Brexit: The Noise of the Unknown

When David Cameron agreed to hold a referendum on whether Britain should stay in the European Union (EU), he surely did not believe that there was a significant chance that it would go the way it did. Now Britain, and by extension Europe, has been plunged into an unknown by the vote of a slender majority of Britons to leave the EU.

For both the United Kingdom and Europe, we are facing a long period of the unknown. For the United States and the rest of the world, however, the consequences are much more amorphous. There is the risk of contagion, that chaos and uncertainty in Europe will infect global financial markets and embolden nationalist and nativist movements. But there is also the basic fact that the precise relationship between the UK and the EU doesn’t necessarily matter to the rest of the world, other than the short-term turmoil unleashed on financial markets.

And those markets are suffering one of their worst days in years, with global equities selling off and “safe haven” investments such as US Treasuries and gold seeing substantial inflows. Make no mistake: This is a major event, politically and financially. We don’t see many days when exchange rates and yields on US Treasuries move more than 10%, and various global equities plummet another 5-10%.

Yet the actual financial and even political ramifications of this referendum are also extremely fuzzy. Yes, the vote is a deep and perhaps fatal blow to the decades-long experiment in greater political and economic integration for the more than two dozen European nations that make up the EU. But what actually happens now is anyone’s guess, and no one is going to know how this plays out in reality for years. That’s right. It will take years for the specifics of a UK disengagement from the EU to be hashed out. The only certainty today is that no one knows what happens next.

Stepping back from market disruption, we are left with a few simple questions: Does any of this fundamentally alter global commerce, the flow of goods and services, domestic wages, and demand? Does any of this shift the tenor of the US presidential election, the fate of the Chinese Communist Party, or the viability of economic and political reform in India? Does it tip the balance one way or the other in the impeachment and corruption scandals in Brazil, or the prospect of structural economic reform in Italy? Does it aid or retard the progress of ISIS in Syria, or the ability of the South African government to move into a less crony-ridden future?

The answer, of course, is no. Brexit is a global Big Deal, but the market reaction is clearly excessive, and speaks to the hair-trigger capacity of market players and computer algorithms, that shape so much day-to-day activity, to generate extreme reactions.

For the US, this vote really changes almost nothing. Yes, it may take years to renegotiate trading arrangements with a Great Britain that is separate from the European Union, but trade will not cease, nor will it become substantially more expensive in the interim. Businesses and governments will adjust to the ad hoc nature of the present, as they always do and always have.

The ebb and flow of capital and commerce is also likely to be much less impacted. Great Britain’s 64 million inhabitants are not about to demand fewer smartphones or consume fewer commodities. Apple’s next upgrade cycle will change not a whit, nor will its challenges in China be either eased or made more severe. Caterpillar will not find that the global commodity cycle sees either an uptick or diminution of demand. And the US campaign season will continue largely as it did before, with the vast majority of Americans unaware and uninterested in a Brexit, and not about to vote differently for Hillary, The Donald, or their local rep as a result.

For those in the US opposed to trade pacts and their extension, the British referendum may offer some modest ballast, but it’s doubtful that the swath of discontent animating voters in the industrial heartland is about to shift allegiances between either Bernie and whomever, or Hillary and Trump, simply because Newcastle-upon-Tyne voted to Remain even as Sunderland chose to Leave.

Nor will the vote change the level of domestic wages in the United States, let alone the anti-corruption crusade of Xi Jinping in China. We may live in a globally connected world, especially in financial markets where capital ebbs and flows with little regard for national borders. But we aren’t so globally connected. Absent a complete meltdown of financial markets (which last happened in the fall of 2008), politics remain local and regional, and economies remain separate and distinct.

The immediate financial meltdown, therefore, is likely to end sooner rather than later. The political ramifications for Europe will take years to unfold, but today’s financial chaos is more probably a brief bout of bedlam that soon will end, given the limited effects described above. Europe now represents one of the great question marks of our age in terms of how it will be governed, but not in terms of its challenging demographics combined with its remarkable culture of affluence and ennui.

The Brexit referendum is a classic and clichéd monkey wrench in the gears, changing the narrative of integration and casting the experiment of the EU into doubt. That is an existential question of the first order, and a structural challenge as well. But in terms of the wheels of commerce and the rest of the world, it is distinct and contained, at least for now. It may presage other global shifts, but until it does, this remains a story of Great Britain and Europe, and not a harbinger of a world order about to unravel, no matter how much financial markets may be saying just that.

This first was sent as a market update by Envestnet