Why Brexit Matters Matters to Your Portfolio
Ever since the Brits voted to leave the European Union, the stock market in the U.S. has been all over the place—down 500 points one day, up 300 the next day. But amid all those fluctuations it hovers right around where it had been before the vote.
Foreign markets—such as the FTSE in London, the DAX in Germany, and the CAC in France—have also seen their share of wild swings, but their markets are grinding lower than the American one. The thinking is that Brexit impacts them more than us.
Some economists, including those at Goldman Sachs, are even predicting a small recession for Britain, believing that the uncertainty caused by the ‘yes’ vote, together with Prime Minister Cameron’s decision to resign, will cause UK consumers and businesses to reduce their spending.
Money Changes Everything
You might be surprised to learn that most economists do not think money is important. For them, money is simply the most tradable commodity that makes what would have happened without it (bartering) easier. Misguided as this theory is, it created the space the politicians needed to create a single currency. However, along with immigration, the lack of control over one’s money could spark the eventual demise of the European experiment.
For money is more than a medium of exchange for barter. It is a yardstick created by a government to measure everything having to do with economic life: contracts, tax bills, etc. Why else is ten dollars ten dollars, other than because the government says so?
Also, your money is ultimately the debt of a government and a future claim on society’s resources. Do you think a German citizen wants to be on the hook for the future claims of a Greek citizen, or, alternatively, a Greek citizen for a French citizen? Of course not!
The UK Bails on the Eurozone
Because the UK kept its money—the pound—when it entered the Eurozone, it is somewhat surprising that the UK is the first country to vote to exit the EU. I had thought it would be a country such as Greece that uses the single currency. However, the Greek economy is in such dire straits the people there didn’t seem to have the confidence to call it quits.
The UK vote seems more about immigration and economic insecurity than currency, as Brits voted against the ability of citizens from another Eurozone country to enter the UK and possibly take away their jobs. Add to that the heightened fear of terrorism emanating from the current refugee crisis.
The Silver Lining, So Far
One bright spot for investors continues to be the bond market, as investors now believe that the ‘yes’ vote reduces the chances that our Federal Reserve will raise interest rates anytime soon. So it looks as though investors will be able to own bonds without fearing interest rate increases for much longer than previously predicted.
The vote also amplifies the deflationary forces that were already causing slower worldwide economic growth, keeping interest rates low, and providing a favorable backdrop for bonds. Lower interest rates keep mortgage rates low this helps fuel the housing market, which has been a prime driver for economic growth here.
The Unwinding of the Single Currency
The euro (the currency) has been in existence for 14 years, since 2002. It will not take 14 years, however, to get rid of it. If it starts to unwind, it will happen quickly. All it will take is for voters in a country that use the single currency to do what Britain just did and vote themselves out of the EU.
If that happens, the whole European experiment could unwind, and the recession predicted for Britain could grow to include many more countries including the U.S.
These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.