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Connecting the Dots Of BREXIT

If you connect the dots of Brexit, Brazil, China, US, and Japan a picture emerges of a general slowing of economic growth across countries against a backdrop of failing government policy giving rise to increasing levels of political risk. And it is this rising political risk that could turn already slowing growth into outright recession by elevating level of policy uncertainty. So, yes it will get worse, just a question of timing.

Look at the rising levels of political risk in each dot: the possible impeachment of Dilma in Brazil, Brexit and the potential exit from the EU, the political extremism in the US of Trump/Sanders, the growing concern about the effectiveness of Abenomics, and, of course, the China’s focus on corruption and taking over the South China Sea. In all of these cases, political risk is rising because of slowing growth if not outright depressions. And, in all of these cases, growth is slowing even with 8 years of massive government and monetary stimulus. So, political outcomes become more extreme because what is left to do for policy that has not already not been tried other than extreme measures, e.g. leaving the EU or EMU. Hence rising levels of policy uncertainty.

I am not surprised at the failure of these policy to create sustainable growth. As you know, I have been arguing that a good part of economic growth during 2002-2008 was unsustainable because it was created by the credit bubble. However, in the aftermath of the crash, policy makers could not accept those “crash” levels of their economies so they unleash a wave of monetary and fiscal policies to push their economies back to pre-crash levels. Now after 8 years of this type of policy, the world is faced with an even higher levels of debt, and slowing economies as the effectiveness of policy ebb. So, now it gets worse because as growth slows, political risk rises, the potential downside and all of these is pushing up policy uncertainty that slow economic growth even further.

Brexit illustrates the point. Of course, Brexit should not matter to markets. The UK is a relatively small economy that would have a minimal impact on the world economy even if it were to slip into a steep recession. The dire warnings of the stay camp are, in my mind, just rhetoric. The UK can exit and cut a deal with the EU and US for trade much as Switzerland and Norway have. Life goes on, e.g. DB does not move its operations to Paris. But, of course, Brexit does matter to markets because it increases the probability of a break-up of the EU and EMU. Other countries will walk the same path that the UK is taking because they too are faced with similar issues of a being in an economic union without a political union. The slowing of economic growth reveals the problems of the lack of a political union.

In my view, the fundamental force that is driving the UK to consider leaving the EU is the issue of immigration and the lack of a political union. Immigration is a problem for the UK because people are acting in their own economic interest and migrating to the UK. They are coming from countries with slower growth, rising unemployment and low levels of welfare and government subsidies. As the European economies slow this allure of immigrating to the UK grows. The lack of a political union means that there is no policy counter to this dynamic and a trickle of immigration becomes a flood. Further, the rules of the economic union exacerbate this problem because these weaker countries are forced to reduce their already lower level of subsidies for their populations which, in turn, accelerates the move to countries such as the UK, e.g. Greece. So, what is the UK to do? They leave because if they don’t their overall standard of living will fall towards the levels of the countries from which people are leaving. Contrast this lack of a political union with that of the US. Ultimately, this means the breakup of both the EMU and the EU. Maybe not today but soon.

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