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Seismic economic event possible this week
Stock market meltdowns, currency crashes and bank runs – that’s the sort of financial mess we could find ourselves in next week if Britain decides to leave the European Union.
Last week some of the UK’s major papers reported that a “Brexit” (Britain leaving the EU) was now more likely than ever to happen.
The Rupert Murdoch-backed Sun newspaper even threw its support behind the idea.
It was enough to send markets into a brief tailspin: the pound was sold off, and German bunds (considered the safest assets in Europe) were so sought after… so much so that yields actually turned negative (investors were paying the German government to hold their cash).
Are the fears justified? Well, sort of.
Traders and investors genuinely haven’t a clue as to how the world economy will cope if Britain leaves the European Union, but at the same time, I hear over and over again that it is in fact unlikely to happen.
It is human nature to worry about something that could, but probably won’t, cause us pain, so let’s look at what we’re facing and what this Brexit means exactly.
Also read: Should Britain leave the EU? The view of seven Aussie economists
How on earth has it come to this?
Yep, you guessed it, politics! Really briefly, there’s a party in the UK called UKIP, or the UK Independence Party. Think One Nation but with a little more tact.
Its leader, Nigel Farage, was pulling voters away from Britain’s conservative party (Tories, currently in government) by rallying against immigration from the EU, and its negative effects on Britain.
His fear campaign had a shopping list of things Britons were apparently worried about like immigration-related terrorism, and local jobs going to migrants.
Some of Prime Minister David Cameron’s back benchers started to get a little upset by all this and encouraged the PM to promise a referendum on a decision to stay in or leave the EU.
Britain being a member of the EU makes immigration between England and the European continent oh-so-easy, so a Brexit, as far as some are concerned, makes everyone’s problems magically disappear.
It seemed like a good idea before the election, but now David Cameron regrets his decision to call a referendum because of its potential implications. So what exactly is he facing now?
Trade collapse
The whole point of having a “union” is to make two individual things better, together. If a Brexit eventuates it’ll be because the majority of Britons say, ‘you know what? We think we’ll actually be better off on our own’.
To put it in some context, think of it like a marriage. If you’re married you’re unlikely to have to pay your partner interest on money borrowed.
You own the money together, so ‘borrowing’ money is more of a transfer between your accounts, rather than a “loan”. So it is with the EU. The EU is Britain’s major trading partner.
Huge amounts of exports and imports currently flow across the English Channel quite freely. If Britain were to leave the EU, trade would no longer be free. The laws of economics tell you that won’t end well.
Tariffs and quotas though are just one aspect of trade. There are many other advantages to being locked in wedded bliss with another half.
One example is $500 million in EU subsidies for rural industries that British farmers currently receive. Britain will forgo these if it decides to part ways with the EU’s member states.
Also read: British PM warns of Brexit pain
Immigration
The immigration issue in the Brexit debate is a big one. In May the Office for National Statistics said net migration from the EU into the UK had risen to 184,000 in 2015, and overall, net migration was 333,000 – the second-highest figure on record.
Recent media reports quote studies showing that immigration has a small but positive economic and fiscal impact, and that it is important for businesses recruiting workers.
Some Londoners have expressed real concern though about being overwhelmed by foreigners.
The way they put it is that they feel like their losing their British identity. There are also heightened fears around immigration and increased threats of terrorism.
Any economist will tell you that net migration is vital to economic growth.
Heck, Australia owes much of its economic growth story to hard-working migrants. However fears about controlling the extent and scope of migration will play a big part in Britons’ decision making come time to vote later this week.
Financial markets
No one can say definitively how the British and European financial markets will hold up if there’s a break-up.
You’d hardly call the European economic block a robust commercial unit at the moment, but at the same time those in the Remain camp believe Britain is better off linked with Europe.
Right now, the dominant market theme is uncertainty. Market participants genuinely don’t know how it’s all going to play out.
That uncertainty is leading to some selling of risky assets, and some buying of what are perceived to be safe bets, like German bunds (bonds).
Also read: Brexit fears hammer Aussie shares
Word on the street is that financial markets could collapse if Britain leaves the European Union.
It may only be a short-term rout, but given the fragility of the British and Eurozone economies at present, it could very well result in another financial crisis.
Cooler heads though are brushing that aside by saying a Brexit simply isn’t going to happen.
Pound
For those wanting to gauge the mood of markets right up until voting closes, keep an eye on the pound. It’s been one of the biggest casualties from the growing strength of the pro-Brexit camp.
Late last week it fell heavily on news that the Brexit movement was gaining strength. It’s since found its footing.
Where to from here?
It must be said that apart from possible chaos and confusion following a Brexit, economists are also worried about a “domino effect” if other countries decide to follow Britain’s lead.
There’s little holding this theory together in my view, but if that were to happen, we’d be back to the same sort of market shenanigans we were dealing with when Greece was facing expulsion from the Eurozone.
It all comes to a head on the 23rd of June. That’s when a referendum will decide whether the UK continues on, or leaves a union it has been a part of for more than 40 years.
Also read: IMF says Brexit impact 'negative and substantial' for UK
Final word
I’m used to the “coldness” of financial markets, but late last week I watched Wall Street rally following the death of British MP, Jo Cox.
The death led to the suspension of the Brexit campaign and Wall Street took it as a possible sign – because Ms Cox was pro-Europe – that the independence vote would lose ground as supporters of Ms Cox took up the baton for her.
It all makes sense, but it was a reminder to me that markets don’t really honour or respect humanity, they’re just powerful vehicles for financial gain.
David Taylor is a journalist with the ABC. Before taking up a position with the ABC, David was a financial markets analyst and economics commentator. You can follow him on Twitter: @DavidTaylorABC.
