Benjamin Tal is a good economist. As I noted a few weeks ago, he’s been especially effective at countering the notion that Canada is destined for a U.S.-style housing bust. But sometimes received wisdom is what it should be—wise. That is the case with Brexit.
There has been a tremendous amount of analysis and the consensus is that there could be nothing positive for the global economy about a separation of the United Kingdom and the European Union. Yet Tal last week advised the clients of CIBC World Markets to keep calm and carry on even if Britons vote to exit the EU on June 23. “In the case of a ‘Leave’ victory, the initial sell-off should provide some interesting buying opportunities,” Tal said in a note published June 17. “Markets will realize that beyond the rhetoric, Brexit is nothing more than another Y2K.”
Exaggeration is an acceptable form of rhetoric. In April, I wrote that without Prime Minister Justin Trudeau’s deficit spending, the economy would be nowhere. Obviously, that wasn’t strictly true. Canada’s highly indebted households still are spending, for example. (You can decide for yourself how sustainable that might be.) Back to Brexit: It is fair to argue that the worst-case scenarios are over the top; but to say that separation ranks among history’s non-events is too cavalier. Would a vote to leave be catastrophic? Maybe not. But it would be bad. Full stop. It is folly to suggest otherwise.
To be sure, bettors reckon this is a moot discussion. The latest polls give a slight edge to the “Remain” camp—roughly 51% to 49%. That’s too close to call. Still, it feels like the momentum is with the Prime Minister David Cameron and the pro-Europe campaign. The Economist argued the poll numbers might be exaggerating the strength of the “Leave” campaign, as British conservatives have shown a tendency to obscure their true intentions when talking to pollsters. (One explanation for why pollsters failed to predict Cameron’s landslide victory last year was because “Brintroverts” refused to admit they intended to vote Conservative, an uncool choice in everyday conversation.) Bookmakers put the odds of separation at a mere 25%. Investors and traders were with the bookies, as the pound rose to the a five-month high on the eve of the vote and European stock markets posted their largest three-day gain in almost a year.
So, no need to belabour a Brexit discussion. Odds are that by this time on June 24, global financial markets will be in the midst of a relief rally—unless that is what we are witnessing now, in which case they may simply be buoyant. But what if traders are getting ahead of themselves? What if the murder of a pro-Europe member of Parliament fails to quiet the anger and frustration that feeds the campaign to quit the EU?
There is an immediate risk of financial chaos; maybe not the kind of chaos that followed the collapse of Lehman Brothers in 2008, but certainly some ugliness. “Macro shocks trigger bigger reactions today than historically because markets are less liquid,” economists at Bank of America wrote. The Bank of Canada observed something similar in its June Financial System Review. The biggest problem with comparing Brexit to Y2K is that the global financial markets were far more stable 16 years ago than they are now. Whether it is stricter regulations, negative interest rates, or fragile confidence, banks and other market participants are less than keen these days to hold large piles of risky assets. The sort of uncertainty that would follow a Brexit vote could easily cause traders and investors to retreat. Stock prices would fall and interest rates would rise. Hundreds of millions of dollars could be lost.
Tal reckons that sort of reaction would represent a chance to buy assets at a discount. If you know what you are doing, perhaps that’s true. What Tal neglected to say is that the wolves will be out. George Soros, the billionaire hedge-fund investor who caused the British pound to crash in 1992 by betting against it, predicts a similar calamity would follow Brexit. The Bank of England and other central banks such as the U.S. Federal Reserve will be ready to flood markets with cash at the first sign of trouble. That could be exactly what Soros and other hedge-fund managers are waiting for. “Today, there are speculative forces in the markets that are much bigger and more powerful,” he wrote in the Guardian on June 20. “They will be eager to exploit any miscalculations by the British government or British voters.” Financial markets could be dangerous places after a Brexit vote.
One of Tal’s justifications for a blasé attitude about Brexit is that economic incentives would soon pull the U.K. and the EU back together in new type of trading relationship. That’s the argument of an economist who sees a world of rational actors instead of human beings. There are elections next year in Germany, France and the Netherlands. The pro-European leaders of those countries will have very little political incentive to be soft on Britain, especially since all those countries have anti-EU movements of their own. It would take at least two years to negotiate the breakup and then as long as a decade to extricate the UK from Europe. At some point during that time, Scotland could attempt again to breakup with England, or other countries could try to follow Britain out of the EU. The uncertainty would cripple business confidence and trade, driving the UK into a recession, according to the International Monetary Fund, the Bank of England and most every other forecaster that has run the numbers.
The global economy grew 3.6% in 1999 and 4.8% in 2000, according to the IMF. It grew 3.1% last year and will advance 3.2% this year, according to the fund. Y2K turned out to be a phantom risk, but the world probably could have absorbed the glitch. Today, there simply isn’t enough demand and confidence to shrug off a massive crack in one of foundations of globalization. Brexit probably won’t happen. Let’s hope—because if it does, we will be feeling the effects for a long time.
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