The Brits have voted to say “so long, farewell, auf wiedersehen, goodbye” to the European Union in a referendum that yielded 51.9% of voters opting to leave.
Global stock markets were hit hard following the surprise decision given all the uncertainty it creates.
The only sure bet is that Friday’s market volatility is likely to continue because it could be a long goodbye. Of course, no one knows how long it will take for the UK to sever its ties with the EU, or even what the new European order will look like. Nobody knows whether other Eurosceptic countries now will be inspired to leave the EU.
Nobody knows if there will be spillovers to other regions, including to the US. While we don’t expect that Brexit and its consequences will cause a global recession, our “Stay Home” investment strategy should continue to outperform the “Go Global” alternative given the heightened global uncertainties.
Consider the following:
(1) Going down a long road with no cans to kick.
Up to two years of negotiation is specified within Article 50
of the Lisbon Treaty, which vaguely maps out an orderly process for leaving the EU. David Cameron, the UK prime minister who resigned
as a result of the vote, will leave up to his successor the questions of when and whether to invoke Article 50 — which no country has ever done since the article was put into place in 2009.
Another option is for the UK to determine its own course. Either way, sorting out all of the new relationships from trade to immigration to business operations is going to take a really long time. For comparison, the free-trade agreement between the EU and Canada has taken nearly a decade
to develop and has not yet been ratified
. EU-UK negotiations are likely to be much more hostile, especially if not conducted as specified in the treaty.
(2) Less binding ties for UK.
Even before the Brexit vote, the UK resisted fully integrating with the EU. The nation has been one of six EU member states not participating in the Schengen Area, which includes 26 European countries (22 of which are EU members) that have abolished passport checks and other border controls for citizens and many legally present non-EU nationals traveling among these countries. And the UK has been one of nine member states (out of 28) that maintains its own currency. Further, only the UK and Denmark have opted out of the Economic and Monetary Union (EMU) and are exempt from moving toward adopting the euro — leaving monetary policy as a domestic issue. That’s according to a 5/12/15 EurActiv.com article,
which listed a few more of the UK’s voluntary opt-outs from the EU as well.
Prime Minister David Cameron had even negotiated for additional acts of separation from the other EU nations, which would have gone into effect had UK citizens voted to stay.
They included an amendment
to the Treaties stating that the UK would not be a part of the EU’s movement towards an “ever closer union.” But many of the Brexit voters obviously didn’t believe that Cameron had won sufficient independence, with immigration and economic issues topping their complaint list. (For more, see the BBC’s 2/20 article titled “What Cameron wanted and what he got.”)
Victory for the “leavers” aside, the UK cannot entirely divorce itself from having to deal with the EU, for nearly half of the UK’s trade comes from within the EU’s borders. In a 6/24 article,
Bloomberg outlined three models for what a post-Brexit UK might look like relative to the EU: the Norwegian Model, a New Deal, or WTO Rules. Under the Norwegian Model, the UK would still be a part of the European Economic Area, contributing to the EU budget and participating in the EU’s single market.
A New Deal scenario would require the UK to negotiate its own free-trade agreement with the EU, with the extent of Britain’s market access up for negotiation. The UK wouldn’t have to negotiate as much if it simply used the WTO’s rules to set its own tariffs, but it wouldn’t have any sort of favored relationship with the EU. So the outcomes could vary widely in terms of just how integrated with the EU the UK will become. To that end, exactly how the remaining member states will function as a bloc in the absence of the UK is also a big unknown.
(3) Not so easy to leave the euro.
The initial economic consequences of a Brexit could be nasty for the UK, causing a DIY-recession, as some have warned. But such a recession likely would stay relatively contained within the UK-EU borders. A more concerning possibility: the exodus of other EU-skeptical countries, further weakening the shaken union.
However, it would certainly be much more difficult for nations participating in the Eurozone to leave the EU, as they would have to untangle from the euro and reestablish independent currencies, which the UK already has in place. No special language in Article 50 seems to dictate how this would be handled.
Back when talk of a “Grexit” — i.e., Greece leaving the EU — was all the rage, the BBC discussed in a 5/10/12 article
how nearly impossible it would be for a country to leave the euro without leaving the EU. And leaving the euro could get messy, especially legally speaking, as all basic financial transactions would have to be redenominated.
(4) Who might be next to walk out the door?
Obviously, the bigger the economy and its relevance in the EU, the more likely any such exit is to irrevocably disintegrate the union.
The BBC provided
a helpful breakdown of the EU’s 2015 budget contributions (net after rebates) by country: Germany (21%), France (16), UK (13), Italy (11), Spain (8), and the Netherlands (6), with the remaining 22 member states contributing less than 5% each (for a total of 25%).
The UK’s “leave” isn’t enough to take down the EU. But it could spark a political contagion. While a leave from a lesser contributor to the EU’s budget might not put an end to the EU, an exit from a primary contributor certainly could be detrimental to the union.
But how likely is it that Germany, France, Italy, or Spain would leave? Three recent articles from reputable media sources (i.e., Washington Post, Fortune,
) each had different lists of possible exit candidates. Spain didn’t top any of the lists. But France was on all three. Germany and Italy also got a couple of notable mentions.
In all three countries, the rise of alternative, far-right-wing, nationalist political leaders reflects growing anti-European sentiments. For example, “Madame Frexit” is what Marine Le Pen — a far-right front-runner for France’s presidential election next spring — has declared as her own alias. While the possibility is growing, none of these alternative parties is expected to gain enough traction to force exit referendums. But then again, Britain wasn’t expected to leave the EU either.
(5) Ripple effects could range from minor waves to tsunamis.
Lots of the initial analysis about the implications of a Brexit from global agencies has focused on the potential negative spillovers to the global economy. But they are mere guesstimates of what might happen, because the details of how a Brexit will unfold are uncertain.
The press release for June’s OECD Global Economic Outlook stated:
“Brexit would lead to economic uncertainty and hinder trade growth, with global effects being even stronger if the British withdrawal from the EU triggers volatility in financial markets.”
And the IMF’s April World Economic Outlook stated:
“In the United Kingdom, the planned June referendum on European Union membership has already created uncertainty for investors; a ‘Brexit’ could do severe regional and global damage by disrupting established trading relationships.” So trade and financial market volatility are on the worry lists of these major international agencies.
(6) Central banks can’t do much about political contagion.
Never fear — central bankers around the world are at the ready to keep the global economy and markets afloat, as they have since the Great Recession. In a 6/21 speech,
ECB President Mario Draghi promised: “We stand ready to act by using all the instruments available within our mandate, if necessary, to achieve our objective. In particular, the ECB is ready for all contingencies following the UK’s EU referendum.” In other words, he won’t hesitate to “do whatever it takes” to support the Eurozone, even if that means injecting more stimulus or going further negative on interest rates.
Even the Bank of Japan is ready to intervene if need be, according to Reuters
on Friday. So too Fed Chair Janet Yellen and her colleagues seem likely to postpone another rate hike until next year, having been spooked out of raising rates at their June 14-15 meeting.
They’ve repeatedly cited the possible spillover effects from global uncertainties, such as Brexit, as very worrisome. Nevertheless, as we observe above, while central banks may still have some tools to avert a financial contagion, there’s not much they can do about an anti-Globalization political contagion, especially with limited monetary policy. That being said, Yellen went so far as to admit during her June press conference
that “close coordination” of fiscal policy among central banks could be used in an “extreme situation.”
(7) House of Commons website crashes.
There is a remote chance that all of the fretting about Brexit might be for naught. On Friday, while stock markets were crashing around the world, so did the website of the House of Commons. On Friday night, so many users were aiming to sign a petition for a do-over of the Brexit referendum that the website couldn’t handle the traffic, reported the Associated Press
. That isn’t officially on the table right now. But what is on the table is a possible second independence referendum for Scotland to leave the UK. Scotland, along with London and Northern Ireland, voted to remain
in the EU.
(8) The more things change, the more they stay the same.
In any event, it most likely will take the UK a very long time to actually leave. And that might give some weight to the possibility of a Bremain revolt. Even if a Brexit goes through, it might all be for show. The UK might not be very successful in negotiating any more real independence from the EU than it already has now. In other words, the UK will continue to do business with the EU and vice versa. In the meantime, the suspense will be palpable as the Brexit drama unfolds, foreshadowing what might happen if other EU member states decide to exit.
Dr. Ed Yardeni
is the President of Yardeni Research, Inc., a provider of independent global investment strategy research. To read more of his blogs, CLICK HERE NOW.
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