Brexit: What’s Next?


Very few international events throughout both, mankind’s history and the history of financial markets have achieved a cause/effect reaction so unmistakably clear as the one produced by the Brexit vote on June 23rd, and the effect it had over the next couple of days, after 43 years of having been a most prominent member of the EU.

Friday 24th and Monday 27th’s reaction throughout global financial markets was unequivocal: stark disapproval of the result (record fall in Sterling –to a 30-year low–, a strong fall in most currencies –except the US dollar, and the Japanese yen–, a sizeable fall in the world’s equity markets –particularly acute in the UK and the EU–, flight to safety –a strong rise in the US bond markets, and less so, but still noticeable in the Japanese–, strong rise in gold, etc.), coupled with nervousness and uncertainty because of the new era that, in all probability, such an event can end up signifying, not only for the UK itself and the EU, but for the world as a whole. Near paralyzation of new business ventures and of new hiring, and many business decisions in general are almost guaranteed to occur and will last while confusion and uncertainty prevail for a few months, in the best case scenario.

Almost at once, the rating agencies, S&P and Fitch, degraded the credit quality of the UK’s debt, losing the highly coveted AAA rating; furthermore, the outlook of it’s debt changed from stable to negative. The price of British banking stocks (in USD) with heavy exposure to the British economy (Lloyds, Barclays, and RBS) lost slightly over 35% of their market capitalization in just two work days; the stock price of HSBC only lost 12.9%, given that it is a truly global bank.  All of the previous reactions are not only very logical, but also extremely painful, costly, and regrettable.

There are multiple reasons that make the British’s vote outcome an egregious mistake. Without going into detail, the regrettable outcome can be summarized in one concept: there is strength in unity, weakness in division. The loss of such an important and momentous membership, as that of being an outstanding member of the EU, will inevitably bring very costly and onerous consequences for the UK.

Most of the time, the coordination of multinational efforts towards a common goal typically generates great benefits among the participant nations. The formation and launching of the EU has been the economic, social, and political project of nations of utmost importance and reach in human history, up to date. The separation of one of the most prominent and influential members cannot, in any conceivable manner, bring about health and well-being among the member nations, and more so for the UK, the nation that unilaterally has decided to withdraw from such a far-reaching and meaningful economic, political, and social endeavor.

In addition to the immediate uncertainty and nervousness brought about to the whole world by the multi-mentioned decision, the most likely outcome in the near future is a substantial decrease in investment (local and foreign), employment, and competitiveness in the UK (all three caused by the paralyzation and postponement of key business decisions), along with many other costly and painful economic and social implications associated to this process.

The economic integration of the UK with continental Europe is truly substantial, since 50% of the UK’s total exports are forwarded to the EU. Up to now, thanks to the common market, those exports are tax-free.

The exit agreements can take a few years to be arranged and fully implemented, hence, the big (mostly legal) changes to the rules of the game will not go into effect immediately. Nonetheless, companies within the EU that purchase products and services  from the UK are not going to wait until the new rules are clear and enacted. In no time the EU companies will start to replace their British suppliers with companies from other nations, even among themselves. This will imply, for a great portion of British companies, a substantial drop in sales, employment losses and a very likely recession, just the opposite to what the Brexit voters are expecting and looking for.

Contemporary national economies are complex and delicate mechanisms, yet with relatively clear and logic rules of the game, at least in their essential processes and interrelations. No one in their right mind would dare modify them without an appropriate causation knowledge. Quite regrettably, a dysfunctional interpretation of the current democratic system makes it so, that a decision as momentous as the one being analyzed can be in the hands of the general population; a population that is essentially void of the minimum foundations required to make a well-informed, mature decision. Indeed, it doesn’t make any sense to expect people to give reasonable answers to binary questions in very complex subjects which they don’t really comprehend.

The UK has been an advanced nation, a leading country, one of the nations that in more than one way has been a role model for the rest of the world, a pillar of the new world order after WWII. The UK managed to transit with great dignity and integrity from being a hegemonic economy, the largest on Earth during the 18th and 19th centuries, to become a large second-class economy, basically circumscribed to the English island, yet with great world influence because of its history, pride, traditions and globalizing spirit. Previously, the UK showed the world how to move from an absolutist monarchic regime, to a parliamentary democracy, with no wars during the process. The UK is the cradle of Adam Smith, the father of economics.

Two former Prime Ministers, John Major (1990–1995), and Tony Blair (1997–2007), both from rival parties, campaigned together in favor of the Remain camp. Likewise, so did all business people (officers and major shareholders) of the companies engaged in exports to the EU. In an analog manner, all governments of developed nations, with no exception, the IMF, the Bank of England, and many other institutions, unequivocally expressed their desire for the UK to remain within the EU. Hence, the referendum result can be interpreted as a popular revolt against expert knowledge, and institutions.

Brexit is a perfect example of what professor Robert N. Proctor from Stanford University describes as “Culturally constructed ignorance”. Proctor has coined a term for this social phenomena: agnotology, describing it as “culturally constructed ignorance, created by special interest groups to create confusion and suppress the truth in a socially important issue.”

Who, in their right judgement, deliberately and unilaterally breaks up with one’s main trade partner? This is the equivalent of shooting oneself in the foot!

Granted, the events under analysis will take many weeks and months to sufficiently permeate throughout the British economy and society before being able to emit a more definitive judgement, one supported by additional real, statistically proven facts. Nevertheless, the cascade of mostly negative effects for the UK will inevitably be materializing almost by the day. The negative impact of Brexit can go beyond the UK and the EU, with clear implications and greater risks in national and international security issues, and anti-terrorism endeavors.

“The more things change, the more they stay the same.”                                                            –Jean-Baptiste Alphonse Karr

The global political system is in a crisis. The way nations are governed has been essentially the same over the past 240 years, since the formation of the USA. The world’s political system is exhausted, highly dysfunctional, and in dire need of profound changes to be a better match for current challenges, needs and opportunities. Among many other pieces evidence (political gridlock and procrastination all over the world, etc.) the multi-mentioned British experience is a classical example of this.

The previously mentioned global political crisis has naturally generated a great deal of disenchantment and ill-feelings in significant portions of the world’s population, including those of developed nations. Hence, this background has been a very fertile field for the coming-to-being of demagogues, populists, and irresponsible politicians that have greatly contributed to a marked social polarization during recent years. This is the primary reason of the proliferation of unpropitious and threatening characters like Donald Trump in the US and Marine Le Pen in France, among many others.

A quick breakdown of June 23rd’s results says a lot about the ideological, geographical, and generational divisions of the British population:

  • In the city of London, close to 75% of the vote was for Remain. It is evident that the financial and service sectors in general, mostly based in London, with a majority of educated population (many young professionals), is highly oriented towards an integrated Europe, as well as towards a global economy.
  • In Scotland, the Remain vote was a solid 62%. Notwithstanding the Scottish separatist movement, there is a clear preference towards integration, against isolationism.
  • By segmenting the vote by age, citizens below 35 years old decidedly (close to 75%)  voted to remain within the EU. Senior citizens were the ones also decidedly (close to 75%) in favor of Brexit.
  • In Gibraltar, with a minuscule population, the preference to remain within the EU was impressively above 90%.
  • Small, rural and postindustrial populations were also clearly in favor of Brexit. This seems to be a reflection of the great fear felt by having been left out of the big globalizing wave engulfing the planet.

In summary, small town inhabitants, and senior citizens were the ones that, on the average, tilted the balance in favor of Brexit.

Brexit-1The referendum decision made on June 23rd, possibly opened a huge front; one that, if appropriately managed, can generate big benefits for the world as a whole, at the expense of the UK’s citizens. Hopefully, other countries around the world have learned from the UK’s experience. It requires a better understanding from global society of how not to do things and why. Alternatively, a new era of great socio-economic and political convulsion and divisionism will come to being –a true global nightmare. Naturally, there is plenty of room for all sorts of intermediate outcomes. Let’s hope that the first possibility prevails, for the progress and wellbeing of all nations on Earth.

It seems highly unlikely that most of the British electorate had an objective idea, reasonably complete and balanced, about the momentous implications and effects of both alternatives under the ballot, and particularly about Brexit. If this statement is true, then we have a case of momentous decisions in the hands of populations insufficiently prepared to make them, causing  huge and irreparable damage. Undoubtedly, this is one of the great tragedies (and areas of opportunity) of the current global political system.

Is there any possibility of Regrexit, that is, to reconsider the catastrophic outcome of June 23rd’s vote? Nobody knows. However, there are some beams of light in that direction:

  1. An initiative was made public several weeks before the vote, requesting two conditions for the referendum to be valid; understandably, this initiative is now asking the result to be annulled:

• A minimum of registered voters turnout of 75%.

• A minimum of 60% of votes for the winning side.

According to British rules, in order for Parliament to consider and analyze a proposal, a minimum of 100 thousand citizens must be behind any petition. By the evening of Tuesday, June 28th, over 3.5 million registered British voters were already behind the annulment initiative.

In both accounts, the vote of June 23rd fell short. The total number of citizens voting was slightly over 70% of registered voters, and Brexit won with only 52% of votes. Total number of votes for Brexit was slightly over 17 million.

2. On June 26th, Angela Merkel’s chief of staff stated that the British government should reconsider Brexit.

3. In an open letter published in the Daily Telegraph on June 27th, Jeremy Hunt, the UK’s Health Secretary, proposed that before the new Prime Minister presents the formal withdrawal of the UK from the EU, the UK should seek a special agreement on immigration with the EU and, if reached, a new referendum on the permanence of the UK within the EU should be made.

The number of possibilities on the UK’s exit from the EU is very limited. Nonetheless, there is still a paradoxical and interesting possibility: that the UK negotiates with the EU a similar deal to the one existent between Norway and the EU (or even Switzerland’s). In essence, Norway’s arrangement with the EU implies a virtual belonging to the union, with most of the benefits of membership, with similar economic contributions, yet without vote and voice in the EU’s decisions.

Naturally, if the UK ends up in an arrangement of this nature with the EU, it would be a big hoax, a most regrettable consequence of June 23rd’s vote. Ironically, Brexit itself is so costly that, even a Norway-like arrangement would still be far superior than Brexit.

It is very difficult to find a positive outcome from June 23rd’s voted decision in the UK. Interestingly, there is an extremely valuable one: To learn from others. If enough rationality surfaces around the world in the days, weeks, and months after June 23rd, radical anti-globalization movements should be highly discredited, once the costly and onerous effects of that vote are fully acknowledged by the rest of the world. Hopefully, the Brexit experience will provide effective armouring against ignorance, demagoguery, and populism.

Unfortunately, there is also a very worrisome possibility: if the vote results are not appropriately assimilated, it could generate an era of nightmares in the world, where separation, divisionism, and instability, would be the prevailing sign of the times.

In essence, on June 23rd, the UK’s voters chose between unity, fraternity, and solidarity, versus division, isolationism, and confrontation (the anti-institution, anti-expert knowledge vote).

There is no doubt about the great deficiencies and imperfections in all human institutions. Understandably, the EU is a work in progress, imperfect, unfinished, yet essentially functional. The EU has been providing huge benefits for each and every one of its 27 members, but also has an enormous potential for improvement.

David Cameron’s government took a great risk and lost. To have called a referendum in such a complex and polarized subject as the UK’s relation with the EU proved to be a catastrophic error. As a result, regardless of possible arrangements that avoid an altogether Brexit implementation, the UK has incurred a huge reputational damage and has lost something that had cost it many decades and two world wars to achieve: an enviable level of stability and predictability. Most regrettably, these very valuable and virtuous attributes have been lost in a most damaging and foolish toss-of-a-coin.

History shows that, most of time, the best way to progress is by improving established social, political, and economical institutions, and the way of doing this is by constructively working from the inside. Radical divisionism that pretend to undo the long distance already walked without providing functional solutions in exchange should be vanished forever.

Brexit has brought to light a crossroads that the world is on. Countries must choose between opening up, looking for associations, and solidarity with other nations Vs. closing up, constantly looking for separation, and isolationism. Indeed, this is the current version of the classical debate between the Enlightenment ideals and many of the most deplorable practices of obscurantism of the Middle Ages. These ideological confrontations should have already been overcome by mankind. Sadly, this is not yet the case.

Not surprisingly, the UK’s divorce from the EU goes against the most fundamental spiritual and religious principle: Love thy neighbor. Undoubtedly, love, reconciliation, and solidarity will always be a far superior alternative to hatred, resentment, and fragmentation.

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About Martin Marmolejo

Global Investment Manager | Founder & Managing Director at MMA Global Investment Management | Proud husband and father | Follow me @globalmarmolejo.

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