, including banning exports. This, in turn, affects the global market because Russian exports account for 10.5 percent of the world’s wheat exports.
Increasing Prices
It’s not yet clear how badly the agriculture sector will be affected by this year’s low yields, but the Central Bank of Russia is expecting the rate of food inflation to increase in the third quarter. In fact, food prices have already increased. The minimum cost of a month’s worth of food per person, estimated at 4,233 rubles ($71), has increased since the beginning of the year by 14.9 percent on average in the country and by 16.4 percent in Moscow. As a result, in June, the consumer price index rose by 4.4 percent in annual terms, which is higher than the 4 percent inflation target set by the central bank.

The only thing worse for the Kremlin than high inflation is increasing domestic wheat prices. News of Russia’s declining grain production and the one-month delay of the harvesting season have already resulted in an increase in the export price of wheat, possibly making wheat in Russia more expensive. The current price is closer to levels seen in 2015, when Russia implemented an export duty on wheat as the value of the ruble declined because of falling oil prices.
This time, it’s the weather that may drive Moscow to act. Russia’s western regions have experienced a cold spring and summer, with temperatures 3 degrees Celsius (5.4 degrees Fahrenheit) lower than normal for May and June. These two months are important for both winter and spring grain crops. For winter crops, this is the ripening season; for spring crops, it is when seeds are planted. Lower temperatures in the summer affect growth and crop quality. In the next month, temperatures are expected to be lower than average.
Russia’s Federal Service for Hydrometeorology and Environmental Monitoring anticipates that several regions will suffer agriculture losses due to bad weather. Several regions also declared a state of emergency because of severe weather conditions. This covers a large agricultural area, indicating both winter and spring crops may experience problems.
The National Association of Agriculture Insurers estimates that losses caused by adverse weather conditions for winter crops will total 2.6 billion rubles. But the NAAI can cover only up to 1 billion rubles. It’s unlikely that the state will be able to make up the difference, since its budget to cover agriculture losses has been cut to 2.5 billion for the entire year. Since 2011, the state has subsidized 50 percent of the costs of agriculture-related insurance.
Domestic Supplies Are the Priority
Russia is a massive producer of commodities, and though oil is still Russia’s most important export commodity, the country is also a net exporter of grains. Moscow uses commodity exports to gain leverage over other countries. While this has worked well with energy exports, particularly when oil prices were high, it has been less effective with grain exports. Russia’s first priority here is to support its domestic needs, since a shortage in grains could lead to social and political instability.

Since the end of the Cold War, Russia has also tried to maintain influence over grain producing former Soviet states like Ukraine, Kazakhstan and Belarus. This would allow Moscow to control roughly 15 percent of global wheat production in total and almost 17 percent of global exports, according to the U.S. Department of Agriculture. In 2010, when Russia’s wheat production neared its minimum target due to bad weather conditions, it asked its customs union partners Belarus and Kazakhstan to stop exporting grains. Having control over the international price of grain makes controlling the domestic price easier.

In the end, Russia needs to ensure it can meet its own needs and avoid turning to imports because this can have detrimental effects. In the 1980s, the Soviet Union had a massive grain shortage. The U.S. had put an embargo on grain sales to the Soviet Union, which lasted until 1981. While many at the time believed it had only a limited impact, the embargo actually affected average Russians greatly. The U.S. is unlikely to take a similar measure now. But the U.S. and the EU have maintained sanctions against Russia since 2014, so it’s not inconceivable that these sanctions could be extended to grain. While it’s unlikely that Russian production will decline to the point that the country will need to import grains, weather is unpredictable, and Moscow must plan for the worst-case scenario. And even under the current circumstances, Moscow doesn’t have much room to maneuver. Any decline in grain production below expectations could have a negative economic impact – especially at a time when the government is already facing declining revenue.