'No-Deal' Brexit Looms Very Large As Europe Faces Its Lehman Moment

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Includes: ADRU, BBEU, DBEU, DBEZ, DBUK, DEUR, DEZU, DGBP, DRR, EDOM, EEA, EPV, ERO, EUFX, EUO, EURL, EWU, EZU, FEEU, FEP, FEU, FEUZ, FEZ, FIEE, FIEU, FKU, FLEE, FLGB, FXB, FXE, GBB, GSEU, HEDJ, HEWU, HEZU, HFXE, IEUR, IEV, PTEU, QGBR, RFEU, UEUR, UGBP, ULE, UPV, URR, VGK
by: Peter Cooper
Summary

EU unlikely to grant an extension to Brexit deadline.

Risks paralysis of Brussels government if it does.

'No-deal' a catastrophe for EU about to happen.

Lehman Brothers writ even larger.

Take immediate evasive action.

The Wall Street Journal opined last week that it had lost the plot in trying to follow the Brexit - Britain's tortured exit process from the European Union - but noted that markets seem to have decided this is a non-event. Is this the biggest error in macro policy thinking since the US authorities decided that it would be safe to pull the plug on Lehman Brothers in 2008, and the world tumbled into the Great Recession and financial markets crashed?

Now, while I can understand what the WSJ is saying, this simply is not good enough. It is possible to follow the Brexit process without dropping off to sleep or losing the plot. That said, I will be the first to admit that I was wrong in my earlier conclusions that a no-deal simply was not possible.

True UK lawmakers never did approve it. They have indeed voted against the "no-deal" twice recently. The problem is that when they gave the original negotiation mandate, they left "no-deal" as the default option in case of a breakdown in negotiations or failure to pass a deal. In any case, their recent votes are "non-binding" recommendations and cannot stop the "no-deal" happening by default.

Final Brexit Countdown

And unfortunately that is where we have got to this week for the final shakedown in this almost three-year saga in which the British Prime Minister Theresa May goes to Brussels to meet her 27 EU opposite numbers to sign off a deal, or not as the case now almost certainly seems to be.

British MPs have twice heavily defeated a motion to back the deal that Mrs. May negotiated and signed off with the European Union (subject to parliamentary approval). She was expected to try one more time on Tuesday. But it emerged on Sunday night that she is going to cancel this vote because it will be lost. That incidentally will prevent any further discussion of a second referendum or a vote on an amendment proposing it.

Therefore the British position at the meeting in Brussels later this week will be to ask for an extension of the deadline for more discussions to try to reach a consensus around the twice-rejected deal. How likely are the EU27 to unanimously agree?

Over the weekend, it emerged that opinion in the European Commission, the executive head of the EU where I was an intern many years ago, is that such an extension carries a very grave risk of paralyzing the institutions of the European Union.

Prime Ministerial Meltdown

Basically Mrs. May is now viewed as a liability because she cannot deliver on the Brexit deal (as so clearly demonstrated by her heavy losses in votes in parliament to secure it) and could well resign or be replaced in a coup by her own party once an extension is agreed.

Then a new British Prime Minister could cancel the Brexit altogether and plunge the EU into paralysis as the UK would be a member but without representation in the European Parliament, thereby annulling the legal standing of this vital institution.

The only practical way to ensure that such an appalling situation does not happen is to take the default "no-deal" option and dump the UK out of the EU on March 29th. But the Bank of England has warned that will be an economic "catastrophe" for the UK with a surge in tariffs, plunge in sterling, higher inflation and a house price crash.

The knock-on effect on the EU from abandoning its second largest member would also be grave. But perhaps not as bad as risking paralysis in its whole government system (probably for yet another "no-deal" situation).

European Lehman Moment

Is this the European equivalent of a Lehman moment? The unexpected consequences of such a sudden, major dislocation in the world's fifth largest economy would be dynamite to the global financial system. At the very least investors ought to be taking a prudent view and getting out while they still can from marginal positions. Precious metals and bonds would be the obvious places to hide.

However, this could be a true black swan event appearing just as the WSJ commentators got bored and walked off the job. At least Seeking Alpha is still discussing such potential game changers as they reach a climax. I very much hope to be wrong on this, by the way, and take no pleasure at all in seeing it happen.

But I know the European Commission from the inside and its first mandate is to defend the institutions of the Treaty of Rome, and the idea that it might take a risk on this score is not something I would bet on.

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.