Brexit: The British Say Good-Bye to the EU

Brexit: The British Say Good-Bye to the EU

Yesterday, the United Kingdom voted on whether to stay within the EU or leave — and the British chose to leave. I say the British, not the UK, because Northern Ireland and Scotland voted heavily to remain (Wales and England opted out). In my opinion, the British made a mistake. While this opinion is mine, it seems to be shared by many investors, as equity markets around the world weakened today, volatility increased, and the pound sterling fell to a thirty year low.

The decision to leave seems to have come down to the question of sovereignty and protecting the borders. Given the recent spate of terrorism in Europe, one could hardly blame them. My opinion to stay was based purely on economics. I generally side with the outcome that would increase prosperity. I believe a vote to exit will have the opposite effect. Free trade allows goods to be sold more cheaply, which enables consumers to purchase more goods. This in turn creates a demand for more goods which increases employment. The growth in labor further expands the demand for goods. This cycle creates wealth and improves societies’ standard of living and I’m all for this. I fear the exit will drive trading costs higher, and instead, reduce wealth. I hope I am wrong.

Those opposed to remaining think differently on this point, but I believe they are overly optimistic. In my last blog (click here to read), I wrote about the Swiss experience as an example that the British should consider. In addition, I think the results of the Smoot-Hawley Tariff are another example to study. I know an exit is different from a tariff, but I think parallels can be drawn between the two because both increase costs and thus lower trade. The Smoot-Hawley Tariff of 1930 raised US tariffs on more than 20,000 foreign goods. Passed at the onset of the Great Depression, the goal was to protect American business and jobs, but the results could not have differed more. By reducing imports into the United States, foreign countries had fewer American dollars to buy American goods. The tax also led other countries to enact retaliatory tariffs against American goods. The consequence of all this was that within a few years world trade fell by more than 40% and unemployment exploded.

Let me be clear, I’m not suggesting that a Brexit is going to have the same effect. In fact, I think the markets are overreacting and the direct economic impact will be small. I am more concerned with Northern Ireland and Scotland having future referendums concerning a United Kingdom exit. Although the Scots voted against independence in 2014, Scottish First Minister Nicola Sturgeon has vowed to revisit the issue. This outcome may also further other separatist movements in Europe.

So what happens now? Although the referendum is nonbinding, I can’t imagine that politicians will go against the will of the people. British Prime Minister David Cameron has already announced his resignation this fall. The UK will probably invoke Article 50 of the Treaty on European Union which gives them a two year period to negotiate their withdrawal. During this period the UK may have to renegotiate trade agreements with over 50 countries outside the EU, as well.

For now, we’ll have to wait and see. Long term, the effects are difficult to predict, but the change raises uncertainty and this is never positive for capital markets.

 

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About The Author

Rick Cloutier, CFA is the Chief Investment Strategist for Washington Trust Bank with over 25 years of portfolio management and investment experience. He is responsible for directing the portfolio management, research, and trading activities for the bank’s multi-asset class strategies. He is also responsible for overseeing the client portfolio manager team and portfolio analytics team. Rick has written numerous articles for Investopedia and wrote a weekly column for the Fall River Herald News in Massachusetts. His research has appeared in numerous journals, including the Journal of Investment Management and Financial Innovations, the Journal of Business Management and Economics, and the International Journal of Revenue Management. He provided a nightly commentary on WALE radio and authored the novel Caveat Emptor. Rick earned his MBA at Boston University.