Nevermind the Brexit, UK will emerge with a good trade deal

Tomohiro Ohsumi | Bloomberg | Getty Images

The British never wanted to be part of a German-dominated European federal super state.

The exit from the EU will allow the U.K. to reclaim parts of national authority that its political elites ceded to unelected Brussels officials free of any meaningful democratic oversight.

The scare-mongering about the end of the U.K. and the unraveling EU is meaningless. My guess is that the U.K. will do better that the unwieldy "union" of 27 countries whose leaders have yet to figure out where they are going.

But let's take a look at the U.K. first.

The first good sign is that the leave leaders are behaving in the tradition of the British battle cry: "Keep Calm and Carry On."

They are watching the fury and the confusion in Berlin, Paris and Brussels. The leading voices in these capitals are screaming for an expeditious divorce as a swift and exemplary punishment (yes, to deter other would-be exit followers), because the Europe's oldest parliamentary democracy spoke for the rest of the continent and dared to denounce the EU's failing ways.

In case you wondered, that is how low the ideal of European brotherhood and union has fallen. These muddled up and agitated minds in Paris, Berlin and Brussels will just create more chaos and alienate more people who were looking at the EU as a haven of peace and prosperity.

The leave people, by contrast, are playing with an uncanny gemütlichkeit. They are saying that they are Europeans, and that they just want to build a close European relationship of a different kind.

Will that work? All we hear now is that it won't.

U.K.'s trade and military trump cards

Well, maybe there is some prescience in there, but please take a look at these numbers.

The U.K. is by far Germany's most profitable export market. Last year, Germany's trade surplus with the U.K. came in at 51 billion euros ($56 billion), accounting for 34 percent of the German surplus with the EU. That surplus was also 42 percent higher than the German trade surplus with France, Berlin's largest European trade partner.

With its 89.3 billion euro worth of exports to the U.K. last year, Britain is Germany's third-largest export market, after the U.S. and France.

Will Germany give this up by shutting the U.K. out of a free-trade agreement with the EU? Of course it won't.

And here is another interesting story. You probably heard the Germans boasting about their booming China trade. Here is how booming that is: Last year, German exports to the U.K. were 25 percent higher than its sales to China. The big difference being that Germans made a huge surplus with the U.K., but their China trade recorded a 20 billion euro deficit – a fourfold increase from the deficit in 2014.

No wonder that Chancellor Merkel keeps saying that there is no need to be "nasty" with the U.K., while reassuring her compatriots that she would negotiate the U.K.'s exit from the EU with a great attention to German interests.

So, put this one up for the U.K.: It has a huge leverage in its trade negotiations with the EU.

The U.K.'s military power is another ace. All Europeans know and publicly recognize, including the French, that Europe's defense makes no sense without the well-equipped and well-trained British military forces. As a reminder of that, the NATO's Secretary General Jens Stoltenberg said last Friday that the "U.K. will remain a strong and committed NATO ally and will continue to play its leading role (emphasis added) in our alliance."

Now, try to apply the radical threat brandished at the U.K. that "out is out" when the East Europeans are clamoring for military protection, and the Americans and the British remain the only credible military force in Western Europe.

And that's where Washington comes in. In a speech at Stanford University on June 24, 2016 President Barack Obama said that "the special relationship between the United States and the United Kingdom is enduring, and the United Kingdom's membership in NATO remains a vital cornerstone of U.S. foreign, security, and economic policy (emphasis added)."

He also said that "the United Kingdom and the European Union will remain indispensable partners of the United States even as they begin negotiating their ongoing relationship to ensure continued stability, security, and prosperity for Europe, Great Britain and Northern Ireland, and the world."

The EU's blind alley

The existing trade and defense ties explain why I think that the U.K. will have no trouble getting a deal it wants with the EU.

But the EU, and its future, is a much bigger worry. The union's leading tenors - Germany, France and Italy - have no idea what to do next, mostly because they are in a state of an intractable political disarray.

Here are the unpalatable choices they are facing.

First, a move toward further sovereignty transfers and a federal state - favored by some in the original six EU members - is out of the question because there is no popular support for that.

Second, the prevailing mood of the moment is the opposite: A loose confederation of nation states. That would whittle down the huge and democratically unaccountable Brussels bureaucracy, and it would repatriate a large amount of authority transferred to the EU Commission.

The only problem here is that such a loosening of ties that bind would be lethal to the monetary union whose credibility and survival require a federal state with a common fiscal policy.

But, sadly, that is a mission impossible for the present German, French and Italian governments.

The surviving German government is a political miracle of sorts. After last Friday's reconciliation attempt, the sister CDU and CSU coalition center-right parties are pretending that their ten-month old strife is over, but tensions and key policy differences remain as strong as ever. The Socialist SPD Party – the third coalition partner – is gearing up for general elections in September 2017 where they will be fighting against the CDU and the CSU. The confrontation is already reaching a fever pitch in the area of foreign policy, with disagreements on economic policy also ready to go public.

And then there is the French problem. The French press is reporting (without the official denial from the Elysée Palace) that Germany's Chancellor Merkel has put an end to the all-important French-German partnership, prompting the question of whether an isolated chancellor's influence is coming to naught.

The French seem to agree with that view. They are now building alternative partnerships with German and Italian Socialists. But that is of questionable value because France is in an acrimonious election campaign, punctuated by crippling strikes and months-long demonstrations. The country's Socialist president, polling at 15-17 percent, is the weakest and the most unpopular leader in the 58 years of the Fifth Republic. His center-right opposition also looks splintered and disorganized. Only the extreme-right anti-European Front National (FN, polling between 30 and 40 percent) seems well organized and emboldened by the British referendum, and by strong anti-EU forces gaining ground in Austria, Italy and the Netherlands.

Italy's erstwhile can-do Prime Minister Matteo Renzi is less so these days. An informal but determined coalition of center-right political forces just scored big in local elections, taking mayor's offices in Rome and Turin. The same group, coalescing around the Five Star Movement (M5S), seems ready to go again against the ruling Democratic Party (PD) in a vote on an outdated and destabilizing bi-cameral legislature next October. If he loses the vote – which now looks like a near-certainty – Mr. Renzi repeated last week that he would "resign and go home" to Florence.

That is the EU that the UK will be negotiating with about a free-trade in goods and services. And London will be doing that from a position of the EU's second-largest trading partner (after the U.S.), and the most powerful military and political force in Western Europe.

Investment thoughts

The U.K. now has the possibility of correcting mistakes committed over the last 43 years by allowing a creeping accession to the EU's centralized power structures. The UK's positioning in the "heart of Europe," as triumphantly claimed by the former Prime Minister Tony Blair, had nothing to do with London's original intent of joining a prosperous customs union and a unified market in an expanding European free-trading area.

The new British government can go back to its initial objective and negotiate with the EU a trading relationship it wants. Its trump cards are (a) a large economy, (b) strong trade and investment ties with the rest of Europe and (c) its position as one of the world's leading military and political powers.

Throughout that process, the U.K. is certain to have a full support of the United States.

Markets will gradually absorb all that and revert to fundamentals, after the bloodbath of last week's wrong trading bets.

The euro area has entered a period of worsening political disarray. Germany is living with an unstable government and rising Europhobic extreme right political forces. France is experiencing growing socio-political problems in the run-up to elections in May 2017. Spain is likely to remain in a state of protracted inter-regnum following this Sunday's elections. Italy is facing a distinct possibility of a falling government and a new round of chaos next October.

As long as its mandate lasts, the ECB will hold the fort and continue to nurse along the unfolding economic recovery.

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