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Last Updated on: 22nd June 2016, 12:41 pm
This is the last week of the Brexit debates before the long awaited referendum finally happens. Polls still show the two camps for leave and remain at neck and neck. If the leave camp does manage to edge out even a tiny margin of victory, the turmoil surrounding Brexit has only begun. Consider three ways that Britain leaving the European Union could potentially derail the still fragile global economy.
Brexit Would Call Global Investment Channels into Question
This idea centers around international corporations and the repercussions of a leave vote for them. Many U.S. and Chinese based companies invest heavily in British operations so they are able to easily access the free trade channels from the United Kingdom into the whole of the European Union. If a Brexit were to occur, a great number of these multinational corporations would be staring at dramatically lowered profits. This would also create an urgent and unparalleled need for hundreds of companies to reset their various global investment channels so that they had free trade access to the EU. Many of them would wait to see how the negotiations over the U.K.'s exit went in terms of access to the common market. EU observers have already noted this might take minimally (or even longer than) two years. This could cause an investment freeze effect on both Britain and the entire European area.
The International Monetary Fund commented on this effect in their April report. Post exit arrangement negotiations would probably take years. This would create a extensive time frame of continuous uncertainty that would dramatically weigh on investment and confidence at the same time as it increased volatility in financial markets. Such an exit would also mean that financial flows and two way trade probably would be disrupted. Specialization and economies of scale would be curtailed as integration and cooperation unwound.
This is bad enough for Europe. It would impact the whole world if the continent encounters a terrible gridlock in trade and investment. The EU has been measured as anywhere from first to third biggest economy on the planet. As the easily leading exporting and importing trade block around the globe, a slowdown in the European Union translates into a worldwide phenomenon. The worst part about it is that it would go on like this for at least months and even possibly for years while they worked out the details of the divorce and rebuilt trade and investment channels.
Brexit Would Create European and Global Uncertainty
Uncertainty is the worst possible buzzword for markets, particularly if it is long lasting. This problem starts with effects on the European Union. While the long and drawn out exit negotiations proceeded torturously along, investment is not the only problem Europe might encounter. The Brexit could create more exits from other countries which are closely watching Britain's referendum. Experts already point out that nationalist groups throughout Europe are carefully observing the outcome of the referendum to see how they can utilize the results to their advantage. Spain's polls show that the nationalist leftist Podemos alliance is set to become the second largest party in Spain only a few days after the Brexit referendum. Marine Le Pen's party in France also will likely be the second party in France by the next election in a few years and would love to hold a French referendum on the EU membership. Today in France only 38% of the French approve of the EU.
Investment uncertainty is another problem facing not only Europe but also the United States if the Brexit were to go ahead. Billions of dollars have been invested in Britain and by Britain abroad. All of this money could be on standby while the British government races to arrange new trade deals with its key trading partners. Anywhere from billions to trillions of dollars from and to the U.S. would become questionable. In 2014, direct investment in the EU from America amounted to around 1.81 trillion euros. Direct investment in the U.S. from Europe totaled a still greater 1.99 trillion Euros, per the European Commission. Only a small amount of this investment becoming disrupted would have dramatic consequences around the world. This same idea also extends to international corporations and investors from India, China, and Japan.
Brexit Would Create Wildly Disruptive Currency Swings
As investors have seen for decades now, wild currency swings are disruptive on an epic scale. They make it difficult for companies to do business and turn profits in overseas markets. All of the uncertainty surrounding a Brexit would surely cause an enormous currency rebalancing. The British pound has already experienced this on a small scale in the weeks leading up to the referendum as polls swung in favor of a leave vote last week. In a matter of days the pound dropped around 5%. An actual Brexit would be worse. Billionaire currency hedge fund investor George Soros predicts the pound would plunge between 15% and 20% in a few hours to days.
Investors would meanwhile turn their pounds in for Swiss francs, U.S. dollars, and Japanese yen, the perceived safe haven currencies. The Euro would also likely weaken in sympathy with the pound as investors fret over the future of the European Union. Sudden currency swings like these lead to anywhere from short to medium term chaos in markets. When the Swiss suddenly abandoned their currency peg to the Euro a few years ago, the Swiss franc strengthened as much as 30% against the Euro before settling at 13% higher in a matter of hours. This kind of chaos tends to hurt multinational company operations and profits until the currency markets finally return to more normal stable levels. This is why gold makes more sense than ever in 2016.