Topic: 3 Brexit Doomsday Scenarios By Adam Hayes, CFA
The British government has set the wheels in motion for a popular referendum on June 23rd over whether to leave the European Union (EU). A British exit, or Brexit, would be the first such departure from the EU, despite the lingering possibility that a peripheral Eurozone economy, such as Greece or Spain, would be forced out. Previously, such a vote had not been anticipated to occur until at least the end of the year 2017.
The country is currently divided in early polling, with 43% of the population in favor and 40% opposed. Meanwhile, the Parliament is also split, as well as the corporations who comprise the FTSE 100 stock index in the U.K. (For more, see also: Brexit Uncertainties Dominate EU Summit.)
Some politicians and economists argue that a Brexit will free the United Kingdom to stabilize its economy and enact monetary policy more easily. They claim that the British economy will flourish outside the protectionism of the EU. Opponents, including Prime Minister David Cameron, warn that it could be a big mistake. Here are some negative possible outcomes stemming from a British exit. (For related reading, see: Will The UK Leave the EU?)
The British pound has already fallen more than 4% against the U.S. dollar, and nearly 6% versus the euro since the beginning of the year. Observers have noted that as the likelihood of a 'yes' vote to leave the EU increases, economic and political uncertainty also increase, causing the pound to fall. Many believe that foreign investment into Britain would fall and the demand for the pound abroad would weaken. (For more, see: British Pound Tumbles on Potential 'Brexit'.)
While a fall in the pound's value could theoretically benefit exporters, Britain's current account deficit, which stands at 4.5% of GDP, crucially needs foreign inflows of capital to finance it. In the absence of eager foreign direct investment, that budget deficit would be harder to support and the currency could fall even further.
Opponents of a Brexit note that around 90% of British trade occurs with EU partners. Leaving the Eurozone may cause both political and economic rifts that will negatively impact trade. David Cameron has gone on the record saying, "Leaving Europe would threaten our economic and our national security." The result could be increased British protectionism in order to compete internationally and consequently a hit to Britain's GDP. French insurer AXA's analysis has pegged the drop in GDP to be somewhere between 2% and 7%. According to a new report by think tank Open Europe, Britain's GDP could be reduced by 2.2% over the next couple of decades, coupled with only a +1.55% best case scenario to the upside. The graph below illustrates Open Europe's conclusions.
Jobs could also be lost. Labor party leaders have stated that more than 50,000 manufacturing jobs would be lost and over 100,000 jobs lost in the banking sector. Some also worry that job-creating companies will be incentivized to leave Britain in favor of a location where they can easily and cheaply obtain European migrant labor, taking those jobs away as they relocate.
Some firms that are already thinking about scaling back in the U.K. in the event of a Brexit include food giant Nestlé, auto makers Hyundai Motor Company and Ford Motor Co. (F), and investment bank Goldman Sachs Group Inc. (GS). In fact, in a recent poll, nearly 30% of companies surveyed would leave the U.K. or drastically scale back operations there in the event of a Brexit.
U.K. unemployment currently stands at 5.4% after a slow recovery from a peak of over 8% following the 2008 financial crisis. A Brexit could cause that figure to spike back up to Great Recession levels. (For more, see: Brexit: Could Boris Johnson Keep Britain out of the EU?)
The Bottom Line
Britain's population is set to vote for a British exit, or Brexit, from the European Union in June of this year. While its supporters claim that being free from the EU pact would allow its economy to grow more rapidly and with greater autonomy, many others suggest that it can lead to the possible doomsday scenarios of currency collapse or a significant reduction in GDP and a loss of many thousands of jobs. With current polls projecting a split outcome among voters, politicians and businesses, the value of the pound and British asset markets may waver as the risk and uncertainty surrounding the vote increase.