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Brexit’s Not Over

Brexit’s Not Over

A leave supporter is seen as fishing boats campaigning for Brexit sail down the Thames through central London on June 15, 2016. Source: billboard.com

A leave supporter is seen as fishing boats campaigning for Brexit sail down the Thames through central London on June 15, 2016. Source: billboard.com

By Jacob Hess

In an interview with the Economic Club on September 12th 2016, Jamie Dimon, the CEO of J.P. Morgan Chase, warned that Brexit could result in a “big recession” and that the “Eurozone could unravel.” At the conclusion of the June Federal Reserve meeting, Chairwoman Janet Yellen echoed his position, saying that Brexit “could have significant economic repercussions.” These two financial figureheads are just two of many who foresee negative Brexit consequences on the United Kingdom and its neighbors.

In fact, a poll of the European Union’s largest nations showed that the UK’s exit was viewed negatively among Europeans. In Sweden, 89 percent of respondents said that Brexit would be a “bad thing” for the European Union. Similar numbers came out the Netherlands, Germany, Hungary, and Spain where 70 percent or more respondents showed disproval.  In the same countries, an average of 13.4 percent had opinions to the contrary. A negative consensus sentiment should not a surprise. The United Kingdom, with Germany and France, formed the Union’s core on political and economic matters.

The question still remains. Was Brexit a bad thing? If it was, for whom? Even though voters in the United Kingdom decided that an exit was the most beneficial, the vote count was nearly split. Political tension over immigration and labor resulted in the resignation of Prime Minister David Cameron, who was replaced by the Conservative Party’s Theresa May. Socially, divisions between isolationists and their counterparts peaked as the migrating E.U. laborer was thrown into the spotlight. These issues became the face of the UK’s departure and continue to populate short-term discussions about the repercussions of Brexit.

In the long-run, the normalization of a United Kingdom independent of the European Union could have larger implications for the global economy. As the fifth largest economy in the world by gross domestic product, the UK’s [HH1] import and export chains have international significance. Any major disruptions could result in weaker global growth. According to the most recent data, the UK is the world’s ninth largest exporter and the fifth largest importer with a majority of its business going through one of the largest regional economies in the world, the EU.

British Prime Minister Theresa May. Source: newstatesman.com

British Prime Minister Theresa May. Source: newstatesman.com

Initially, investors showed their apprehension by selling on major markets across the globe. Reuters estimated that about $2 trillion in value was lost in stock markets the Friday after the Brexit vote. In Germany, the major stock index, which follows the largest public German companies, fell over 7 percent. In France, investors reacted similarly while Italian and Spanish traders forced losses to over 12 percent. The stocks which fell the most were the biggest banks in the UK, Lloyds, Barclays, and RBS, all seeing a drop in share price around 30 percent.

The poor reaction of European stock markets represented the general aversion towards an exit vote. No major economic or financial data had shown that pessimism was justified, but a general sense of uncertainty can be enough to make investors sell. While the fickle response to the UK’s exit in stock markets was quickly reversed over the next month, some weakness began to show itself in the later part of the summer.

The British pound, a notoriously sound currency known for its strength over the US dollar, fell dramatically before and after the Brexit vote. As defined by Harvard economists Reinhart and Rogoff, the pound experienced a short-term currency crash seeing losses of around 15 percent within a month. The crash could end up hurting the economies of the remaining EU members as their goods will become more expensive to the fifth largest importer in the world. A stronger euro could also counter some stimulus measures implemented by the European Central Bank, which is looking to jumpstart low inflation in the region.

For the UK, a weaker pound scenario has mixed consequences. As a currency’s value declines , businesses find more demand for their goods in foreign markets, but they may face softer consumption at home.  However, positive effects from extra foreign demand are typically smaller for countries with a current account deficit, like the UK. Therefore, Brexit could depress the amount of capital flowing into the country, and from there, disposable income and investment could be squeezed as well.

As economic data usually takes a while to compile, assessment of Brexit’s long-term economic impact is restricted to informal collections of data. The Economist provided some interesting insights and trends in a mid-July article. Restaurant reservation statistics collected by a local website reveal nothing unusual, and retail store traffic trends remained unchanged. On the other hand, data from a job-search website showed that “there were one-quarter fewer jobs” almost a month after Brexit. In addition, a peer-to-peer loan service reported lending down 10 percent and a real estate pricing site estimated that about 1,000 London homes saw decreases in price.

The flat trends in restaurant and retail business suggest that Brits don’t feel a need to adjust their consumption habits because of the exit. Instead, personal income is more likely to fall implicitly with the devaluation of the pound and more expensive trade with the EU. Businesses are more likely to recognize this effect, and adjust their behavior accordingly. For them, the reported drop in housing prices could be the most frightening as it represents lower foreign demand and shrinking national wealth, which would ultimately stunt economic growth.

It seems evident that domestic markets in the UK will be hurt by a devalued currency, stagnant personal income growth, and a pessimistic business outlook, but will similar effects be evident in EU member economies? [HH2] The largest expected impact on the continent’s economy will be in foreign trade. According to Woodford Funds, “63 percent of Britain’s goods exports are linked to European Union.” Thus, its exit could bring about shifts in trade relationships, as the UK will not be bound to regional ties that were secured by the EU.

This newfound policy freedom will dictate long-term trade consequences as the new British leadership will have the option to adjust trade relationships away from its neighbors; although, any major shift is unlikely. During the period of trade negotiations, foreign direct investment into Britain will begin to weaken, according to Woodford, as firms on both sides will be subject to higher tariffs, uncoordinated regulations, and currency fluctuations. One thing is certain: business relationships between EU firms and UK firms will see some strain, whether it be higher costs or more regulation. This negative dynamic will mute the economic efficiency that comes from operating in “a single market.”

The weight on trade and financing that will be placed on the UK and the EU after Brexit will be reflected in GDP data over the next couple of years. Analysis from the London School of Economics suggests that British GDP will fall 2.2 percent optimistically and as much as 9.5 percent in the worst case scenario. On the other hand, Tim Congdon of the Independence Party estimated a savings of 10 percent of GDP after leaving.

Numerical projections vary across institutions with most regressing towards a flat mean. European GDP numbers are already soft and have been slowing over the past couple of years. UK’s exit will do nothing to quicken the stagnant growth, and in fact, will most likely hinder it. Disunity not only creates uncertainty, which is bad for financial markets, but it allows economies to drift apart even though similarities in infrastructure would benefit business relationships on both sides. For that reason, figureheads like Dimon and Yellen are justified in expecting negative economic consequences from Brexit. The unraveling of the EU’s regional dominance could be in danger with the option for further exits now clearly on the table.

 

 

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