Brexit Casts Dark Shadow on World’s Great Move to Openness

Brexit: The Modern Era's Biggest Foreign Policy Mistake?
  • Spain vote, U.S.-led Pacific trade deal among next barometers
  • India central bank chief issues plea for keeping ’open world’

Britain’s departure from the European Union dealt what may be the biggest blow yet to globalization, challenging a decades-long embrace of freer movement of goods, services and people.

While the ultimate economic implications will take months, or years, to be quantified, central bankers didn’t have the luxury of time in the aftermath of the U.K. referendum result on Friday. From London to Mumbai to Tokyo, they pledged -- and in some cases acted -- to assure liquidity amid turmoil.

The success of the Brexit movement, fed by stagnant wages and resentment over inequality since the Great Recession, is one more jolt for a global economy left bruised by years of crisis fighting that’s restricted momentum. It will also give heart to those calling for raising barriers, from continental anti-EU elements to the Donald Trump presidential campaign in the U.S.

“We’re pretty sure that world economic growth is going to notch down a bit,” said Alan Blinder, a Princeton University economist and a former Federal Reserve vice chairman. “Brexit looks to be not just a garden-variety negative surprise, but a very big negative surprise.”


How Britain Voted: Brexit Results

For full coverage of the referendum, click here


Bailout Anger

Confidence in globalization had already been on the wane for years, punctuated by the rise of national-resource nationalists like the late Hugo Chavez in Venezuela and Evo Morales in Bolivia. Discontent fueled by the perception of bailouts for wealthy bankers amid the U.S. housing meltdown last decade, and euro-region debt crisis in the current one, has now been capped by Britons voting to leave the world’s largest trading bloc.

“Brexit is the greatest blow to the liberal international order since it was founded after World War II,” said Thomas Wright, a fellow at the Washington-based Brookings Institution. “The order has faced threats before but to have one of its founding members cut and run, chasing the siren call of nationalism, is a real blow.”

In the eight years after central banks mobilized to address turbulence from the U.S. mortgage collapse, the global economy has suffered through the near breakup of the euro area, a U.S. budget impasse that temporarily shut down the government and a Chinese slowdown. Now, the Brexit-sparked market ructions are pulling policy makers back into action, and augur yet further monetary easing at least in some economies.

For a round-up of central bank comments and actions on Brexit click here.

The reactions followed a sell-off in stocks that started in Asia, a collapse in the pound to its lowest level against the dollar since 1985, surge in the yen, tumble in oil futures and a rally in gold to the highest level since 2014. Yields on 10-year Treasuries headed for the biggest decline since 2011.

Lower stock prices, widening credit spreads, and a firmer dollar threaten to constrain business investment levels already lackluster in much of the developed world. The OECD said this month that the global economy is stuck in a “low-growth trap.”

“Uncertainty is a killer for capital spending,” said John Ryding, chief economist at RDQ Economics in New York.

In the 19-nation euro area that’s still struggling in places to shake off the debt crisis, the Brexit vote aftermath is likely to damp growth and inflation expectations. Yet the European Central Bank may struggle to support the economy further at a time when its policy instruments are already stretched.

Cameron’s Backfire

For Europe’s establishment political parties, the U.K. referendum aftermath -- the result of an effort by Prime Minister David Cameron to stare down Euro-skeptics in his party -- serves up another danger sign, following the rise of populism in Greece, Spain and even Germany that has hampered the EU’s ability to extricate itself from the financial crisis itself. 

Spain’s June 26 election, the second in six months after a surge in support for new parties left a hung parliament, will offer the next reading of Europe’s political backdrop.

Almost a quarter of EU citizens view the bloc “very negatively,” according to the most recent Euro barometer public opinion poll conducted by the EU Commission in November 2015.

For the U.S., market turmoil and a strengthening dollar that reduces American exporters’ competitiveness could lop anywhere from about 0.25 percentage point to 0.6 percentage point off of growth over this year and next, said economists, who added that it’s difficult to make longer-term estimates.

Fed Implications

Fed policy makers, uncertain about the pace of expansion, have kept the target range for their benchmark rate at 0.25 percent to 0.5 percent for four consecutive meetings. Market disturbances -- which helped to stay their hand more than once in the past year -- will likely keep them on hold for several more meetings, economists said.

“Yellen’s already made it clear she sees this as one of the most significant global economic risks of the year,” said Chris Low, chief economist at FTN Financial in New York. “It’ll keep the Fed on hold likely through the end of the year.”

Japan, like the euro region, faces inflation rates distant from policy makers’ targets, yet with even weaker growth, which has pushed the central bank ever deeper into unorthodox monetary steps. The Bank of Japan had already been forecast to step up stimulus in coming weeks, and the market turmoil only cements that call. On the political front, Prime Minister Shinzo Abe has maintained his party’s fortunes in part thanks to the failure of opposition parties to capitalize on a rising wealth gap.

Trade Deal?

Another coming test for openness will come from the fate of the Obama administration’s Trans Pacific Partnership free-trade agreement with Japan and 10 other Asia-Pacific economies. The deal has been stuck in the U.S. Congress for ratification. Trump, the presumptive Republican nominee for president, has opposed the agreement.

For his part, Indian central bank Governor Raghuram Rajan, who famously warned about the build-up of global financial risks in 2005 as the International Monetary Fund’s chief economist, issued a call for action Friday to avoid a spiral toward protectionism and risk aversion.

“The message from this is that the authorities across the world will pay more attention to building popular and political support for keeping an open world,” Rajan said. The onus is on policy makers to ensure “that we don’t shut down on trade, we don’t shut down on immigration, we don’t shut down on capital flows.”

G-20 Commitments

Throughout the economic and political turbulence of recent years, the world’s top advanced and emerging markets have pledged to avoid competitive devaluations -- commitments reinforced in February with a Group of 20 communique. Governments also said then they would do more to help boost global growth.

“This is exactly the kind of shock the global economy didn’t need,” said Klaus Baader, chief Asia-Pacific economist at Societe Generale SA. “But I wouldn’t say it is calamitous.”

Still, the uncertainty over the impact could drag on for months, economists said, because the scope of the fallout for the rest of Europe isn’t clear, and the U.K.’s withdrawal negotiation could take years.

Listen to the Benchmark Brexit Special Podcast:

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Risk Aversion

Emerging markets Friday were collateral damage from investors’ exodus from riskier assets -- a trend that could leave China among those exposed in Asia if it becomes confronted with capital outflows. The financial hubs of Singapore and Hong Kong could also come under pressure, according to Bloomberg Intelligence.

“A weaker EU and a more marginalized U.K. will be less attractive economic and commercial partners for China and other Asian countries in the short term and longer run,” said Tim Summers, senior consulting fellow on Asia at Chatham House in Hong Kong.

Whatever the longer-term economic outcome, for now the immediate lesson for investors is to prepare for greater volatility.

Spain’s June 26 election, the second in six months after a surge in support for new parties left a hung parliament, will offer the next reading of Europe’s political backdrop.
Spain’s June 26 election, the second in six months after a surge in support for new parties left a hung parliament, will offer the next reading of Europe’s political backdrop.
Photographer: Jose Miguel Fernandez/NurPhoto via Getty Images

“The failure of opinion polls or prediction (betting) markets to foresee the result means that markets will see greater unpredictability around future events,” said Richard Jerram, chief economist at Bank of Singapore Ltd. That could matter especially for the November U.S. election, with Trump -- the anti-immigration advocate of trade barriers on China -- behind in the polls.

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