The surprising vote by the U.K. to leave the European Union — a decision dubbed the Brexit for British exit– has caused the pound sterling to plunge to a 30-year low against the U.S. dollar and stock indices around the globe to swoon, as the specter of uncertainty made investors run for the hills. The decision to leave the European Union also cost Prime Minister David Cameron his job.
On June 24, the day after the referendum, the Dow Jones Industrial Average was down 3.4% to 17,400, the S&P 500 mirrored the decline while the Nasdaq was down more steeply, falling by 4.1%. Gold hit a 2-year high while oil futures fell. In Europe, the FTSE 100 in London lost 3.2%, France’s CAC was off 8% and Germany’s DAX index closed the day down 6.8%. Bigger selloffs were seen in Italy’s FTSE MIB and Spain’s IBEX — each down more than 12%. In Asia, Japan’s Nikkei 225 index fell 7.9% and Hong Kong’s Hang Seng index was off 2.9%. The euro was down 2.5% versus the dollar. U.S. government bonds soared and the yield on the 10-year Treasury fell to as low as 1.4% — a near historic level.
Wharton finance professor Jeremy Siegel said the markets responded as expected in the face of this U.K. development, which most politicians and brokers betting on the outcome didn’t foresee. However, he is certain about how the Fed will react. These developments are “totally taking out any expectation of a rate increase this year,” he said, adding that “the January futures on the fed funds rate is trading exactly where it is today.” [As markets began to normalize, Siegel now says he is not ruling out a Fed hike late this year.]
Wharton finance professor Joao Gomes agrees that the Fed will take a breather. “On the U.S. side, the response will surely be to delay interest rate hikes and perhaps a few reassuring statements that make it clear to investors that there is a safe haven and any downside risk can be limited.”
Indeed, Siegel believes the current blood bath in the markets will be short-lived. “My opinion is we’re going to get a lot of reversals … powerful reversals of this,” he said on Wharton Business Radio’s “Behind the Markets” show that airs on SiriusXM channel 111. He pointed out that the FTSE is still trading above where it was a week ago and the market, in dollar terms, is down only 3% compared to 7% to 9% for other regional markets in Europe.
“There was no panic. There was a lot of liquidity in these markets. In all of the major markets, it was a very active opening but we didn’t have many disruptions.”–Jeremy Siegel
Moreover, “there was no panic. There was a lot of liquidity in these markets. In all of the major markets, it was a very active opening but we didn’t have many disruptions. They were liquid,” he said. “That’s saying an awful lot for a huge, major reversal.” Siegel added that U.S. stock futures were down 700 points but the markets opened normally and have rallied off the lows.
Gomes adds that while “this is the kind of additional uncertainty and volatility that will dampen short-term growth prospects” over the longer term, the Brexit’s impact should be contained. “Once the dust settles, the effect is unlikely to be large,” he says. “Europe has not grown significantly since 2008 and it will not grow significantly again next year. We are already used to that scenario and to this permanent-crisis mode.”
Impact on U.S., U.K and EU
Scheherazade Rehman, director of the European Union Research Center at The George Washington University, said Brexit is “what we call a ‘black swan’ event in Washington, D.C. We didn’t see it coming.” How will it affect the U.S.? Beyond volatility in the markets, “we really have lost our champion for free trade, globalization and eyes and ears on the ground with regard to security and other concerns at the EU table now – since they will not be sitting at closed door meetings anymore,” she said on Wharton Business Radio’s Knowledge at Wharton Show on SiriusXM channel 111.
As for the U.K., Rehman said its economy will take a hit. “It will become more expensive for them to trade with the EU,” she said. The EU will tell the U.K. that “you still have access to the common market but you have to pay for that. You have to pay more than you pay now, except now you have no decision-making power.” However, Brian Klaas, a fellow at the London School of Economics, said on “Behind the Markets” that the EU can only punish the U.K. to a certain extent. “If they punish Britain too much, they will also suffer” since it constitutes 6% of the European economy. But if they don’t punish enough, others might leave.
The U.K. will try to retain existing trade and investment arrangements with the EU, but the bloc will not make it easy. “We will see initially at least a very tough stance from Brussels regarding the negotiations with the U.K.,” Gomes adds. Indeed, Olivier Chatain, a professor at HEC Paris and a senior fellow at Wharton’s Mack Institute for Innovation Management, believes the EU – France and Germany in particular – will want to make an example of the U.K. to deter other exits, he said on the Knowledge at Wharton Show.
Many questions remain about the terms of exit and how negotiations between the U.K and the EU might proceed. On Friday, the Financial Times reported on an article in a German newspaper claiming that it had a copy of Germany’s “post-Brexit-referendum strategy.” The report says the U.K should not be treated leniently in exit talks because doing so might encourage other countries to follow. Handelsblatt reported, according to the Times, that there would be “‘no automatic access to single market’ because other states, including France, Austria, Finland, Hungary and the Netherlands, might seek similar deals. ‘The extent of such imitation effects would depend largely on how Great Britain was being treated.’”
“There was no panic. There was a lot of liquidity in these markets. In all of the major markets, it was a very active opening but we didn’t have many disruptions.”–Jeremy Siegel
But the fear that there could be a dash for the door could be overblown. Siegel said EU nations that have adopted the euro as their currency are less likely to leave the union. “No one wants to give up the euro,” he said. “That’s the difference from what’s happening in the U.K.” For an EU country using euros to change its currency “is an order of magnitude more difficult and less popular” than the Brexit. Take Greece. Despite its financial woes, the Greeks won’t ditch the euro to go back to the drachma and face devaluation. If Greece won’t leave, it’s unlikely others will, he said.
Eventually, Gomes expects an agreement to emerge between post-Brexit U.K. and the EU. “After some mutual recriminations, which could last some time, everyone in Brussels and London [will work toward a rapprochement because both have] a strong vested interest in making this relationship work,” he says. “That basically means working out a new treaty that preserves as much of the meaningful economic ties as possible while reassuring the British people that immigration can be controlled.”
It would be ironic, however, if the EU used its clout over negotiations to push the U.K. to adopt its immigration policies. “This referendum was used as a lever to negotiate on the immigrant crisis that’s happening in Europe right now,” Rehman said. “The interesting part will be, were the EU to negotiate with the U.K., will immigration rear its head again? Meaning that, ‘we’ll agree to the terms of the trade if you agree to — whatever — on the immigration issue.’ That would be somewhat ironic.”
Gomes adds that the “big wildcard” is the role of the nationalist and anti-European movements in countries like France, Poland and Spain. “There will be tension in the coming weeks and months between two opposing thoughts and views of the world,” he says. On the one hand, he expects the central court in Brussels to act quickly “to reassure businesses that nothing fundamental will change.” On the other hand, he says politicians will point out that Europe is “broken” and that something needs to change. “There’s a desire of the Brexit winners and anti-European parties and voters elsewhere, starting with upcoming Spanish election, to exploit this, to draw special concessions from the EU or simply to win elections.”
Scotland’s Future in Play?
Of the many political outcomes of Brexit, one that looms large is the possibility that Scotland may demand a second referendum on whether or not it wants to be in the U.K. In the first referendum in 2014, Scotland voted to stay within the EU. “Scotland is pro-European, and if the Scottish feel they are being dragged out of Europe by English voters who they didn’t much like anyway, they may ask for a second referendum,” said Sebastian Mallaby, senior fellow for international economics at the Council of Foreign Relations, in a Knowledge at Wharton article earlier this week.
After the Brexit vote, Scotland’s First Minister Nicola Sturgeon said a second referendum is now highly likely and announced she would start creating legislation required for a new vote on Scottish independence. Ironically, some of the strongest arguments made in England to convince Scotland to remain in the U.K. in 2014 were that Scotland might be forced out of the EU were Scotland to go its separate way. Now it is the vote on the Brexit that will take Scotland out of the EU unless, as some observers suggest may be likely, Scotland approves independence in a new referendum and decides to remain. Scots voted 62% to 38% in favor of remaining in the EU.
“Once the dust settles, the effect is unlikely to be large.”–Joao Gomes
How Scotland responds also would depend on who would be the next U.K. prime minister, how the negotiations proceed and how strongly the economy grows in the next few years, Gomes says. “Ultimately, this vote was about a lot of people concluding that they were better off economically outside the EU,” he said. “Scotland, in particular, will have to make its own judgment — is it better off tied to England or the European Union?”
Next Turn for the EU
The central problem with the crisis in Europe is a failure of leadership in addressing problems their people face, said Gordon Brown, British Labor Party politician, former British prime minister and former U.K. chancellor of the exchequer, who spoke at the Wharton Global Forum in Amsterdam. “The level of the debate in the European referendum in Britain has been so poor and so low that nobody has tried to explain the problems that people are complaining about.” Immigration and job security are two key issues.
Brown said people are displaced by “big and fast-changing global forces rather than from the European Union.” Meanwhile, terror attacks by Islamic radical and extremist groups also breed prejudice, intolerance and hate. “There is skepticism in a number of different countries in Europe where people are unfairly blaming the European Union for problems that essentially arise from global change,” he said. “Unless there are leaders who are prepared to take this on and say to people, ‘Look, we are trying to manage global change. Work with us to do so,” skepticism will increase.
Even as some have questioned the continued relevance of the EU, Brown said the single institutional structure is still needed for Europe. “Europe has had to come to terms with the fact over the last 30 years that national identities will always remain strong,” he added. “You have 28 nations with their own traditions, cultures, own languages and their own ways of thinking about how they integrate with each other. You have to balance that sense of identity with the need for cooperation. You cannot assume that you can bury the identities and move towards a federal super state.”
In the end, U.K. citizens decided that they were more British than they were European. “This [Brexit] vote was essentially about nationalism, national pride and reasserting control over decisions affecting [Britain’s] citizens,” said Gomes. But Chatain thinks that when U.K. fully realizes the implications of leaving the EU, “buyers remorse may happen sooner than we think.”
