econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 25 June 2016

Brexit: Why So Scary?

by Pebblewriter, Pebblewriter.com

Listening to various government officials and billionaires talk about the Brexit, I'm reminded of the Barry McGuire Vietnam War classic Eve of Destruction (how many other songs can work the word "coagulating" into the lyrics?)

Would a Brexit really bring the house of cards tumbling down? And, why are TPTB (the powers that be) so apoplectic about it? And, finally, what can we expect from key currency pairs and equity indices?

Instead of focusing on the intraday squiggles in the markets, today I'd like to take a step back and evaluate the big picture in light of what the Brexit might really mean.

First, let me assure you that I have no horse in this race. Though, given the steady stream of lies and misinformation from government sources over the years, I'm naturally hesitant to believe most of what they say.

The City of London is one of two critical financial centers of the world (the other obviously being NY) and would not disappear if the UK were to leave the EU. It would continue as before, though with less interference from Brussels.

Likewise, I believe trade would be largely unaffected. There would be winners and losers, but trade is usually a mutually beneficial exercise - or, it doesn't happen at all. Were one party to try to press unfair advantage, the other would have plenty of ammunition with which to level things out.

Why TPTB Are Freaking Out

The biggest potential risk, I believe, is in the derivatives markets. In the wake of the Great Financial Crisis, central bankers have spun an elaborate web of interlocking relationships between currencies, interest rates, debt and risk.

Rather than reduce the $1.5 quadrillion (imagine a stack of $100 bills over 1 million miles high) in derivatives exposure that nearly destroyed the financial world, they have tried to massage it into meaninglessness by permitting participants to engage in fairy tale accounting.

Demonocracy.com has some great visuals on the amount of money involved.

This one shows $1 trillion, so you'd have to multiply the number of $1 trillion towers by 1,500, but you probably get the idea.

If I write a contract limiting your interest rate and currency exposure on a $500 million euro debt facility, I'm on the hook should things move against me. If I sell pieces of the this contract to 50 different banks and insurance companies, they're technically on the hook, too.

Yet, I'm allowed to say that I have no exposure simply by pointing out that I have other positions that offset my risk. This is called netting. And, it completely ignores the risk that my other positions might not fully offset the risk, as well as the risk that any number of the participants in the daisy chain of obligations might go belly up as did Lehman, Bear Stears and AIG a few years back.

Many other banks and investment banks would have followed them into oblivion had not TPTB decided to let them utilize fairy tale accounting. The government officials, bankers and billionaires arguing that the Brexit could be disastrous for global finance know all about the risk. In fact, they're deeply familiar with them.

This past November, I updated the biggest banks' Wipeout Ratios. As the table below shows, a mere 0.25% decline in the value of their derivative portfolios would wipe out the Tier 1 Capital of JPM, C, GS and BAC. Is it possible that a 0.25% decline might occur in the wake of a Brexit?

The Bureau of International Settlements sure seems to think so - unless you believe the timing of the all hands on deck meeting scheduled for Jul 23-28 in Basel is a coincidence.

Let's take a look at some of the key currencies and indices that might be affected by a potential Brexit, and why TPTB cannot permit the referendum results to stand.

The first currency that comes to mind, of course, is the British pound. In euro terms, the EURGBP, it has followed some fairly well-formed patterns.

Note that the EURGBP represents the amount of pounds sterling it takes to buy one euro. So, as the value increases, it represents an increase in the amount of pounds it takes, a relative weakness in GBP. As the value decreases, it represents a relative strength in GBP.

In general, EURGBP has maintained an inverse relationship to the S&P 500 - meaning that EURGBP strength (GBP weakness) has been negative for stocks, and vice versa. To put it another way, a strong GBP is good for stocks, and a weak GBP (rising EURGBP) is bad for stocks.

The rising white channel, in general, represents a gradual decrease in the value of the GBP relative to the euro, while the falling purple channel represents a gradual increase in its value.

The chart above shows six distinct periods of valuation shifts.

(1) From the advent of the euro until May 2000, the GBP strengthened relative to the EUR. Note that SPX topped out two months prior in Mar 2000.

(2) For the most part, the EURGBP recovered while stocks plummeted.

(3) While SPX climbed from its 2002 lows to its 2007 highs, EURGBP went mostly sideways.

(4) As stocks plunged again, EURGBP spiked higher, topping out 3 months before SPX bottomed in Mar 2009.

(5) As SPX recovered from its 2009 lows, EURGBP began a slow, steady decline to the bottom of the white channel.

(6) EURGBP began a sharp rise again in Jul 2015, rebounding about 1/3 of the way back to the top of the channel. EURGBP bottomed out on Jul 17, 2015, when SPX closed at 2126 - just 8 points shy of its new all-time high set on May 20, 2015. Over the next five weeks, while EURGBP bounced off the channel bottom, SPX shed 12.2%.

What Does it All Mean?

By now, two conclusions should be patently obvious. First, a sudden devaluation in the GBP could do a great deal of damage to stocks. We can argue sovereignty and national pride all day long, but this is the relationship that has TPTB's knickers in a bunch. It's also why you'll find few cabbies or maids warning about the dangers of a Brexit.


Editor's note: An extended version of this is article was posted for subscribers at pebblewriter.com.


>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical Investing Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.



You can also comment using Facebook directly using he comment block below.





Econintersect Investing


search_box

Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.


Take a look at what is going on inside of Econintersect.com
Main Home
Analysis Blog
Energy and Falling Productivity
Reinhard Selten: Pioneering Analyst of Rationality and Human Behaviour
News Blog
Americans Wary Of Drone Delivery
Britain's Wealthiest Households
What Next In The South China Sea
The Dollar - Gold Relationship
Almost Half Of Rape Cases End Without A Conviction
People With 'Obesity Gene' Can Still Lose Weight
The World's Most Generous Countries In 2016
What We Read Today 24 September 2016
Is The Butterfly Effect Real
August 2016 Philly Fed Coincident Index Shows Continuing Slowing Of Economic Rate of Growth
Global Bonds: Why Our Analyst Says Things Just Got "Monumental"
Trends In Expenditures By US Colleges And Universities, 1987-2013
Why Firms In Developing Nations Don't Grow As Fast
Investing Blog
The Week Ahead: How Will Election News Impact The Market?
How To Protect Your Money Against Negative Interest Rates
Opinion Blog
There's No Wall Between The Fed And Banco De Mexico
The Setting Sun: Japan Faces Monetary Exhaustion
Precious Metals Blog
War On Cash Turns To $20, $50, And $100 Bills
Live Markets
23Sep2016 Market Close: US Indexes Close Lower As Crude Prices Slip, Fed Lowers Economic Growth Prospects, Indicators Melting Into Bearish Territory
Amazon Books & More






.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government



Crowdfunding ....






























 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved