The Day After The U.K. Votes To Leave

By Mohamed El-Erian

Here’s what the world could look like on June 24 if the “Leave” camp won the previous day’s referendum on whether the U.K. should continue to be part of the European Union:

The foreign exchange markets are in turmoil, with the pound falling 7 percent to 10 percent and the euro down about 3 percent to 5 percent. Stocks also are under considerable pressure as investors try to price in greater institutional uncertainties and the coming hit to economic growth.

Prime Minister David Cameron has announced his resignation, leaving his Conservative Party in disarray as it tries to figure out how to unite behind a new leader after a divisive debate in the months leading up to the referendum. Scotland is looking to resurrect its bid for independence. The Irish are wondering what will happen to the free transfer of goods and people between the republic and the north.

The rest of Europe is stunned, and worried about a domino effect. Meanwhile, those who backed the U.K.’s exit from the European Union are trying to make sure their victory doesn’t turn into defeat, especially as some members if Parliament look into procedural ways to bypass the Leave vote.

Human nature being what it is, a media frenzy is feeding a blame game over who caused the U.K.’s departure from the EU.

The first target is the British electorate. Rather than casting their ballots on the basis of rational and calm consideration of the issues, too many voters ended up being motivated by a single, and very emotional, topic: immigration.

The electorate is largely indifferent to this accusation. After all, it was the Conservative Party, and Cameron in particular, that decided before the previous general election that a referendum was a good idea. Surely, the country’s political leaders knew what they were doing, and had taken into account the nation’s well-being.

Cameron’s response is that the promise to hold a Brexit referendum was a necessity. The government was being squeezed by the U.K. Independence Party, the anti-EU, anti-establishment movement that was eating away at the Conservatives base. The choice for the Tories was to either lose the general election or promise a referendum during the next Parliament.

UKIP, however, is jubilant about the outcome. The party’s leader Nigel Farage and his associates are certain that the short-term disruptions are a small price to pay for the opportunities available to Britain now that it is liberated from the restrictions of the EU. In their view, the U.K.’s membership in the union was a mistake from day one because the European project itself was flawed.

The architects of a united Europe say their vision of “an ever-closer union” — economic, financial, social and political — was never in doubt. And to the extent that the U.K. viewed the EU as only a super free-trade zone, this vision would have evolved over many decades of beneficial membership.

But such optimism has been rejected by anti-establishment parties in the countries traditionally viewed as anchoring a united Europe. These far-right groups, including the National Front in France, the AfD in Germany and the Danish People’s Party, point to an economic system that has failed to deliver on its promise. How else to explain sluggish growth, alarmingly high youth unemployment in certain countries, recurrent financial drama in Greece and an inability to deal with the refugee crisis?

As in an Agatha Christie novel, there appear to be multiple suspects and, in this case, multiple culprits. But a single factor bears the largest responsibility for the debacle: The repeated inability of advanced countries to deliver high inclusive growth. And the longer this deficiency is allowed to persist, the greater the damage will be.

Sophisticated advanced economies do not do well in periods of frustratingly low growth, especially when the measly benefits go to segments of the population that are already the most well-off, as has been the case recently. Under these circumstances, the list of improbable and unthinkable events isn’t limited just to the emergence of anti-establishment parties, the fragmentation of established ones, negative nominal interest rates, economic isolationism, increasingly ineffective if not counter-productive central banks, and the risk of a lost generation of unemployed and unemployable youth.

The solution to low and non-inclusive growth in the advanced world isn’t a mystery, however. Many economists already agree on what is needed and why. What has been sadly and persistently lacking is the political will and ability to implement such measures.

Perhaps the trauma of Brexit could bring about a “Sputnik Moment” that would shock political leaders into uniting behind a common vision of high inclusive shared growth and force an agreement on steps that would help avoid recessions and financial instability.

The realization that only a costly and painful economic and financial shock could trigger the appropriate policy response from legislatures on both sides of the Atlantic is further evidence of the political dysfunction that, for far too long, has placed too much of the policy burden on overstretched and increasingly exhausted central banks.

And we shouldn’t feel reassured even if the U.K. ends up by voting to remain in the EU: Yes that would remove the immediate threat of economic and financial disruptions but, unfortunately, it would do nothing to address with the system’s underlying growth defects, which are certain to cause further turmoil.

Bloomberg

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell