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Is Brexit costing $100 billion a year?

Is Brexit costing $100 billion a year?

Economic News

Bloomberg found that Brexit is costing the UK economy £100 billion a year. Let’s dig a little deeper on this question.

When any region of the world undergoes extreme change in policy or structure, its economy will undoubtedly see impacts in systems of trade, supply, and demand.

Take the COVID-19 pandemic as an example.

With more people at home, online businesses thrived, appealing to those who kept safe from the virus; on the other hand, companies with a smaller online following tended to struggle, as in-person shoppers were scarce. To fully understand the economic situation of the United Kingdom over the past few years, looking at Brexit and its economic impact is crucial. Initiated on January 31, 2020, Brexit was the official departure of the United Kingdom from the European Union; this event, through restrictions and changes made to the UK’s relationship with Europe, has affected most sectors of the British economy, along with the supply and demand of the products within.

Why did the UK leave the European Union?

Well, many UK citizens wanted to see a more open country with a stronger economy, improved systems of trade and public services, and more freedom from the EU. In the fishing industry, for example, captains were hopeful that freedom from European quotas would give them opportunities to sell more product, bringing in more profits. However, the process came with complications. Along with COVID-19, Brexit closed off the United Kingdom, disturbing the supply and demand of many sectors of the British economy through decreases in rates of international trade and travel. Focusing on the fishing and tourism sectors of the United Kingdom’s economy, the impacts of Brexit on supply and demand can be seen through the hopes these sectors had for the process, the initial impact in each sector, and their projected outlooks for the future. 

Although it contributes to less than 1% of the UK’s yearly economic output, the fishing industry is one through which Brexit’s impacts on supply and demand are clear.

Moreover, a case where the hopes of fishermen before Brexit were not met throughout the process.

While the idea of closed borders and restricted travel seems like a detriment to trade, one promise from the British government before Brexit was that fishermen in the United Kingdom would not have to abide by European quotas, an opportunity to maximize profits with larger quantities of product; however, these changes were not as they seemed. The extended quotas came for only a select few species: mackerel and herring. However, while the change left the majority of the industry stagnant, fishermen managed to increase their yearly catch overall.

Although the supply of seafood in the UK only increased by around 2% from 2019 to 2020, with the beginning of Brexit, the projected increase in quantity of seafood produced, or supply, by 2025 is 12.4%, or 107,000 tons; additionally, from January 2021 to January 2022, just two years after the UK’s official departure from Europe, the yearly catch has already increased by 6.4%. The British government did not provide exactly what they had promised, but Brexit has still managed to bring positive change to supply in the fishing industry. 

The UK became more closed through Brexit.

A chance to show their power and control while free from the European Union; as trade was restricted and Europeans were loath to buy international goods, fishermen were left with a surplus of product. Supply continued to rise through Brexit and the COVID pandemic, but demand did not; in the Port of Grimsby alone, fishermen were left with over 900 kilograms of excess seafood per week, a problematic trend that leaves the ocean with less life and the port with more waste. A fisherman from the Port of Scarborough accounts that, with longer and more complicated exports from the United Kingdom to Europe, “fish is less fresh,” and “customers have been lost.” With greater incentives to turn to fresher substitutes in Europe, fishermen in the UK have been deprived of many customers needed to purchase an increasing supply of seafood.

Bank of England

Additionally, the surplus can be examined through the lens of the Law of Diminishing Marginal Utility, stating that as more units of product are produced, and the product becomes more common, the Marginal Utility, or satisfaction gained from that good, decreases; with more seafood and less customers globally, fishermen were marketing a common product that lacked great international desire. The lack of customer desire, along with a 20% increase in price per kilo of popular fish species, such as mackerel, from 2017 to 2021 were further disincentives to European customers, explaining the sharp decline in seafood trade with the EU seen in Figure 5.

Overall, it is hard to say whether the effect that Brexit has had on the fishing industry is positive or negative.

The freedom from European quotas has brought larger quantities of product to markets already, with supply projected to increase by over 100,000 tons of seafood by 2025. However, restricted borders and more complicated export processes from the UK to Europe have given European customers less incentive to buy British seafood, as it is less fresh and more costly. Despite the decline in seafood trade with the EU, there is hope that, as the presence of COVID-19 dwindles, international trade will be revived. Nevertheless, today, the UK is left with a surplus of product, making the fishermen’s quarry less desirable; supply continues to rise, but demand continues to fall. 

Supporting over 11% of the United Kingdom’s total jobs, tourism is a sector of the British economy projected to be worth over 250 billion Great British Pounds by the year 2025.

Initially looking at the policies of Brexit, with the United Kingdom closing off from Europe, a region that accounts for over 50% of UK tourists, it would make sense that tourism and tourist-related goods would see a clear decline in supply and demand with Brexit in effect; less people willing to travel to the UK, all things equal, brings less necessity for the tourism sector of the British economy.

However, hopes for increased trade following the June 2016 referendum, the first British vote to leave the European Union, led institutions to sell the British pound in large quantity, driving down the value of sterling silver and bringing record numbers of tourists to the United Kingdom; a surprising, yet logical outcome. Tom Jenkins, CEO of the European Travel Association, argues that currency is a driving force behind tourism; thus, numbers of incoming visitors increased as other currencies, such as the US Dollar and the Euro, were worth more compared to the pound.

As tourism soared, an uptick was seen in both the supply and demand of tourist-related products; a simple industry, such as bus tours in London, saw a 70% increase in sales from June 2016 to December 2019, evidence to the rise in supply and demand of services following the referendum.

Despite the rise in tourists in the years leading up to Brexit’s initiation, the appearance of COVID-19 makes its impact unclear as it began. With the pandemic striking in early 2020, travel was undoubtedly restricted, with an 82% decrease in tourism in the United Kingdom from 2019 to 2021; so, it is quite hard to distinguish the effects of COVID from the effects of Brexit on the industry when it comes to those traveling for leisure. Focusing on a key aspect of the UK’s tourism sector, we may examine the most popular paid tourist attraction in London, the London Eye.

The Eye, generally selling 3 to 3.5 million tickets annually, saw a 60% decrease in ticket sales in 2021, with 1.4 million tickets sold.

Each of the London Eyey’s 32 ovoidal capsules weighs 10 tonnes and can carry 25 people

The decrease, explained by Frank Uekotter, a professor at the University of Birmingham, does show a sharp decrease in ticket sales following the initiation of Brexit, a fall in both supply and demand; however, we must not look past the fact that, in 2021, the Eye was operating amidst a global pandemic, making travel more difficult and shielding the attraction from international business. Overall, it is difficult to discern the effect of Brexit on British tourism. Following the 2016 referendum, the UK saw record levels of tourism, showing increases in both supply and demand of tourist goods.

However, upon the initiation of Brexit itself in January 2020, the COVID-19 pandemic makes distinguishing the specific effect of Brexit complicated. Yes, there has been a sharp decrease in tourism in the past few years, decreasing supply and demand of tourist-related services.

However, would we have seen the same decline in a pandemic-free world?

To push forward and to make improvements in life, all we can do is find the ways in which we can develop as a society, making positive changes along the way; with Brexit in the United Kingdom, the same is true. While the COVID-19 pandemic complicates the results of Brexit in most sectors of the economy, there are still ways by which we can make recommendations for the future.

Turning to the UK’s fishing industry, it is evident that Brexit brought a large surplus of product in a time where demand was falling fairly rapidly. According to a study done by students at The University of York, fishermen in the UK are projected to see an increase of over 100,000 tons in their yearly catch by 2025, as quotas are released and fishermen have the ability to bring in more product. To improve, and to avoid the tens of thousands of kilos of seafood waste in each port along the British coast, fishermen must recognize their limits, knowing that if demand is not necessarily increasing, they need not bring in loads of surplus product.

While it is easier said than done, fishermen in the UK can make a difference if changes are made to the sector; they must forgo waste now to maintain their industry in the future. A similar story is told for the sectors of any economy; understand how to use your resources most efficiently and without any waste, and the world will see a prosperous future.

(Figure 1): Number of tourists coming into the UK from 2002 to 2022

(Figure 2): British pound value as compared to the US Dollar

Nobel Prize Winning Economist Professor Paul Romer on Hyperinflation & Protecting Science

(Figure 3): Number of travel visas granted in the UK from 2011 to 2021

(Figure 4): Number of work visas granted in the UK from 2011 to 2021

Physics Nobel Prize Winner MIT Professor Frank Wilczek on Different Universes, String Theory, Gravitation, Newton & Big Bang

(Figure 5): UK trade in seafood with the EU over the past four years

Written by Thomas Heath

Bibliography:

Jewell, Hannah, “Brexit Explained for Confused Americans”, The Washington Post, New York, NY, video, February 2019, https://www.youtube.com/watch?v=ecnGuivg0is

 Hughes, Shelly, “Brexit “fails to deliver Government promises on fishing industry”, new study reveals”, University of York Press, Heslington, UK, vol. 1, 2022

Kenyon, Darren, “Brexit and British Fishermen; Impacts of Brexit on UK Fishing”, Grimsby, UK, DW Documentary, video, June 2022, https://www.youtube.com/watch?v=XXA1GiQ-UeY

Figure 5: UK Parliament, “UK Fisheries Statistics”, House of Commons Library, London, UK, January 2022, https://researchbriefings.files.parliament.uk/documents/SN02788/SN02788.pdf

Woodson, James, “Export Market Prices for UK Mackerel”, Selena Wamucii Press Department, May 2022, https://www.selinawamucii.com/insights/prices/united-kingdom/mackerel/

Figure 2: Clark, David, “GBP to USD Exchange Rate”, Bloomberg News Press, New York, NY, 2022

UK Government, “Drivers of Demand for Travel in London”, Transport for London, London, UK, vol. 2, 2022

Figure 1: Gutierrez-Cruz, Vianny, “Travel and Tourism in the UK; Statistics and Facts”, Statista Research Press, London, UK,  2021

Furthermore, Figure 4: Clark, David, “Number of Work Visas Granted in the United Kingdom from 2011 to 2021”, Statista Research Department, London, UK, 2022

Figure 3: Clark, David, “Number of Travel Visas Granted in the UK from 2011 to 2021”, Statista Research Department, London, UK, 2022

Jenkins, Tom, “Impact Brexit Will Have on UK and EU Tourism”, (CGTN America, 2020), https://www.youtube.com/watch?v=9OEh6H7wuN0

UK Government, “Immigration Statistics, Ending December 2021”, National Statistics, London, UK, March 2022, https://www.gov.uk/government/statistics/immigration-statistics-year-ending-december-2021/summary-of-latest-statistics#:~:text=There%20were%20239%2C987%20work%2Drelated,increased%20by%2037%2C551%20or%2033%25.

Uekotter, Frank, “Making Sense of Brexit”, video, University of Birmingham, April 2022, https://www.youtube.com/watch?v=CobVJcCmvzA

Is US Bank In Trouble?

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US Bank Building in Sheboygan, Wisconsin

According to Moody’s:

“Comerica’s unrealized losses represent 40% of its common equity tier 1 capital, which is a bank’s highest-quality capital because it is fully available to cover losses. 

This percentage is even higher at U.S. Bancorp: Unrealized losses represent almost 60% of this tier 1 capital. The unrealized losses represent 40% of First Republic Bank’s tier 1 capital but about 80% of the bank’s customers are uninsured.

For comparison, unrealized losses constituted between 30% and 40% of common equity tier 1 capital for Signature Bank and 120% for SVB.”

Furthermore, if you look at the stock price US Bank faces trouble. However, they are awash in cash and liquidity. And as we all know, if we keep less than $250,000 in one account, we have the backing of the FDIC! See for details: FDIC insurance | U.S. Bank (usbank.com).

Of course at the same time, everyone wants to know how healthy their bank stands! And so let’s dig in!

Below we have a chart showing unrealized depreciation on Hold to Maturity Securities (HTM) for top 100 banks versus equity. 

These unrealized losses are NOT reflected in profits or a deduct to equity via Other Comprehensive Income (OCI) – only in the footnotes! Moreover, we don’t find these losses reflected in stress tests or measures of capital adequacy. 

Furthermore a 25 bp (1/4 of 1 percent) increase in rates for a 10-year security causes approximately 2 points in losses (100 par to 98 to reflect yield discount). 

Looks pretty fantastic for US Bank! Less than 20% of its net equity finds itself impaired by long-term loan losses. Bank of America claims sterling health and they find nearly half of their equity impaired by losses on loans. Of course, neither bank plans to sell these loans. However, as SVB showed us, when a bank run occurs, a bank needs every dollar it can access. See our piece: How Did Silicon Valley Bank Fail?

Of course, now things seem different as the Federal government decided to backstop all banks. So from an existential standpoint, there is no risk. Of course, who knows, politicians can change their minds!

For more coverage on the bank crisis see our pieces:

Will Wells Fargo Fail?

Is my money Safe in Schwab?

In fact with this federal backstop, even famous short seller and market cynic thins the crisis might be over. See our piece: What is Michael Burry holding?

Lately all we can read about these days are banks failing everywhere! Are we in a financial crisis? Now some worry will Bank of America collapse? And many others worry whether or not will Wells Fargo fail? 

And of course, many others worry about whether the more local establishments can keep breathing. Will First Republic Bank fail? Or is my money Safe in Schwab?

US Bank is a financial institution that provides a wide range of banking and financial services to individuals, businesses, and institutions.

US Bank was founded in 1863 as the First National Bank of Cincinnati. Over the years, the bank underwent several mergers and acquisitions, expanding its operations and geographic reach. In 1966, the bank changed its name to United States National Bank of Oregon and, in 1997, it adopted its current name, US Bank.

In the last two decades, US Bank grew significantly.

According to its financial reports, the bank’s total assets increased from $162 billion in 2001 to over $600 billion in assets today, representing a growth rate of over 240%. The bank also expanded its operations into new markets, acquired other financial institutions, and diversified its product offerings.

One of the key drivers of US Bank’s growth has been its focus on digital banking and technology. In recent years, the bank has invested heavily in digital infrastructure, launching mobile banking apps, online account management tools, and other digital services to meet the evolving needs of its customers.

The US Bank Tower in downtown Los Angeles, California

In conclusion, US Bank’s history finds itself marked by growth, innovation, and a commitment to providing high-quality banking services to its customers.

U.S. Bancorp logo.svg

U.S. Bancorp
 – U.S. Bancorp Annual Report 2010 (Referrer:About U.S. Bancorp–Annual Meeting

Is US Bank In Trouble?

How Did Silicon Valley Bank Fail?

Business

Silicon Valley Bank Blinders

Silicon Valley Bank logo, 2022.svg

The Silicon Valley Bank failure strikes me as a colossal failure of bank regulation, and instructive on how rotten the whole edifice is. I write this post in an inquisitive spirit. I don’t know the details of how SVB was regulated, and I hope some readers do and can chime in. 

As reported so far by media, the collapse was breathtakingly simple. SVB paid a bit higher interest rates than the measly 0.01% (yes) that Chase offers. It attracted large deposits from venture capital backed firms in the valley. Crucially, only the first $250,000 are insured, so most of those deposits are uninsured. The deposits are financially savvy customers who know they have to get in line first should anything go wrong. SVB put much of that money into long-maturity bonds, hoping to reap the difference between slightly higher long-term interest rates and what it pays on deposits.  But as we’ve known for hundreds of years, if interest rates rise, then the market value of those long-term bonds fall. Now if everyone comes asking for their money back, the assets are not worth enough to pay everyone back.  

In sum, you have “duration mismatch” plus run-prone uninsured depositors.

We teach this in the first week of an MBA or undergraduate banking class. This isn’t crypto or derivatives or special purpose vehicles or anything fancy. 

Where were the regulators? The Dodd Frank act added hundreds of thousands of pages of regulations, and an army of hundreds of regulators. The Fed enacts “stress tests” in case regular regulation fails. How can this massive architecture fail to spot basic duration mismatch and a massive run-prone deposit base? It’s not hard to fix, either. Banks can quickly enter swap contracts to cheaply alter their exposure to interest rate risk without selling the whole asset portfolio. 

Michael Cembalist assembled numbers. This wasn’t hard to see. 

Even Q3 2022 — a long time ago — SVB was a huge outlier in having next to no retail deposits (vertical axis, “sticky” because they are insured and regular people), and a huge asset base of loans and securities. 

Michael then asks 

.. how much duration risk did each bank take in its investment portfolio during the deposit surge, and how much was invested at the lows in Treasury and Agency yields? As a proxy for these questions now that rates have risen, we can examine the impact on Common Equity Tier 1 Capital ratios from an assumed immediate realization of unrealized securities losses … That’s what is shown in the first chart: again, SVB was in a duration world of its own as of the end of 2022, which is remarkable given its funding profile shown earlier.

Again, in simpler terms. “Capital” is the value of assets (loans, securities) less debt (mostly deposits). But banks are allowed to put long-term assets into a “hold to maturity” bucket, and not count declines in the market value of those assets. That’s great, unless people knock on the door and ask for their money now, in which case the bank has to sell the securities, and then it realizes the market value. Michael simply asked how much each bank was worth in Q42002 if it actually had to sell its assets. A bit less in each case — except SVB (third from left) where the answer is essentially zero. And Michael just used public data. This is not a hard calculation for the Fed’s team of dozens of regulators assigned to each large bank. 

Perhaps the rules are at fault?

If a regulator allows “hold to maturity” accounting, then, as above, they might think the bank is fine. But are regulators really so blind? Are the hundreds of thousands of pages of rules stopping them from making basic duration calculations that you can do in an afternoon? If so, a bonfire is in order. 

This isn’t the first time. Notice that when SBF was pillaging FTX customer funds for proprietary trading, the SEC did not say “we knew all about this but didn’t have enough rules to stop it.” The Bank of England just missed a collapse of pension funds who were doing exactly the same thing: borrowing against their long bonds to double up, and forgetting that occasionally markets go the wrong way and you have to sell to make margin calls. (That’s week 2 of the MBA class.)  

Ben Eisen and Andrew Ackerman in WSJ ask the right question (10 minutes before I started writing this post!) Where Were the Regulators as SVB Crashed? 

“The aftermath of these two cases is evidence of a significant supervisory problem,” said Karen Petrou, managing partner of Federal Financial Analytics, a regulatory advisory firm for the banking industry. “That’s why we have fleets of bank examiners, and that’s what they’re supposed to be doing.”

The Federal Reserve was the primary federal regulator for both banks.

Notably, the risks at the two firms were lurking in plain sight. A rapid rise in assets and deposits was recorded on their balance sheets, and mounting losses on bond holdings were evident in notes to their financial statements.

moreover, 

“Rapid growth should always be at least a yellow flag for supervisors,” said Daniel Tarullo, a former Federal Reserve governor who was the central bank’s point person on regulation following the financial crisis…

In addition, nearly 90% of SVB’s deposits were uninsured, making them more prone to flight in times of trouble since the Federal Deposit Insurance Corp. doesn’t stand behind them.

90% is a big number. Hard to miss.  The article echoes some confusion about “liquidity”

SVB and Silvergate both had less onerous liquidity rules than the biggest banks. In the wake of the failures, regulators may take a fresh look at liquidity rules,…

This is absolutely not about liquidity.

SBV would have been underwater if it sold all its securities at the bid prices. Also 

Silvergate and SVB may have been particularly susceptible to the change in economic conditions because they concentrated their businesses in boom-bust sectors…

That suggests the need for regulators to take a broader view of the risks in the financial system. “All the financial regulators need to start taking charge and thinking through the structural consequences of what’s happening right now,” she [Saule Omarova] said

Absolutely not! I think the problem may be that regulators are taking “big views,” like climate stress tests. This is basic Finance 101 measure duration risk and hot money deposits. This needs a narrow view! 

There is a larger implication. The Fed faces many headwinds in its interest rate raising effort. For example, each point of higher real interest rates raises interest costs on the debt by about $250 billion (1 percent x 100% debt/GDP ratio). A rate rise that leads to recession will lead to more stimulus and bailout, which is what fed inflation in the first place. 

But now we have another. If the Fed has allowed duration risk to seep in to the too-big to fail banking system, then interest rate rises will induce the hard choice between yet more bailout and a financial storm. Let us hope the problem is more limited – as Michael’s graphs suggest. 

Why did SVB do it?

How could they be so blind to the idea that interest rates might rise? Why did Silicon Valley startups risk cash, that they now claim will force them to bankruptcy, in uninsured deposits? Well, they’re already clamoring for a bailout. And given 2020, in which the Fed bailed out even money market funds, the idea that surely a bailout will rescue us should anything go wrong might have had something to do with it. 

(On the startup bailout. It is claimed that the startups who put all their cash in SVB will now be forced to close, so get going with the bailout now. It is not startups who lose money, it is their venture capital investors, and it is they who benefit from the bailout. 

Let us presume they don’t suffer sunk cost fallacy. You have a great company, worth investing $10 million. The company loses $5 million of your cash before they had a chance to spend it. That loss obviously has nothing to do with the company’s prospects. What do you do? Obviously, pony up another $5 million and get it going again. And tell them to put their cash in a real bank this time.) 

How could this enormous regulatory architecture miss something so simple? 

This is something we should be asking more generally. 8% inflation. Apparently simple bank failures. What went wrong? Everyone  I know at the Fed are smart, hard working, honest and dedicated public servants. It’s about the least political agency in Washington. Yet how can we be seeing such simple o-ring level failures? 

I can only conclude that this overall architecture — allow large leverage, assume regulators will spot risks — is inherently broken. If such good people are working in a system that cannot spot something so simple, the project is hopeless. After all, a portfolio of long-term treasuries is about the safest thing on the planet — unless it is financed by hot money deposits. Why do we have teams of regulators looking over the safest assets on the planet? And failing? Time to start over, as I argued in Towards a run free financial system

Or… back to my first question, am I missing something? 

****

Updates: 

A nice explainer thread (HT marginal revolution). VC invests in a new company. SVB offers an additional few million in debt, with one catch, the company must use SVB as the bank for deposits. Furthrmore, SVB invests the deposits in long-term mortgage backed securities. SVB basically prints up money to use for its investment! 

“SVB goes to founders right after they raise a very, very expensive venture round from top venture firms offering:

– 10-30% of the round in debt

– 12-24 month term

– interest only with a balloon payment

– at a rate just above prime 

For investors, it also seems like a no-downside scenario for your portfolio: Give up 10-25 bps in dilution for a gigantic credit facility at functionally zero interest rate.

If your PortCo doesn’t need it, the cash just sits. If they do, it might save them in a crunch. The deals typically have deposit covenants attached. Meaning: you borrow from us, you bank with us.

And everyone is broadly okay with that deal. It’s a pretty easy sell! “You need somewhere to put your money. Why not put it with us and get cheap capital too?”

My Photo

Written by Stanford Professor John H. Cochrane

John H. Cochrane is a senior fellow at the Hoover Institution. He is also a research associate of the National Bureau of Economic Research and an adjunct scholar of the CATO Institute. 

Before joining Hoover, Cochrane was a Professor of Finance at the University of Chicago’s Booth School of Business, and earlier at its Economics Department. Cochrane earned a bachelor’s degree in physics at MIT and his PhD in economics at the University of California at Berkeley. He was a junior staff economist on the Council of Economic Advisers (1982–83).

Cochrane’s recent publications include the book Asset Pricing and articles on dynamics in stock and bond markets.

In addition, the volatility of exchange rates, the term structure of interest rates, the returns to venture capital, liquidity premiums in stock prices, the relation between stock prices and business cycles, and option pricing when investors can’t perfectly hedge. His monetary economics publications include articles on the relationship between deficits and inflation, the effects of monetary policy, and the fiscal theory of the price level. He has also written articles on macroeconomics, health insurance, time-series econometrics, financial regulation, and other topics. He was a coauthor of The Squam Lake Report. His Asset Pricing PhD class is available online via Coursera. 

Cochrane frequently contributes editorial opinion essays to the Wall Street Journal, Bloomberg.com, and other publications. Lastly, he maintains the Grumpy Economist blog.

The Grumpy Economist: Silicon Valley Bank Blinders (johnhcochrane.blogspot.com)

How Did Silicon Valley Bank Fail?

Is Brexit costing $100 billion a year?