InnOvation Capital & Management, LLC
LAW – POLICY – FINANCE – MARKETS
INFORMATION FOR THE ENTERPRISE AND INVESTOR
JULY 5, 2016
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One of the most important Current Events of the year has been the referendum in the United Kingdom with respect to its membership in the European Union. We will devote significant space this month to the topic of the “Brexit.” IntelDigest will review the political aspects of the event this week. In the coming weeks, we will concentrate on finance, trade and economies. We will finish July with a discussion of Debt around the world, and how that is expected to influence our investment decisions going forward.
First, the politics … we believe that the issue which pushed voters “over the edge” is the perception that unelected bureaucrats had too much influence over citizens’ lives. The European Union has become the “United States of Europe,” with similar dysfunction in governance. What began as a common market for trade evolved into a “federal” system, with bureaucrats in Brussels implementing trade and immigration policies having significant effect on businesses and individuals throughout the 28 member nations.
Too many people have been feeling left out economically in a globalized world. Foreign leaders in Brussels … having different customs, cultures and priorities … regulate domestic policies. There is widespread resentment of the elites who manage the financial system or who benefit from globalization. And, the influx of immigrants from alien cultures was the impetus for many “Leave” votes.
It is possible that the leaders of the member states, collectively called the European Council, may have realized the enormity of the problem which they had created, and the need for a different approach. After the Brexit vote, the foreign ministers of the “EU 6” original members (France, Germany, Netherlands, Belgium, Luxembourg and Italy) issued an unusual joint statement, recognizing “…. different levels of ambition amongst Member States when it comes to the project of European integration …. we have to find better ways of dealing with these different levels of ambition so as to ensure that Europe delivers better on the expectations of all European citizens.”
A few days later, the full European Council met, and stated, among other things, that:
“…. The outcome of the UK referendum creates a new situation for the European Union. We are determined to remain united and work in the framework of the EU to deal with the challenges of the 21st century and find solutions in the interest of our nations and peoples…
…. The European Union is a historic achievement of peace, prosperity and security on the European continent and remains our common framework. At the same time many people express dissatisfaction with the current state of affairs, be it at the European or national level. Europeans expect us to do better when it comes to providing security, jobs and growth, as well as hope for a better future. We need to deliver on this, in a way that unites us, not least in the interest of the young.
…. This is why we are starting today a political reflection to give an impulse to further reforms, in line with our Strategic Agenda, and to the development of the EU with 27 Member States ….”
“Better late than never.” The European Council seems to understand that the Brexit vote is a VERY BIG DEAL. There is a significant level of disillusionment throughout the member nations on the subject of globalization. Wages are flat and jobs are scarce. Many people have tired of waiting for the “trickle down” effects in the economies of interconnected modern societies.
If the U.K. leaves the E.U., other members may try to follow the Brits out the door. With more referenda in member states which are in far worse economic shape than the U.K., there is a very real danger that the E.U. could break into smaller blocs.
Although a Brexit may have positive outcomes for the U.K. in the long term, all parties are likely to be hurt over the next two years. The reality is that the U.K. needs the E.U., and the E.U. needs a vibrant and strong U.K. as a partner. Trade among the E.U. members is very important; remember that the idea of the E.U. began as a common market for trade.
For example, Germany must maintain free trade with both the U.K. and the other E.U. member states. Exports account for half of Germany’s GDP. Economic weakness has already reduced sales to China and the rest of the E.U. If significant barriers to trade with the U.K. are adopted at the same time that the world is slipping into recession, the strongest economy in the European Union will be hit hard.
Some potential problems:
- rising unemployment and falling tax revenue in Germany
- rising unemployment among Germany’s trading partners
- an influx of foreign workers to Germany
Other areas of concern:
We are already seeing political instability in the U.K. in the wake of the Brexit referendum; if other E.U. members are forced by popular sentiment to hold Exit votes, you can multiply that instability.
Just as the Pound Sterling has had a precipitous 10% drop, the Euro will likely recede over the coming year. Trade agreements among all the European countries would have to be negotiated anew if the Netherlands, Italy, France or others decide to follow the path of the U.K.
The status of E.U. citizens living abroad becomes a major issue. There are many Brits living and working across the European Union, and millions of E.U. citizens … from all across the bloc, but mostly from newer E.U. members Poland and Lithuania … living and working in the U.K.
The European Union is one of the largest oil markets in the world. Should a recession in Europe follow the Brexit, demand for oil will fall. The U.K. is an integral part of the E.U. energy market, and a member of the European Energy Community. What would its status be after the divorce?
China does a lot of business with the European markets today … over 15% of China’s total exports. A recession in the U.K. would likely spread to continental Europe, taking a toll on China exports.
Finally, let’s not forget the Russians. The European Union has been able to successfully negotiate trade and oil/gas deals with Russia, and has maintained sanctions against Russia for two years because of its aggression against Ukraine. Russia would enjoy negotiating with a weaker European Union. And, a divided Europe will also present a less coherent response to future Russian aggression.