Brexit advice needed?

Published: Jul 2016
Man climbing in cave on mountain at sunset

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The global economy faces an uphill struggle in the months, and years, to come. But, in the words of the late, great Muhammad Ali: “It isn’t the mountains ahead to climb that wear you out; it’s the pebble in your shoe.”

Muhammad Ali

The greatest champion of all times passed away in June, following an exhausting fight against Parkinson’s. Considering the recent developments and the obstacles on the road ahead, it looks as if the global economy also faces an epic struggle to keep growth going, let alone boost it. On the long and winding road up the mountain, many countries are not so much hampered by pebbles in their shoes as by huge debt and populist burdens on their backs.

In the US it became clear that Donald Trump will be the presidential candidate representing the Republican party. His opponent will go by the name of Hillary Clinton. Neither candidate is universally popular but we think the prospect of a Trump victory will unnerve the markets more. Now we know the outcome of the EU referendum in Britain, chances of a Trump win will be taken more seriously.

I shook up the world

Although we are not sure if the eulogy for the EU can already be written, Brexit is not just a big blow to the UK and the EU but to the whole concept of globalisation and to mainstream politicians everywhere in the West.

The British have shown the world that no matter how many politicians, economists, historians and other experts warn for apocalyptic results of a decision, many voters don’t care about the experts’ opinion anymore. They have made very clear that if anything, a very large part of the electorate views experts not as wise, educated men and women whose advice and insights should be heeded, but as hacks who are part of a cosy establishment just trying to keep in place the order that has given them the opportunity to become to be seen as experts in the first place.

In other words, the so-called experts were painted as self-serving elites who were just trying to scaremonger people into voting Remain. After the world suffered the biggest daily loss of global equity markets ever, the British leave voter could justifiably and rightly repeat Ali’s words: “I shook up the world. I shook up the world.”

Disunited Kingdom

How the divorce will be handled remains to be seen but it will undoubtedly be a tortuous process as the UK is divided to the bone. There are gaping gaps between young and old, poor and rich, London and the rest of the UK. England/Wales and Northern Ireland/Scotland are in opposing camps while voters are increasingly estranged from politics. For example, the generational cleavage is blindingly obvious: 75% of the 18-24 year olds voted Remain while 61% of the 65-year-olds and over opted for Leave. And don’t forget the ocean dividing politicians and the population: two-thirds of the British MPs were in favour of staying inside the EU. Representative democracy has clearly taken a great hit.

The first big casualty of the vote result was Prime Minister David Cameron, who will resign. This doesn’t automatically mean that the British will have to go to the voting booths again to vote for a new government. The Tories will have a leadership election and could continue to govern until the next elections in 2020 if they would like to do so after having named a new PM.

There’s one caveat: elections can be held early if a supermajority (two-thirds) of British Parliament supports a vote of no confidence and parliamentarians don’t succeed in forming a new government. The takeaway here is that there won’t just be lots of uncertainty pertaining to the relation between the UK and the EU, the UK itself will be in for a long period of insecurity too.

European dominos?

This splintering process will not be reversed any time soon. Moreover, the conventional wisdom that people vote with their wallets has been turned upside down. Most people admitted that they believe that a vote to leave would hurt them financially, but they went on to choose the exit anyway. This will make sitting politicians in other countries very nervous. Economics isn’t the only game in town anymore when it comes to political success. But it still is a very important game. The most worrying is that compared to many other EU states, the UK economy has been doing quite well. So if British voters are already angry, it must be even worse in many other parts of the EU. Those political and economic frustrations will translate into pressure on other EU states to hold a referendum.

Although we do not think these will take place in the near term, political discord and uncertainty are rife. In Spain, two elections in the space of six months have shown that the old two-party system is dead and it remains to be seen if the new government can offer stable and coherent guidance through these insecure times. Over in Italy, Prime Minister Matteo Renzi’s position is at risk following disastrous local elections while a referendum will be held in October on changes to the electoral system. Renzi has thrown in his lot with the outcome.

Glimmers of hope in sea of darkness

How about other parts of the global economy? Will they compensate for Europe’s troubles and the danger of a Trump presidency in the US? At the time you are reading this article, Japanese Prime Minister Shinzō Abe’s Liberal Democratic Party has probably succeeded in winning the elections for half of the seats in the Japanese Upper House.

However, this does not mean to say that Abe will run a tight economic ship. His party may gradually unwind the monetary component of the famed three-arrow-policy (Abenomics) due to growing criticism of the Bank of Japan and there is the continuing risk of Abe shifting his attention to his nationalist agenda.

There are some political glimmers of hope in Latin America where ‘super populism’ appears to be making way for ‘normal populism’. Developments in countries such as Argentina, Brazil, and Cuba could be beneficial to the markets. Yet, we do not see the continent making quick progress on reforming their political and economic systems, which means that economic growth could pick up as confidence in Brazil, Argentina and others gradually return, but it will not be enough to compensate for troubles elsewhere.

What does not kill you…

Coming back to Europe, the response to the Brexit vote will probably not be of one Europe pulling itself together and strengthening Europe in areas that can only be tackled jointly. For such a united approach, divisions within Europe are simply too large and there remain too many unknowns.

From a political point of view this means more headwinds for the Eurozone and thus a weaker euro and probably larger spreads between the interest rate spreads between German bonds and those of the euro periphery countries. The other side of this coin is that we can continue to expect a flight to traditional safe haven currencies, particularly the US dollar (notwithstanding the Trump threat) and to a lesser extent the Japanese yen and Swiss franc.

The global economy has been through a lot of change in recent years and grey clouds continue to hang over the markets. Let us take heart from Ali’s words to end with an upbeat perspective: “Only a man who knows what it is like to be defeated can reach down to the bottom of his soul and come up with the extra ounce of power it takes to win.”

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