British voters delivered a stunning repudiation to their political and economic elites by voting to leave the European Union by a margin of 52 to 48. The fallout has already started. The pound is down by over 11%, and some experts anticipate that it could ultimately fall to as low as 1.05 to the dollar, its low in the early 1980s sterling crisis. British bank stock prices have fallen by roughly 25%. Safe haven investments have spiked: gold is up 6% and the yen has traded through 100 to the dollar. The Nikkei fell by 8% and US stock futures suggest that the Dow could open down by 600 points.
But Brexit represents something much bigger than an economic or political crisis. Although UKIP played shamelessly on the anti-immigration fears, many of the Leave campaigners argued for national sovereignity and self-determination. And the Northern areas that came in strongly for Leave have been left behind as London and environs prospered. It is simplistic, although it will nevertheless be a popular stance among the elites, to depict the Leave vote as yet another proof that technocrats should be in charge. In fact, the very reason that so many UK citizens rejected the dire warnings of what was in store for them if they dared press the red Leave button was that those experts devised and implemented the neoliberal policies that have increased inequality, reduced their economic stability and accelerated political and social change.
Brexit is a crippling blow to the neoliberal order of unfettered trade and capital flows, and citizens being reduced to being consumers who have to fend for themselves in markets, and worse, increasingly isolated worker who are at the mercy of capitalists who are ever more determined to reduce labor costs and hoard the benefits of productivity gains for themselves. Whether they recognize it or not, and we’ll find out over the coming months and years how well different Leave voters saw the choice they made, they have chosen a lower standard of living as a price worth paying for a hope of more control over their destinies. Sadly, these voters are likely to realize the first part of that equation rather than the second.
What happens next is very much in play. In a radical departure from a failed prime minister stepping down immediately, Cameron plans to remain for 90 days to sort out party leadership. That sounds like a misguided set of priorities, and could possibly serve as cover for a rearguard effort to extract some concessions from the EU and try to schedule another referendum. Even if that is part of the plan, it seems unlikely to succeed, given that Cameron got almost nothing from his pre-referendum negotiations to extract waivers, and the German insistence that the British must be made to suffer as much as possible for this vote pour decourager les autres.
Cameron intends to use those 90 days of his extended departure to sort out some of the elements of this messy separation; his successor would decide when to trigger the formal Article 50 separation process. The Financial Times points out other routes are possible, although they seem implausibly difficult to achieve in practice:
Lawyers in Whitehall and Brussels see two distinct tracks. The first is under Article 50 of the EU treaties — the so-called “exit clause” — which lays down a two-year renewable deadline for a country to leave.
A second track makes arrangements for future relations, from trade to co-operation on security or law enforcement. This is a more complex negotiation and, once agreed, harder to ratify. It requires unanimity and approval by more than 30 European, national and regional parliaments, possibly after national referendums.
There are alternatives. One is to attempt a divorce on British terms. The Leave campaign has outlined plans to legislate in the House of Commons to repeal some EU obligations immediately, while holding-off on invoking the Article 50 divorce clause to deprive the EU of leverage on timing.
Any unilateral steps would seriously raise tensions with the EU. Brussels is looking at options to retaliate, including suspending the privileges enjoyed by British companies under the single market. Sir Andrew Cahn, a former head of UK Trade and Investment, Britain’s trade promotion body, said: “Acting unilaterally would throw the law of the land into uncertainty, and risk a tit-for-tat response from others. It could be a slippery slope to real chaos.”
A major complicating factor is that while unwinding the EU arrangements is comparatively easy (and that still means the process would take roughly two years), negotiating new trade relations is a far more time consuming process, and experts estimate it would take a minimum of five years and still could fail. Again from the Financial Times:
A hard landing would mean that Britain would be left relying on basic World Trade Organisation trading terms, with no privileged access to European markets for UK companies. A softer transition could be arranged, but it would require agreement among all the remaining 27 members.
If, for instance, EU member states rapidly agree a trade deal, it could be provisionally applied while the lengthy and unpredictable process of ratification begins at national level.
Another option is to temporarily revert to an established model — such as that for Norway — to give Britain full access to the single market while its new trade deal is pushed through. That may be impossible for a Brexit government; for several years it would live by EU rules it cannot influence, pay EU budget dues and accept free movement of workers — just the things many voters rejected in the referendum.
The Wall Street Journal gives a flavor of some of the practical implications:
This leaves banks, insurers and fund managers operating in a cloud of huge uncertainty. They are all reliant to some degree on passport agreements that allow their services to be sold across Europe from the U.K. Anyone actually buying and selling securities—the banks’ trading desks—are definitely affected and many may need to move to the Continent. People who travel to perform their work, such as advisers for mergers and acquisitions or capital raising, may be able to stay based in the U.K.
Fund managers’ products would have to be re-registered elsewhere in Europe if the U.K. loses its passports. Many funds already are registered in Luxembourg or Dublin. Some groups are hopeful that the portfolio managers themselves and much of their support staff might be able to remain in the U.K. if the exit negotiations proceed in a constructive way. That is a big if…
For the time it takes to negotiate and exit, the U.K. and its financial sector remains subject to all European rules and agreements. That is one thing that can be said for sure. The other is that this hugely important sector faces great upheaval and high costs as it works out where and how it can continue to pursue its businesses.
Not to be unduly alarmist, but let us not forget former central banker Willem Buiter’s warning from November 2008, How likely is a sterling crisis or: is London really Reykjavik-on-Thames? From his post:
With the pound sterling dropping like a stone against most other currencies and credit default swap rates on long-term UK sovereign debt beginning to edge up, this is a good time to revisit a suggestion I made earlier on a number of occasions (e.g. here, here and here), that there is a non-trivial risk of the UK becoming the next Iceland.
The risk of a triple crisis – a banking crisis, a currency crisis and a sovereign debt default crisis – is always there for countries that are afflicted with the inconsistent quartet identified by Anne Sibert and myself in our work on Iceland: (1) a small country with (2) a large internationally exposed banking sector, (3) a currency that is not a global reserve currency and (4) limited fiscal capacity.
The argument is simple. First consider the case where the banking sector is fundamentally solvent, in the sense that its assets, if held to maturity, would cover its liabilities. Iceland’s banks were supposed to have been in that position, although I have seen no verifiable information on the quality of the three formerly internationally active banks. There is no such thing as a safe bank, even if the bank is sound. Without an explicit or implicit government guarantee, there is always the risk of a bank run (a withdrawal of deposits or a refusal to renew maturing credit and to roll over maturing debt) or a sudden market seizure or ‘strike’ in the markets for the bank’s assets bringing down a fundamentally sound bank.
British banking assets then as now are rougly 450% of GDP. However, the flip side is that the UK has vastly less fiscal and monetary capacity to contend with a crisis than it did then. I suggest you read his carefully reasoned post in full. It discusses in detail the options and constraints faced by countries in this position, and walks through the UK’s exposure then. It’s a good framework for analyzing that that hazard now.
In the meantime, there are immediate consequences and risks. The Transatlantic Trade and Investment Partnership is probably dead. The sterling crisis and the less dramatic fall in the euro are likely to leave some UK and Eurozone financial institutions with large losses on net dollar and other foreign currency positions. While the British banks, given the magnitude of the sterling plunge, are the obvious focus of concern, many Eurobanks are undercapitalized. Worse, the Eurozone in theory will use a bank bail-in if any institution becomes impaired. We’ve warned that this is a prescription for bank runs. And it’s not just banks that are exposed; operating businesses may have foreign currency commitments they will struggle to meet.
The British government is likely to lose its AAA rating, which also means higher funding costs for its banks, since their borrowing rates are at a premium to the local currency risk-free rate. A recession is almost certain, since the UK exports services and imports goods and many of its imports don’t have ready substitutes, while the US and European banks will be doing everything they can to poach both British bankers and their clients, denting the UK balance of trade even more. Richard Smith also points out that a Brexit could imperil Ireland’s ability to operate as a tax haven. And that raises the issue that both Scotland and Ireland supported Remain. Is a UK breakup in the offing?
Will the US live up to its threat to punish the UK for a Brexit? Politico notes:
Regardless, Obama, and his successor, will face a difficult choice: Do they carry through on Obama’s warning in April that a Brexit would put the United Kingdom “at the back of the queue” for a new U.S. trade deal? Or do they cut a deal with the United Kingdom, as some Republicans have suggested in recent days?
Obama traveled to London in April at Cameron’s request to urge the Brits to vote “Remain” and argued that Britain is more influential inside the EU, and a more valuable partner for the United States. Now, administration officials and congressional leaders will be forced to reconsider, again, whether the U.S.-UK special relationship is as important as it once was.
And with the US growth sputtering, our economy will feel the effects. Roughly 25% of S&P earnings come from Europe. The strong dollar will weigh on exporters. Europe is a major export market for China, and China may allow the renminbi to slide. Earlier this year, a devaluation of the renmibi was also seen as having the potential to trigger major upheaval. A flagging US economy going into the election hurts Clinton and Democrats generally. And this vote will embolden other separatist movements, most important, Le Front National.
No matter how this plays out, the UK and EU will have to blaze a difficult path. And this rupture is taking place when advanced economies almost without exception have singularly weak leaders. We are in for a rough ride, and the portents suggest it will be much rougher than it needs to be.