Friday, 15 July 2016

Brexit: The Good and the Bad


In this blog post, we cover the trending topic of Brexit. What are the positive and negative implications? 


-   National Sovereignty

The EU is supposed to have nations operating under the bloc’s Single Market mechanism. This is basically to stimulate trade and competition, improve efficiency and reduce prices. But to act as one, all countries should be identical. This is basically a utopian ideal and does not work in practice. Britain’s economic performance has more similarities with the US economic recovery from the GFC compared to the rest of the Eurozone.

Germany has a booming manufacturing sector. Almost every metric Greece is at a low. Britain relies on imports and exports. Greece’s rebalance to exports has been at the cost of a collapse in imports. There is no fiscal union to address underperformance.

Currency Depreciation

A weaker currency is good for UK exports as they are now cheaper and therefore more competitive. Weaker currency is also good for UK's tourism sector as it is cheaper for tourists to come visit. 

Removal of Regulations and Red Tape

The British Chambers of Commerce shows that the total cost of EU regulation is US$12 billion annually. The Lisbon Treaty, introduced in December 2009, has costed British Businesses $US19.3 billion in additional regulation.  But now with Brexit they can pass their own rules and regulations without EU interference. 
This relates to the recent speculation that Britain could become a Singapore style super charged hub. Britain could also become a data haven for online companies such as Apple, Amazon, Facebook and Google. This is because EU is looking to introduce operation laws that combat the growing power of US tech giants from fears that european start ups are being squeezed out. 

New Trade Deals

Theresa May's new government has already started preparing for free trade deals with America and Australia. Creating stronger trade arrangements with the US is of top priority. These plans are being made after President Obama, in attempts to persuade voters to remain in the EU, warned that Brexit would place Britain at the back of the queue for a trade deal with the US. 

Think Tank Open Europe calculated the worst case scenario is the UK losing 2.2% of GDP by 2030. In the GFC, the UK lost 6% of GDP. But, if the UK successfully negotiates free trade deals with Europe in combination with deregulation, GDP can actually increase 1.6%, mimicking the previous set up. 

Implications on US Equity Market 

Brexit prompted interest rates to decline lower than expected, and that put the Fed on hold. This in turn eliminated bond market competition from stocks and loan demand. The recent jobs report on Friday emphasised this acceleration, the positive news compounded as the Fed is now perceived to be on hold due to Britain. 

Something unexpected that happened was the increase in corporate buyers, as big money had disappeared after Brexit. But, takeovers were occurring when you would least expect them to. For instance, Mondelez made a takeover bid for Hershey. Investors might finally have the confidence to see market declines as a buy opportunity. 

Resource Outflow
Passporting is probably one of the largest if not the largest benefit for the UK being in the EU. Passporting allows companies to span their finance and investment services across EU countries without requiring an actual physical presence in these countries. Because London is a major financial capital, it is likely many investment firms will relocate resources (including jobs) out of London and into other countries. Capital Economics estimates that up to half of the UK’s financial services to the EU might be cut- that’s worth $13billion. This effect flows onto US firms as many have established EU headquarters in London.
Also, OECD has suggested British markets are already one of the least regulated in the developed world, making gains from Brexit less enticing. Tax revenues would also fall if companies relocate back to EU.

Domino Effect

Barclays has come out with a worst case scenario. Barclays reports Brexit would hit finances and increase anti-EU movements in other countries. Similar to opening a ‘Pandora’s Box’, it would lead to the collapse of the European Union. The UK is then perceived to be a safe haven from these risks. Investors lead to pound appreciation. The UK will still remain member of nato and UN, but could be perceived as less useful by the US. The American government stated they believe the referendum is a dangerous gamble that would have disastrous effects for the entire continent.   
Downwards pressure on economic forecasts

The World Bank has decreased global growth forecasts from 2.9% in January to 2.4% in June. This move is attributed to slow growth in advanced economies, low commodity prices and weak capital and trade flows. Such forecasts involve downside risk such as growth under expectations in advanced economies or key emerging markets and rising political uncertainty. In an environment of weak growth and policy obstacles, structural reforms are now more needed than ever. Brexit only added to such downwards pressure.

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