Brexit: Keep Calm and Carry On
Once in a while something big, different and often unexpected happens. It happened on Sept. 15, 2008, when Lehman Brothers filed for bankruptcy. Also on Sept. 11, 2001. And a few years ago when Greece almost collapsed and we heard dire rumblings that the European Union would fall apart. Our computers were going to fail on Jan. 1, 2000. There were also the Russian bond default, Long Term Capital Management, the 1986 tax act, the S&L crisis and more.
Another such event occurred on Thursday, when the U.K. electorate unexpectedly decided to exit the European Union (“Brexit”). That set off fear, uncertainty and stock dumping that destroyed, at least for now, trillions of dollars of value.
Investors and commentators fear Brexit will cause a recession in the U.K. with ripple effects elsewhere. Brexit could be long, protracted and messy—a celebrity divorce with complicated assets and no prenuptial agreement. Trade barriers will arise, hurting everyone and the creation of wealth.
Other EU members may follow the U.K., destroying a hugely important free trade bloc. Conversely, Scotland and Northern Ireland, which voted against Brexit, might switch from the U.K. to the EU, creating more chaos. The U.K., a major trading and finance partner of the U.S., will become less important in the global economy, hurting the U.S.
Maybe the Brexit vote was a populist tantrum against “the way things are” and “financial and political elites” and “big remote government.” If so, what does that portend for our presidential election in November? More chaos.
If Brexit excised the British Isles from the world and let them float into isolation in the middle of the ocean, or ended world trade and capital flows and the rule of law in the U.K., it would cause a disaster for the U.S. and the world. But that didn’t happen.
Trade and capital flows will continue. Today’s players, especially in the U.K., generally know the value of free trade and free capital flows. Whatever arrangements the newly liberated U.K. negotiates with the EU and the rest of the world, one should reasonably expect a continuation of free trade and free capital flows. The process will take time, though, hence the uncertainty.
Instead of focusing on creating wealth and general improvement, the U.K. government will distract itself for the next two years disentangling Great Britain from the EU. That has already led Prime Minister David Cameron, who opposed Brexit, to resign. But the U.K. retains tremendous strength and resourcefulness, with plenty of smart people who favored Brexit and now can get it done.
Headwinds in the U.K. could also slow things down in the U.S. But U.K. uncertainty may make U.S. real estate and other investments more appealing for both investors and occupiers, especially in finance. That should help the U.S., especially New York City. But the sudden devaluation of the British pound, if it persists, could create a buying opportunity in London. Those two forces will sort themselves out. Neither feels like the impending end of the world.
Brexit seems likely to further defer any increases in interest rates and cap rates, thus pushing that day of reckoning further into the future. That will just continue our addiction to cheap money. Eventually rates will have to rise and it will hurt.
The EU has enacted, and will no doubt continue to enact, ever-expanding laws on finance, trade, competition, product standards and other matters of concern going beyond—and also often invading and usurping—the internal agendas of their member countries. Those invasions probably helped drive Brexit. The U.K. was subject to all those laws, often adopting them as internal laws of the U.K. When the U.K. leaves the EU, will all this legislation need to start over from scratch? Not necessarily.
It should often be practical to take existing EU laws and adapt them to U.K. tastes and agendas, benefiting from the U.K.’s new freedom and independence from Brussels. Moreover, any continuation of free trade between the EU and the U.K. will probably require the U.K. to keep complying with many of those EU edicts. It’s reasonable to expect more consistency than change.
Everyone seems to agree it makes sense to try to resolve the Brexit uncertainties as soon as possible. The EU itself has said as much, perhaps in the hope that sealing the wound quickly will prevent further infection and damage (and departures). Because investors hate uncertainty, they feel likewise.
Once the uncertainty clears, which will take time, one can reasonably expect the financial world and international trade won’t look all that different than they did before Brexit—just like what eventually happened after each of the earlier disruptions mentioned in the opening paragraph of this column.