Europe is in deep trouble whichever way Brexit vote turns out

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Whichever way Brexit vote turns out, it’s a ‘no win’ for Europe

Britain’s EU referendum is the big risk event global markets are dreading. It could be a nightmare scenario, threatening to trigger a chain reaction that could plunge markets back into a new global catastrophe. The real worry is that the world is already slipping back into a black hole of uncertainty whichever way the vote goes. This time there may be no easy way back.

No wonder world policymakers are panicked. While European Council President Donald Tusk clearly over-exaggerated by warning Brexit could mean the end of Western civilisation, both the IMF and OECD are deeply alarmed about the consequences for the world economy and financial markets. The major central banks are already drawing up contingency plans and getting ready to intervene if the UK votes to leave the EU and markets descend into chaos. It is hard to see what they can do. Global currency, credit and equity markets are already highly agitated.

Europe should be especially worried. Whatever happens in the Brexit vote, Europe will feel deep shockwaves. It is a 'no win situation', with Europe standing to lose whichever way the vote goes. Europe is not long out of the 2009-2013 euro zone crisis and it has taken huge stabilisation efforts from EU governments and the European Central Bank to stop European monetary union and the euro falling apart. It would not take much to open up old wounds and set Europe lurching off into new economic and financial disorder.

A 'leave' vote will have an immediate impact. Capital flight out of the UK, a sterling currency crisis and the threat of economic ruination would hit British markets especially hard. Europe would not be spared and market speculators would quickly home in on contagion risks spilling over into the euro zone. Economic and financial stability would be knocked off its perch. The bears would scent blood and begin the hunt for 'who goes next'.

Even if the UK votes to 'remain', the barn door has been opened far too wide on European disintegration risks. Despite all the healing balm thrown into the ring from the ECB's monetary super-stimulus in the last seven years, the same old problems persist. Europe remains deeply divided, split between the economic haves and have-nots. Extremely rich and powerful Germany juxtaposes on the one side with struggling euro zone nations like Greece, Portugal and Spain on the other.

Immersed in deep debt, stifled by austerity and dogged by rampantly high unemployment, there is little chance of long-lasting economic recovery for these nations, especially considering the extremely challenging global backdrop right now. The threat of hard landing in China, instability in emerging economies and now the threat of Brexit contagion all pose serious dangers ahead for struggling euro zone nations. But there are bigger elephants in the room, not least growing anti-austerity protests in France and the risk that Italy falls victim to the deepening investor gloom.

If the risk of Greece going into national insolvency threatened to up-end global markets, the threat of Italy going into a banking and government debt default would be nemesis for the world economy. The problem would be far too great for the ECB’s limited resources to cope with. The recent election successes of the populist anti-austerity Five Star Movement underlines that there is a ticking time-bomb under conventional Italian politics. Italy remains the sleeping giant of the euro zones’ Doomsday disorders. In time Italy will come back to haunt the markets.

Despite the drive to negative interest rates, the glut of QE money and the high official ramparts surrounding the euro zone's vulnerable financial markets, the ECB's monetary defences are far from impregnable. With market jitters becoming more acute, peripheral yield spreads are already widening relative to German government bonds on safe haven flows. If markets decide to take on the ECB, it could trigger a dangerous re-run of the 1992-1995 and 2011-2012 deconvergence bloodbaths. European markets are highly vulnerable.

The real worry is that EU policymakers continue to kick the can down the road without solving the real economic and social inequalities dogging Europe. As long as Germany gets stronger, at the expense of the weaker European nations, political divisions will widen and the cohesive forces holding Europe together will continue to fragment. Anti-austerity protests and political extremism are on the rise and leading to deepening antipathy towards Brussels and the EU.

These trends are crystal clear in the usual suspects like Greece, where up to three quarters of voters are dissatisfied with the EU. More alarmingly similar trends are showing up in core countries like Austria, Netherlands and France which are witnessing the emergence of more inward-looking, nationalistic and anti-EU tendencies. It bodes badly for the future.

There is much more at stake in Britain's Brexit vote. The survival of European unity, the single market and the euro is on the line. Investors have good cause to be alarmed.

So far, the euro seems to be holding steady by default. Once the Brexit vote is out of the way, the markets will inevitably return to the thorny issue of Europe’s deepening political fractures and place their bets on eventual euro break-up risks down the line.

Euro parity versus the US dollar still beckons. Europe is not out of the woods by any stretch of the imagination, with or without Britain.

 

 

 

Brexit will shake investors’ faith in Britain to the core

It is no exaggeration to say that Britain stands at the edge of disaster. In two weeks time, UK voters will be making a momentous decision that will shape Britain’s future for generations. As the nation heads to June polls on whether to remain in or leave the European Union the stakes are high.  A majority vote in favour of a British EU exit (Brexit) could lurch the country into chaos for years. Its impact will be felt around the globe.

Britain is heading into the unknown and the country seems worryingly split down the middle. Judging by recent surveys, public opinion seems to be edging towards the Leave camp. If this continues, the final run-in to the referendum will be an anxious time for the nation and a source of rising instability for Britain’s financial markets.

International confidence in the UK could be shaken to the core. Britain’s strong growth record, its leading role as a global financial centre and even the survival of the 300-year old British union will be under a cloud. If Britain crashes out of Europe, Scotland has threatened another independence vote in order to stay inside the EU. Britain’s influence as a leading international power would begin to wane.

The main credit ratings agencies have already warned they would take a dim view of UK assets on a British break from Europe, warning that a sovereign downgrade might be inevitable. International confidence in UK investments would suffer badly. Britain is no stranger to currency crisis and the pound could take a beating. International investors would shun stocks, government bonds and industrial assets in the uncertainty. And it might take years before the UK can strike a favourable EU trade deal and forge a new working relationship with Europe.

International investors could lose out heavily, especially those that were coaxed into investing into Britain under Margaret Thatcher’s private sector renaissance in the early 1980’s, when international companies began flooding into the UK. Under sweeping structural reforms, Britain became a Promised Land of free enterprise and market-friendly deregulation for foreign investors. The added advantage was free admission into Europe’s single-market, with front-door access to the EU’s 500 million-strong consumer market.

Over the years, this has reaped rich rewards for Britain and brought strong inflows of foreign direct investments (FDI). Inward FDI has helped finance the UK’s current account deficit and provided vital support for the UK’s asset markets. The UK now stands as the world’s third largest destination for inward FDI behind the US and China, with the stock of FDI investments in Britain currently around 1.7 trillion US dollars. The UK is the top target for FDI flows into Europe thanks to Britain’s track record on providing a safe port for foreign money. All this could change very dramatically.

A beneficiary has been the UK car industry where Asian companies are major stakeholders. Since the 1980s, Japan’s Nissan, Toyota and Honda have built up significant UK manufacturing presences, while India’s Tata Motors has owned Britain’s Jaguar Land Rover since 2008. Any threat to Britain’s free trade access into Europe would cast these investments into doubt. Any barriers to free trading would be bad news for UK-based manufacturers and momentum to quit Britain and switch production to Europe could turn into a stampede.

As the United States learnt to its cost under the strong dollar regime during the mid-1980s, when many US companies switched manufacturing overseas to stay competitive, it has been extremely hard to win back business that has moved offshore. The US’s yawing trade gap is testament to that. Britain could end up in the same boat if international companies panic about losing eligibility for free trade status in Europe. FDI inflows would reverse, tearing a large hole out of Britain’s industrial capacity in the process. It would be bad news for UK growth prospects, for the balance of payments and for British industrial prestige.

Indeed, there is a possibility that Tata Steel’s recent decision to quit UK steelmaking is less to do with global over-supply and heavy loss-making in their UK plants and more to do with a loss of confidence in Britain’s industrial future due to Brexit fears. In addition, recent news of Tata Motors plans to build a factory in Slovakia, its first European JLR car plant outside the UK, could be a bad omen for British car manufacturing shifting into Europe if Brexit takes off.

Brexit also poses serious risks to Britain’s future as a global financial centre. The UK financial services sector is a vital part of the economy, employing over one million people, accounting for 12 per cent of total output and 11.5 per cent of UK government revenues. The City of London is not only home to over 250 foreign banks, but also the European headquarters for many of them. If Britons vote to leave the EU, London faces losing one of its top money spinners – the multi-trillion euros traded-derivatives business which the ECB would like to see housed on European and not UK soil. Furthermore, many foreign banks based in the UK might find it more prudent to comply with the EU’s regulatory framework by moving to Frankfurt or Paris. Brexit could spark a major bank drain out of Britain.

Britain’s economy looks vulnerable. Since the global financial crisis, the UK has grown faster than its Group of Seven partners, but only thanks to the economic fizz of zero interest rates, quantitative easing and loose fiscal policy. Without these policy boosts, underlying UK growth potential would be nearer to 1.5 per cent than the latest 2.0 per cent headline rate. The shock of Brexit, a quick foreign exodus out of UK investments and a collapse in British productive capacity and jobs could hit confidence hard, tipping the economy into a nasty recession.

In the worst case scenario, the UK could fall into a deep depression. Unfortunately, UK policymakers are running out of options to deal with new crises. UK interest rates are already at rock bottom and QE has already run its course. A sharply weaker pound would only be a small fillip for what little would remain of UK manufacturing locked outside of Fortress Europe. Foreign investors would be hit hard by the fall in their sterling-based assets. For international manufacturers, banks and financial services companies there are compelling reasons to get out quick while the going is good.

Brexit will rip the Great out of Britain

Nobody likes two-minded, ‘on the one hand and on the other hand’ economists – this economist included. But it is time to come off the fence and get the formalities over Britain’s imminent European referendum out of the way without further ado.

If Britain votes to remain in the EU on 23^rd June, the impact will be a damp squib and the dust should settle very quickly. But if UK voters opt to quit Europe, it will amount to a national economic disaster, on par with the 1930s depression and 2008’s financial crisis. This time round, there may be no easy way back from what would be left of Britain’s broken economy.

The economy and UK financial markets could be left scarred for many decades and, in the worst case scenario, it could lead to the eventual break-up of the British union if Scotland seeks independence. It will end up a horror show for the economy. Lasting harm to British export prospects, the loss of inward capital flows and the threat to London’s future as a major financial centre will do untold damage to Britain’s standing as a leading industrial nation.

Exit from the EU could mean the UK’s exclusion from the 500-million strong free trade area for an unspecified period of time. It would cast a major shadow over British business’ output, investment and hiring intentions. The risk of recession and mass unemployment would be a high probability.

Consumer confidence could be hit very hard as would the UK’s supposedly ‘rock-solid’ housing market. In recent years, UK property prices have been pumped up to fever-pitch thanks to near-zero interest rates, over-abundant mortgage finance and a rush of foreign money buying up ‘gold brick’ investments in London’s bloated property market. Brexit could sound the death-knell for a new property crash. People forget too easily that nationwide UK house prices collapsed by 20 per cent in the aftermath of 2008’s global financial crisis. It could easily happen again, but a lot worse. Up to 30 to 40 per cent could be wiped off property values.

Brexit could mark the start of a catastrophic collapse in foreign direct investment into the UK. Since Britain first joined the EU in 1973, North American and Asian companies have invested heavily in the UK economy to secure unbridled access to European markets. Outstanding FDI investments in the UK are now worth around $1.7 trillion and any reversal of confidence would put serious strains on the economy and UK currency if they decide to pull out and re-locate to the Continent.

Any threat to London’s dominance as a global financial hub would spark a serious outflow of overseas banks and investment funds from Britain, especially if Brussels decides to stack up legislative rules against institutions operating out of the UK. Major foreign banks have already warned that they are preparing contingency plans to move to European cities like Frankfurt, Paris and Dublin in the event of Brexit. Britain’s financial services dominated economy would be hit hard, compromising the UK’s fragile balance of payments position even more.

Brexit might mark the end of the 300-year old United Kingdom. Scottish nationalists have warned that Brexit would lead to another vote for independence. If Scotland leaves the union, at a stroke, up to 8 per cent of GDP would be lopped off the UK economy. Ratings agencies have warned this would warrant a major UK sovereign downgrade – bad news for the pound.

There may be little immediate economic effect in the aftermath of a leave vote, but in the longer run, Britain could be staring into the jaws of a depression. Putting numbers onto the horror show is extremely arbitrary, but the number 10 keeps cropping up. A depression would mean national output dropping at least 10 per cent and unemployment surging above 10 per cent.

The impact on financial markets would be immediate though – and the number 10 crops up again. Market surveys suggest the pound could lose as much as 10 per cent in face value and Britain’s FTSE-100 stock index could fall by 10 per cent. The odds are the falls would be even greater. The pound could easily touch parity with the US dollar and the euro. It could end up a very nasty rout.

Right now, markets still seem to be putting on a brave face, with the bias favouring the status quo and Britain staying put. But the real event risk is the chance of the unimaginable happening.

Judging by the bandwagon effect in the leave camp right now, consumers, business and markets would be wise to batten down the hatches and prepare for an unexpected shock.