Nobody's Fault But Mine

by: Eric Parnell, CFA


The response by some circles to the "Brexit" vote outcome has been both notable and irksome.

It was not British voters that failed, it was fiscal policy leadership.

Time is running short for fiscal policy makers to finally wake up and start fixing the problem.

"Got a monkey on my back

Got a monkey on my back

Gonna change my ways tonight

Nobody's fault but mine"

- Nobody's Fault But Mine, Led Zeppelin, 1976

The response by some circles to the "Brexit" vote outcome has been both notable and irksome. The financial media was filled with articles over the weekend discussing the "uneducated" and "ill informed" average British voter that effectively ruined their country's four-decade old place in the European Union with one simple vote. How could they not see how disastrous a decision this would be for their country? One commentator whom I typically respect went so far as to proclaim the decision a failure of democracy. Unfortunately for the policy making and media elite that remain blinded by the on-the-ground realities around them, the failure here is not democracy or the supposed ignorance of the average British voter. Instead, it has been the repeated failure of policy makers for some time now to deliver on the promise and improved standards of living that so many average people across the developed world had hoped for when they first got behind joining the common market so many years ago.

The Promise Of Globalization

What is deeply frustrating from my perspective is that I am a strong believer in the economic benefits of globalization. Opening a country up to free trade with other economy should enable a country to focus their resources, the goods and services, that they are best suited to produce while allowing their trade partners to do the same. In the end, more goods and services can be produced and everyone can benefit from the added surplus.

Not only can countries in a common market focus on doing what they do best, but they also have the improved ability to share technology for the benefit of everyone, allow for the freer flow of capital and investment and provide for the access to additional resources such as labor for even further production gains. And with increased productivity and the more effective utilization of scarce resources, the populations of all countries involved should enjoy a better standard of living that improves at a greater rate over time, thanks to the compounding of these benefits.

Unfortunately for those involved in the European Union (BATS:EZU) experiment, such has not been the case for many of its participants in recent years. And this along with the incompetence and failure of the policy makers that are now so incredulous that the British people have decided to throw their place in the EU overboard are to blame, not the British voters or anyone else in the general population across Europe, for its slowly grinding demise. They are not "uneducated" or "ill-informed". Instead, they are simply acting out against the increasingly unsatisfying hand that they feel they have been dealt.

When Policy Fails

The European Union should have been a win-win for everyone involved. But its flaws have become increasingly intolerable for a number of its member countries along the way.

Let's begin with the common euro (NYSEARCA:FXE) currency. What European Union leaders have pursued over the years is an environment where countries are operating under a shared monetary policy but with largely separate fiscal policies. Unfortunately, this was a structure that was never going to work. You simply cannot have shared monetary policy without also having shared fiscal policy. Sure, fiscal guidelines existed that countries were supposed to follow to gain and keep their euro membership, but these were not properly monitored or enforced, which led to some member states getting in over their fiscal heads. As a result, many of these fiscal violators are now suffocating from austerity programs that are choking off the potential for economic recovery at the expense of their general populations.

Are the profligate countries at fault for their misdeeds? Absolutely. But those that were running the EU show also had to know the fiscal attitudes of some of the countries that they were once all to happy to welcome into the fold so that they could more easily ship their export goods. For example, when a country such as Greece (NYSEARCA:GREK) has a checkered legacy of sovereign debt defaults, should we simply assume that it will reform itself to greater fiscal responsibility because it is allowed to join a party where the access to capital is much freer and debt costs meaningfully lower? Indeed, the rational thinker would expect the opposite to occur, which is what has ultimately come to pass.

What has been far more galling in recent years, however, has been the repeated shortcomings of fiscal policy makers for years since the outbreak of the financial crisis. For up until the near collapse of the global financial system, the European Union was maintaining the illusion that everything was working swimmingly. Of course, a global environment over a quarter of a century prior to the crisis that included persistently accommodative global monetary policy, the end of the Cold War and one of the longest period of sustained economic expansion in history can do a lot to smooth over any underlying problems. But once the global system nearly collapsed and so many of the warts were finally revealed, policy makers were forced to react and do so swiftly.

Monetary policy makers have more than delivered in this regard. In fact, they have gone way too far at this point. For they continue to stretch the bounds of unconventional monetary policy ever further. But it's simply not working, because monetary policy alone is not a panacea for the ails of the global economy.

Fiscal policy makers have effectively failed to do their part. Monetary policy makers have bought their fiscal policy counterparts nearly a decade of time now to act and take the necessary steps to fix the underlying structural problems that continue to plague the European Union and the global (NASDAQ:ACWI) economy. But instead of acting swiftly, they have frustratingly dithered. Instead of recognizing what monetary policy makers were buying them was time, fiscal policy makers mistook the illusion of economic improvement resulting of relentless liquidity flows as something both real and sustainable. So they sat back and returned to their partisan ways including ensuring the continued welfare of their respective oligarchical supporters, some of which had a hand in feeding the environment that resulted in the financial crisis in the first place.

Thus, the result has been a toxic brew that has inspired the rise of populist fervor on the far left and nationalist zeal on the far right. The general population across the European Union that were not the cause of the crisis but instead has been along for the ride has seen their economic fortunes languish if not deteriorate over the last many years. They have seen jobs lost, thanks to globalization with the return of no new jobs to take their place. And the training for the structurally unemployed has been woefully insufficient to help attract new employers in many cases. They have also seen the increasing flow of immigrants from other parts of the continent and the world, thanks to the common market come in and take their remaining jobs at lower wages. And they are seeing the conditions under which they have to live, the rules that they have to follow and the calls for changes that they would like to have made dictated in many cases not by their local representative or even their national government for that matter, but some ivory towered foreign leadership in Brussels.

What the general population in many parts of Europe including the United Kingdom (NYSEARCA:EWU) has been left with is not an improving standard of living but instead a deteriorating one. Instead of steadily increasing real incomes, they have seen their household wages either diminishing or falling on a nominal basis for many years now. According to the OECD, for example, household disposable income across the European Union has fallen by a cumulative -1% since 2009, which represents a near -9% pay cut on an inflation-adjusted basis over this same time period. In the United Kingdom where everyone is so incredulous that the general population elected to leave the European Union, household disposable income has risen marginally over this same time period, but on a real basis it has fallen by more than -8%. Moreover and in recognition of the increased income disparity in the U.K. in recent years, the decline in real household disposable income has been notably worse when excluding the top 20% of income earners in the country.

Are people in the United Kingdom "uneducated" or "ill-informed" because they voted to abandon the European Union? Absolutely not. Instead, they are acting completely rationally and are justifiably angry. They have been brought into an economic arrangement by their leadership that is not working and has not been working for some time. Their recent vote was their democratic opportunity to express this frustration. And if it has gotten to the point where a simple majority of the British people have reached the conclusion that the common market was no longer worth the trouble, it highlights how widespread the discontent has become and how badly fiscal policy makers have both failed to deliver on the promise of the common market and effectively communicate its potential merits going forward to the so many in their population that have come to feel otherwise.

Nobody's Fault But Mine

So, here we are today, nearly a decade on from the financial crisis. Monetary policy makers have reached the point of exhaustion in trying to give fiscal policy makers the opportunity to fix the underlying structural problems. Yet, little to no actual progress has been made. Worse yet, fiscal policy makers still don't even seem to understand the errors of their ways.

We are still hearing rumblings of another referendum vote. Surely policy makers think, the people will see the fault of their ways and change their minds with a "remain" vote the next time around, right? No, because the problem isn't the vote, but the deteriorating quality of life and standard of living that was to this point being ignored by the U.K. political and economic elite. People are mad, and if you are a British politician that hasn't done anything about it to this point, the "Brexit" vote is a warning shot that you need to finally act sooner rather than later to start truly fixing the problem.

What has been considerably worse, however, has been the response from European Union leadership in Brussels. They have repeatedly bungled their common market experiment for many years now. Instead of projecting a unifying manner in trying to solve the problems festering in many struggling nations across the common market, they have repeatedly struck a dismissive and threatening tone. Countries whose fiscal houses have fallen into disrepair need to shape up or get out. But if you try to get out, we're going to banish you and rip your economic hearts out in the process. And if your people in a democratic vote decide by a relatively thin simple majority that they want to leave the experiment, we're not going to reach out to you to see what we can do. Instead, we're going to voice our grave disappointment at the terrible mistake that you've made while we do whatever we can to speed up the process to rush you out the door. While it is understandable why EU leadership has to take a hard line with debtors, dissenters, and defectors, it also creates a distressing environment for many of those that remain. And given that the underlying structure of the European Union is already flawed in the first place, the end result of the common market experiment appears to be headed nowhere good, particularly when unemployment for many countries remains chronically high, household disposable income continues to decline on both a nominal and real basis, and the overall standard of living for many continues to deteriorate.

Bottom Line

The fault of what took place with the "Brexit" vote last Thursday lies not with the British voter. Instead, it's nobody's fault other than the leadership of pro-EU British politicians and the European Union itself that has failed to deliver on the great promise of the common market for so many of the general population across the continent including even remotely effective fiscal policy over the past decade since the financial crisis. And it's nobody's fault other than these same leaders that were unable to find a way to convince the disgruntled that they need to hang in there with the experiment for the potential future benefits down the road.

Looking ahead, fiscal policy makers across Europe and many parts of the rest of the developed world for that matter INCLUDING the United States (NYSEARCA:SPY) need to wake up and recognize the reality unfolding around them today. Monetary policy makers have generously bought you time to take the necessary action to fix the global economy by doing the things that central banks simply cannot do nor should they. Time is quickly running out and people are becoming increasingly frustrated as evidenced by the rise of the far left and far right in many countries across the developed world. And the fact that you are not getting re-elected is not because the voter is misguided or ill-informed. Instead, they are mad. And devising ways to hold another vote or organize a revolt among delegates at a convention to try and right the "wrongs" of the voter is not the answer. Instead, it is coming together with other policy makers from various sides of the political aisles to figure out solutions that are going to fix the underlying problems plaguing the economy once and for all.

For if action is not taken soon, the demise of the European Union will become increasingly likely. It will not be just the United Kingdom moving to the exits, but it will also be Italy, and Spain, and Greece, and the Netherlands, and France. And in the process the entire common market experiment will effectively collapse. Until fiscal policy makers finally wake up to the reality unfolding around them with increasingly troubling speed and begin to change their ways, the eventual demise of the European Union will become an increasingly high probability scenario.

Until then, a prudent investment strategy includes remaining defensive including favoring safe-haven assets over higher-risk alternatives. Within stock portfolios, defensive allocations should continue to outperform cyclical and economically sensitive names despite their relatively rich valuations. Moreover for U.S.-based investors, companies with a more domestic focus is also sensible from a risk management standpoint.

The "Brexit" vote has the potential to be the very beginning. And the fact that fiscal policy makers across the world remain relatively tone deaf to the crises unfolding around them, it is very likely that the rapidly growing monkey is going to remain strapped to the back of global financial markets for the foreseeable future. Thus, a prudent risk management approach remains warranted.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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