by Elliott Morss, Morss Global Finance
Introduction
There is considerable uncertainty over what the results of the Brexit vote will be. And while what will actually happen will remains in doubt, there are some fact-based forecasts that can be made. Let’s start with what the vote actually means.
In speculating on this, Max Fisher has come up with a number of options that I supplement with commentary:
- First, and probably most important, the vote is not binding. Until Article 50 of the Lisbon Treaty is invoked (“Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements”). And while heads of the EU are pressing the UK for a decision, UK politicians are biding their time to see how the wind blows.
- Under current UK rules, Scotland who vehemently opposes leaving the EU, has veto power. Now, the British parliament can vote to take away this power, but until that happens….
- As with what Denmark and Ireland did, the UK might call a second referendum.
- Norway is not a member of the EU, but it enjoys most of the free trade privileges of member countries. I don’t think the UK will go this route (see below for why), but it could.
- An exiting member country has two years to negotiate issues like trade and migration. Don’t hold your breath. This process will take some time.
In the meantime, I offer some facts and speculations below.
The European Union, the Eurozone, and the UK
Table 1 provides basic information on the countries in the European Union (EU) and the Eurozone with the US as a reference point. The EU consists of 28 nations while the Eurozone (all using the Euro (€) as their currency) includes 19 nations. The UK continues to use its own currency, the British Pound (£). This makes a Brexit far less problematic than for a Euro country – unless the exiting Euro member chose to continue to use the Euro as its currency.
Measured by GDP, Germany is the largest country in the EU with the UK second. Denmark appears to have the highest per capita income in the EU. The total GDP of the EU is $1.7 less than that of the US.
Table 1. – The European Union, the Eurozone and the US
Wikipedia, IMF
Norway is not an EU member. However, it is a member of the European Economic Area (EEA) and this allows Norway access to the EU’s internal market. This facilitates free movement of goods, capital, services and people between EU countries and Norway. Some think this sort of arrangement might work for the UK. As mentioned above, I doubt it. About 28% of EU legislation was in force in Norway in 2010, and that amount has increased. So if the UK chose this route, it would have to adopt at least some of the EU regulations that the Brexit vote indicated it wanted to avoid.
How Do EU Payments Net Out?
Table 2 provides net payment data by countries to the EU, both in Euros and as a percent of Gross National Income (GNI). Positive numbers represent net receipts, negative numbers net payments to the EU. Germany and Sweden put in the largest shares of their GNI, while Germany’s net contribution dwarfs that of any other member. Hungary receives the largest share while Poland gets the largest absolute payment.
Table 2. – Net Revenues To/From the EU
Source: EU Information Center
Each country’s payment into the EU is divided into three parts: a fixed percentage of gross national income (GNI), customs duties collected on behalf of the EU (known as “traditional own resources”) and a percentage of VAT income.
Table 3 lists the EU’s “outpayment” categories. These items all sound “good”, but the largest item are agricultural subsidies, subsidies the EU insists on maintaining. The other items? I am sure there is a lot of lobbying to determine who gets what.
Table 3. – EU Expenditures, 2015
Source: EU
Economic Analysis
People are worried. As a result of the Brexit vote, the British Pound has weakened from $1.50/£ on June 23rd to $1.33/£ on the 28th,a drop of more than 11%. The Pound has weakened 17% against the Euro over the same period. This will make imports more expensive to UK citizens and add to inflationary pressures. But exporters will love it and the UK trade balance will improve. Americans will be pleased to learn that their $ costs of British products have fallen.
Table 4. – The UK’s Largest Trading Partners, 2015
Source: Comtrade
Risks and uncertainty can generate real economic costs. FocusEconomics surveys 21 leading economic institutions on their UK growth projections. The following chart indicates how Brexit has affected their 2016 and 2017 GDP growth UK projections: 1.9% down to 1.4% for 2016 and 0.3% in 2017, down from the 2.1% projection prior to Brexit.
Conclusions
It is clearly difficult to anticipate the future with so much uncertainty remaining. One fear is that it will result in a domino effect with other countries choosing to exit as well. And there are major inter-country disputes: Germany has “had it” with the “weak sisters” – Greece, Italy, Portugal and Spain. Germany believes austerity is the only answer for these countries. And it sticks to this view even though the IMF and others disagree.
At this time of uncertainty, keep in mind that those engaged in international trade with the UK want it to continue. They are profiting from it and will work for the smoothest transition they can get.
Investment implications? If you like to make random gambles, this is your time.
