See This For What It Is…

I think 99% of what I’ve read on Brexit is politically correct, populist claptrap. “The UK is bad because they won’t play along; the EU is good because we’re all in this together. The UK voter is ignorant and doesn’t understand the economic nightmare they’ve just unleashed. The ‘highly educated and urbane’ technocrats of the European Union (EU) know what’s best for ordinary citizens who simply can’t understand the issues.”

I’ve heard both comments in the past three days and find them ill-informed and woefully shallow attempts to explain a bigger event than I believe most people realize. Understanding the event itself and the possible ramifications requires you to see it for what it is—a vote for control of one’s own affairs…a reclaiming of sovereignty. I’ll try to help—keep in mind this is just my opinion and is clearly not widely shared!

Some history is necessary to understand why the British voted to exit. In the early 1990s, the members of the European Community signed the Treaty on European Union (TEU) with the stated intention to “integrate Europe.” There had been formal agreements in the past, similar in nature but mostly focused on facilitating trade and more efficient economic cooperation. The TEU opened the door to political integration and for the first time put in place governing bodies to enact the “three pillars of the European Union:” namely, EU supra-national institutions to deal with:

  • Economic, social and environmental policies (Pillar 1);
  • Common foreign policy and military matters (Pillar 2); and
  • Police and Judicial cooperation in criminal matters (Pillar 3).

All three of these “pillars” were merely extensions of existing structures that had either formally or informally been in practice, as European countries had been dabbling with various forms and degrees of integration since the late 1950s and more seriously since the early 1970s. What set the TEU apart from the other treaties/agreements was the degree of formalization, the formation of authoritative governmental bodies, and the range of issues on the table for control under the new treaty. The establishment of the “pillar” system was due to the desire of many member states to extend the European Economic Community (EEC) (forerunner to the European Union) into other areas beyond economics.

Not everyone agreed. In fact, the UK in particular (Germany as well!) was adamantly opposed to handing any control or influence over non-economic issues to a supra-national body due to a perceived loss of sovereignty. This is why, instead of simply renaming the EEC as the European Union, the treaty established the European Union as a completely separate legal entity and left the EEC intact as a separate entity.

This is what allowed the UK to be in the EEC with associated trade benefits, etc., but not part of the EU, membership in which required common currency and further integration of foreign policy, judicial, and military matters. Additionally, Germany was most vocally concerned about establishing convergence criteria to ensure that strong members of the union would not be on the hook for the weaker members’ debts. Germany pushed their fiscal and monetary agenda rather hard and was accused throughout Europe of using their strong financial position to bully their smaller and less fortunate European colleagues. Ultimately Germany would not fold…if they were going to be part of this Union, every other member had to meet certain criteria:

  • Inflation rates had to be maintained at no more than 1.5% higher than the average of the three best performing member states;
  • Government finance—annual deficits could be no more than 3% of GDP; furthermore, debt to GDP ratios could not exceed 60%…in the event where for various reasons it is necessary to not meet these criteria, the violation should be temporary and trending toward resolution;
  • Exchange rates—various rules around the exchange rate mechanism prior to joining the EU;
  • Interest rates—The nominal long-term interest rate must not be more than 2% higher than in the three lowest inflation member states.

These criteria became known as the Maastricht criteria (a.k.a. convergence criteria) and were a critical part of joining and maintaining membership in the EU.

It is very important to understand that in all the negotiations leading up to the Treaty, sovereignty was a key issue. Each individual country had its own issues with the transfer of control over certain issues to a central body leading to numerous “exceptions” afforded to specific countries (the UK, Denmark and others). The sovereignty issues were highly contentious as reflected in the ratifying votes: France ratified the Treaty with a vote of 51.05% in favor. Denmark’s first attempt to ratify failed and barely passed after the Denmark exceptions were included in the language. Norway voted against. Sweden ratified the Treaty by a 56% majority vote. Clearly the idea was not universally considered a brilliant one.

The first pillar was most affected by the supra-national powers of the EU, while the other two were less so; however, in the subsequent amendments known as the Treaty of Amsterdam and the Treaty of Nice, the remaining two pillars were brought more into the realm of supra-national as these treaties transferred significant control over policy to the EU. While ultimately the “pillar system” was abandoned for administrative reasons, the power of the EU government had been established and was growing. Concerns over the loss of sovereignty were growing as well in various countries, as several conflicts with EU rules and regulations were taken to court.

Even Germany pressed various issues to its Supreme Court equivalent to determine the constitutionality of various actions taken by the EU. It all went bad during the global financial crisis. The global financial crisis of 2008 turned the smoldering conflict between integration and sovereignty into a bonfire. The EU had been expressly forbidden from printing money, buying the sovereign debt of member countries, quantitative easing-like operations…basically all the tools of modern monetary policy. They were forbidden from doing these things because Germany was rightfully concerned that if the Maastricht criteria were not strictly adhered to, the Union would quickly devolve to the lowest common denominator. The crisis necessitated a bailout of several EU members to the tune of hundreds of billions of Euros, and subsequent aggressive monetary easing, quantitative operations etc…. all powers expressly denied the EU.

So why bring all of this up…the key issue here is sovereignty. It has to be seen in that light to make sense. I wrote about it in 2010 in my quarterly commentary as spreads between the sovereign debts of EU member countries (spreads which are supposed to be tight) began blowing out to as much as 1000 basis points and the bond vigilantes were attacking. As I put it then, Europe had to stop fooling around and decide if it was truly going to marry. Marrying meant full integration. Anything short of that meant divorce.

It was a real test of the EU and their commitment to the thing they’d all signed on to. For the ensuing two years, the EU stuck to the script…Maastricht criteria…harmonize financial ratios…continue to push the original criteria that were established to join even though none of the peripheral nations were even trying to adhere to them. As a matter of fact, most member countries had engaged in various accounting gimmicks to improve the optics of the ratios, though the underlying truth was far worse.

Then came 2012. The technocrats in Brussels decided they’d had enough of following the rules laid out by people who didn’t understand. Mario Draghi stepped up to the microphone and said he would do “whatever it takes to defend the Euro, and it will be enough.” Several member countries went ballistic at the idea. Germany actually sued on the basis that the EU had been expressly denied the authority to do whatever it takes. Germany knew this because it had been the one negotiating the specific authority of the EU Central Bank and was the one most concerned about the risks of a “race to the bottom” monetary policy to accommodate weaker countries that couldn’t get their act together. Because of the agreed integration of police and judicial matters, the EU Court of Justice was the venue with jurisdiction! It decided rather unsurprisingly that the EU did have the authority. “Whatever it takes” was a key moment…it was the moment at which the loss of sovereignty was crystallized.

The UK and many other countries had serious concerns at the outset with ceding control to a foreign body. These concerns were deal-breakers. The Treaty is riddled with carve-outs and exceptions to accommodate each of these issues coaxing various countries to join. The problem was a creeping one…as with all political establishments that once they are put in place they grow their own heart, liver and lungs. They become living, breathing, and most importantly changing entities, which in the case of the EU led to a slowly expanding claim of control over issues that were critical decision points from the very beginning. The UK just decided enough is enough.

Don’t be so superficial as to judge their actions and deride the decision as “not being nice.” How much control over your affairs do you want to cede to someone else? I believe the answer is clear. This is a sentiment I understand completely. There is no doubt that many other people were concerned about sovereignty back in 1992 and have watched nervously as each additional Treaty granting more control to the EU was passed. I’m betting many of these people are at a similar tipping point that the UK just crossed. Don’t be surprised if the talk of a referendum in other countries begins. The same issues that drove the UK to this point were openly expressed in many other countries when this grand experiment began. It’s not a prediction, but I expect there will be others.

In conclusion, don’t be too quick to criticize and scorn the “ignorant British pensioner” who “voted out of fear of foreigners and doesn’t like change.” Their concerns were clearly stated 24 years ago; they were addressed by several specific exceptions to the Treaty fiercely negotiated and fought for; complaints were lodged formally and diplomatically at every step of the way when expectations were not met; the growing control and interference of the EU continues apace with no apparent end. What the EU has become in practice is hardly recognizable compared to the noble intentions and strict, specific rules limiting the authority of the EU laid out by the original TEU and subsequent amendments. The facts have changed. As John M. Keynes famously said, “When the facts change, I change my mind. What do you do, sir?”

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