After the Vote: Impact of Brexit

The UK is leaving the EU.  Reaction: Yikes!  What does this mean to you and me?  Nothing or everything?  Why did they vote to leave?  What will change and how quickly?   Answers to these and other questions may be a good guide for your next move.  

On June 23rd, voters in the United Kingdom, in a very close decision, chose to leave the European Union (EU). Financial market reaction was swift and very negative, as worldwide stock markets plunged on the news. As we write this, markets have settled down and partly recovered. But what does the future hold? As always, the honest answer is that nobody knows for sure, but maybe we can offer some perspective and some issues to consider.

Background

The EU is a politico-economic union of 28 nations. The original idea behind the EU took shape post-WWII as a way to forge closer ties among nations (and hopefully avoid another devastating war). After several preliminary steps, the EU in its current form was formally established in 1992. A common currency (the euro) followed in 2002.  Economically, the agreement provides for the free movement of people, goods, capital, and services among its member nations. Taken as a whole, the EU is neck-and-neck with the United States for the title of the world’s largest economy.

Why did the UK Choose to Leave?

While there were a number of reasons behind the decision, the main reason for leaving can be summed up in one word: immigration. As mentioned earlier, the EU offers free movement of people; border controls are a thing of the past. The ability to travel and move is akin to our ability in the United States to travel and move among states. In a refrain that should sound familiar to us in the U.S., there were concerns in the UK about immigrants coming in and “stealing” jobs from natives. The Syrian refugee crisis only served to exacerbate these concerns. Those in favor of leaving the EU cited a desire to “take back” their country’s sovereignty and determine their own border/immigration policy.

What Exactly does “Leaving” Mean?

That is very unclear at this time. No country has ever pulled out of the EU, so we are in uncharted territory. The UK will have to negotiate new rules around the movement of people, goods, capital, and services. Complicating the situation, the UK will need to get approval from 20 of the 27 remaining EU countries in addition to the European Parliament. Needless to say, this will take some time. Current estimates are that it will take at least 2 years to finalize the exit.

A logical arrangement would be something similar to those enjoyed by Iceland, Norway, Liechtenstein, and Switzerland, which are not official EU members, but are closely tied economically through free trade treaties. However, this is a political issue and political issues are not always resolved logically. With some EU representatives sounding like jilted lovers in the wake of the vote, logic may take a backseat in negotiations.

So it’s just a Matter of Time?

Not necessarily. The exit vote is not a binding vote. The UK Parliament could simply choose to ignore it, though that seems unlikely. There are rumblings of holding another referendum (presumably, voters would be asked, “No, seriously, do you really want to leave the EU?”) which could reverse the decision. This would seem a more likely path than parliamentary inaction.

What are the Financial and Economic Implications?

These will depend on how the UK and the EU redefine their relationship. A smooth transition that retains most, if not all, of the current free trade benefits would minimize the negative impact. If spite plays a large part in the new agreement, it could mean slower growth and more significant economic damage for each. You would think that the specter of negative economic consequences would deter punitive negotiations, especially given that the EU has been struggling with slow growth since the 2008-09 financial recession. However, if history shows us anything, it’s that people do not always act rationally.

Markets will likely remain volatile while all this plays out. Markets hate uncertainty and the potential UK exit is a huge dose of uncertainty. Perhaps the biggest uncertainty revolves around how the UK exit will affect other countries, i.e. will there be a domino effect that sees other countries opting out of the EU. While the Spanish vote on June 26th helped to assuage those fears (the incumbent pro-EU party remained in power), the possibility remains (see: Greece, Italy, France, etc.).

What Should Investors Do?

Given that this is a British-inspired crisis, we will use a British expression: “Keep calm and carry on.” While it can be hard in times of market volatility, try to stay focused on your long-term goals. Use market fluctuations as opportunities to buy or rebalance rather than reasons to panic.

Keep in mind that while the EU has been around in some form since the middle of the last century, Europe has been around for a heck of a lot longer than that. Its future may look different, but I would expect that there will still be a Europe and it will still play a big role in the global economy.

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