- The UK voters have been conned, the costs of Brexit are prohibitive.
- They will either have to vote again (either in a new referendum or a general election) or there will be a ‘Brexit light’.
- The latter option will make a mockery of the promises to Brexit voters, but it will limit the economic dangers.
- Still, the saga has increased the risks in the world economy, especially in the EU.
We sold everything on the Friday after Brexit, as we saw little upside, and many festering risks in the world economy. Risks which Brexit would clearly increase, most notably the risks of an economic slowdown in the EU, causing further political turmoil.
But these are by no means the only pressure points in the world economy, as we described in the previous article.
But markets rallied back (we didn’t expect an immediate crash as a result of Brexit), and it slowly dawned upon us that the most logical explanation is that there will be no Brexit.
Why? In essence, it’s fairly simple. The price of the promises made by the Brexit camp, most notably to control immigration, to pay much less to Brussels and to ‘take back control’ cannot really be achieved at anywhere near acceptable cost.
Let’s start with immigration. The UK wasn’t part of Schengen (which abolished internal border controls), but it was bound by the four freedoms of the internal market, most notably the freedom for EU citizens to live anywhere in the EU.
In order to escape that (the UK is a popular destination for East Europeans, most notably Polish) the UK would really have to get out of the single market. But this opens up a Pandora’s box of problems.
First, since the EU is the UK’s most important market, it would have to negotiate access to the single market, and do that within the two years given by Article 50 (the EU has made it clear no negotiations will start before Article 50 is triggered).
Not only that, it would have to deal with negotiating multiple other trade deals, perhaps as many as 50, basically with much of the rest of the world.
The UK isn’t equipped to do that (trade has been an EU prerogative), let alone in any amount of acceptable time. The resulting uncertainty isn’t exactly good for business. This will affect inward investment, location decisions, job creation, etc.
That alone is already too high a price to pay. But there are other implications, like (Bloomberg):
Britain has voted to exit the EU and Xi’s being forced to reassess his strategy for the 28-member bloc, China’s second-biggest trading partner, according to data compiled by Bloomberg. The U.K. has been a key advocate for China in Europe, from building trade-and-financial links to supporting initiatives such as the Asian Infrastructure Investment Bank. Beijing’s leaders were counting on the U.K’s backing later this year when the bloc decides whether to grant China market-economy status. “One major reason why China attaches great importance to its relations with the U.K. is to leverage EU policy via the U.K.,” said Xie Tao, a professor of political science at Beijing Foreign Studies University. London’s value as a “bridgehead” to Europe has been lost with Brexit, Xie said, leaving China to turn its focus to Germany.
Perhaps even more important is London’s status as a financial center. From Business Insider:
First, international banks are likely to move staff out of London and do less business in the UK. Long before the vote, rival financial centers like Paris began campaigns to woo those bankers. JPMorgan chief Jamie Dimon told an audience of bank employees in Bournemouth, one of many regional financial centers in the UK, that as many as 4,000 jobs may be affected by a Brexit before the vote… It isn’t just a question of whether staff move from London to another financial center, either. New jobs are less likely to be created in London. M&G Investments, the fund arm of insurer Prudential, is looking at expanding its operations in Dublin, according to Reuters. The proposed merger between the London Stock Exchange and Deutsche Borse, which would have seen the combined group based in London, now looks to be on shaky ground. Germany’s financial regulator has also said that London will no longer be the center of euro-denominated trading.
There are myriad other costs and awkward consequences, but this suffices to highlight the fact that it’s not a good idea to actually leave.
Ergo, powers will awake to prevent this and keep the UK in the single market. We can’t see the UK’s economic, financial and political elite shoot themselves in the foot without regrouping and giving this a mighty fight.
It’s fortunate that there is a cooling off period, in which calmer heads can prevail. First the governing Conservative Party has to choose a new leader.
Then they will have to work out a plan and trigger (or not) Article 50, the formal request to leave the EU.
Two outcomes seem likely, either things stay as they are, or the UK opts for membership of the EEA, which guarantees access to the single market. Perhaps they manage some symbolic concessions.
Both of these options amount to betraying the Brexit voters, one could even say they have been conned. It’s obvious if the referendum is simply ignored by Parliament, after all there already is a Parliamentary majority of 350 for remaining in the EU.
But EEA membership, like Norway, would also betray the Brexit voters and we doubt it’s any more attractive than simply remain in the EU. The UK would continue to have access to the single market, but not be a part of setting its rules.
The UK would continue to be bound by the freedom for people to live and work anywhere within the EU, making a mockery of the promise to control immigration.
Even the budgetary consequences aren’t really that much better (Yahoo):
But the fees in Norway, the nearest analog to the UK, are almost as high as what the UK pays to the EU now, and Norway has no say at all in EU decisions.
So either there will be no Brexit (a new referendum or new elections, with the winning side clearly having a mandate for remaining in the EU will be necessary), or it will be a Brexit light (EEA membership), making a mockery of the promises to the Brexit voters.
The economic consequences of the latter are much less damaging, so did we sell in vain? Not necessarily. The whole Brexit saga is still increasing the risks in the world economy, of which there are many, especially in the eurozone.
Stocks are still expensive (especially on a GAAP basis), we see limited upside, and might very well go short when stocks start approaching their all-time highs again. It’s more of a trader’s market, in our opinion.