Thanks to Brexit, a new global financial crash is looming

It is no exaggeration to say that the world economy has just entered into a new age of deep uncertainty. Britain’s decision to quit Europe has sent profound shockwaves around the world at a very bad moment. The world economy is hardly out of one global financial crisis and the odds are surging that another worldwide crash is about to begin.

Britain’s Brexit vote has far-reaching consequences with the potential to throw the world into even bigger economic chaos and disorder than the 2008 global financial crisis. The catastrophic collapse in the UK pound, free-falling global equities and a dramatic surge in market volatility is just the start of it. The lid has been lifted off Pandora’s Box of morbid fear. There is no end to the list of deep concerns in investors’ minds, bringing risk aversion and market panic to boiling point.

Global financial confidence is a fragile house of cards at the moment. Global policymakers have worked courageously and been extremely inventive to keep the forces of global contagion at bay over the last seven years. Zero interest rates, creative monetary engineering and lashings of QE cash have held the line, but there is precious little left in the central banks’ kitty to deal with what may come next. The next crisis could be the one that breaks the central banks.

What complicates matters is that the world is already consumed with fear and loathing about unsustainable global debt levels, the parlous state of global banking, the spectre of a hard landing in China and growing geo-political concerns. Meanwhile, supranational bodies like the United Nations, World Bank, International Monetary Fund, OECD and Group of Seven seem increasingly powerless to make any difference.

Worries about the health of the flagging global economy are genuine. Increased uncertainty will hit economic confidence hard. Consumers will hold back on spending, companies will suspend output and investment intentions and global trade will slow down even more. More vulnerable parts of the world economy will risk slipping back into recession and deflation will continue to get the upper hand.

Major central banks will come under growing pressure to intervene with even more negative interest rates and extra QE provisions. Governments will be forced to end fiscal austerity and open up deficit spending again. Some governments will be tempted down the road of competitive currency devaluations. The world will heading deeper into a bizarre world of increasingly ineffectual and more dangerous policy remedies.

Increasingly alarmed investors will be looking for scapegoats, so it is no surprise the contagion spilling out from Britain is already subsuming European equity markets, peripheral bond and credit spreads and critically hitting the euro hard. Calls for similar EU referendums in France, Italy, Netherlands and Denmark have horrified the markets. Any escalation of the euro crisis could be the beginning of the end for European monetary union.

The risk of other countries leaving the EU or the euro zone is the stuff of nightmares. The European Central Bank is loaded to the gunnels with ‘derivative’ QE assets. Any risk of the ECB partnership untangling and the ensuing threat to the euro and global markets would be unimaginably toxic. A sub-parity euro/dollar fx rate is a strong possibility.

With the initial shock out of the way, the markets are bound to find some level of temporary support in the short term. The likelihood is that any correction will only be a bear market bounce and selling will persist into the longer term. The challenge is what will stop deeper rot from setting in. Central banks in disarray, global economic growth slowing and world trade contracting are all good reasons to dump risk assets at the first opportunity.

Short of running for the hills and joining survivalist movements, investors still have some options. Safe haven trades into high grade German and US government debt should help protect investor capital. On the currency side, Japanese investors have already flooded back into yen, but the US dollar and Swiss franc should also be priority buys for most investors. So too will be the age-old sanctuary of gold. Stocks, credit, emerging markets and commodity currencies like the Canadian and Australian dollars will be given a wide berth.

Right now, the market is in a state of flux and investors should be prepared for the worst. Market soothsayers are bound to dust off the worst of the Doomsday scenarios and the odds are in their favour. The clock is ticking and investors should be prepared for a new crash.