By Clement Thibault
After today, it’s conceivable that the European Union’s political and economic future could be reshaped by the UK’s June 23-scheduled referendum vote regarding whether Britain should retain membership in, or exit, the EU. Popularly known as ‘Brexit’ – shorthand for Britain Exit—the vote outcome could have far-reaching consequences for not just the British and Eurozone economies, but also for global currency and equity markets in particular.
Over the course of three articles, we take a deeper look at what the vote means for all involved. This article examines the reasons for the referendum; Part II, considers the consequences either a remain or leave outcome might have on major currencies; and Part III, describes the affect the vote will likely have on global and UK stocks.
What Exactly Is the European Union?
The European Union (EU) is an economic and political union of 28 free states, located primarily on mainland Europe. Each member state acknowledges, upon joining the EU, that they have entered the international treaties covered by the Union of their own free will, without being forced to do so by a third party or superpower. The Union’s strength – and ironically its fragility – comes from that very fact.
Under Article 50 of the EU treaty, "Any Member State may decide to withdraw from the Union in accordance with its own constitutional requirements". To date, none of the EU’s member states has ever elected to leave the Union, while the waiting list to join the EU is lengthy. A decision by the British people to become the first country to leave the EU could have ramifications not only for the UK's future, but also seriously tarnish the EU's prestige and political power.
Prior to the European Union’s founding on November 1, 1993, Britain was part of the much smaller European Economic Community which it joined in 1975. The EEC—often referred to as the Common Market—had 9 member states and was primarily a trading arrangement.
Similar to the EEC, the European Union represents a single market for its member states. But unlike the earlier accord it has evolved into a much broader—and more political—entity that’s headquartered in Brussels, Belgium and along with trade-related issues, legislates over immigration and visa issues as well.
For many in the UK, that’s at the heart of the current problem.
Why does part of the UK want to leave?
Reasons vary. Politically, some citizens are concerned about the ever-growing power of the EU over its member countries. The EU has exclusive legislation power over areas such as common commercial procedures, transport policies, even rules of competition. This essentially means member states no longer have the right to introduce their own legislation in these areas, which many see as weakening individual sovereignty.
Economically, some believe that the free movement of people and goods—a core principal of the EU—is hurting Britain's own economy, as its government is unable to control the influx of migrant workers into the country, and businesses are free to move elsewhere in the EU at will. The border control argument, which has been going on for a number of years now, has gained greater traction recently and is now also being used in a security context, since some believe that disengaging from the European Union's policy towards the Syrian refugee crisis would benefit UK security.
Additionally, the UK contributes billions to the EU budget but gets quite a bit less in return. How much less is the subject of fierce debate. According to fullfact.org, the UK pays an annual 13 billion pound sterling in fees (approximately $18.4B), while it gets back approximately 4.5 billion pounds (approx. $6.4B) in EU spending on the UK, leaving the balance at minus 8.5 billion sterling (approximately $12B) for the UK.
Why would others want to stay?
Of course, those who wish to remain in the EU have their own set of arguments.
Politically, they want to stay in the EU because they believe united, each member country is stronger than it would be on its own. The EU has always seen itself as a global superpower, a status that currently would be unattainable for any of its individual member countries.
Indeed, while the UK, Germany, and France have far-reaching political influence in many different parts of the world, each could not rival the US’s foreign policy clout on their own. This argument also serves stay supporters when discussing security issues, as they believe that strength in numbers is crucial for dealing with future threats.
Economically, EU member countries are able to export within the EU at no cost, boosting sales of British products to mainland Europe. The EU is also able to negotiate better trade deals, as access to the entire European market is an attractive proposition for external trading partners.
Stay supporters argue that the UK will never be able to negotiate better terms on its own. For example, the TTIP, Transatlantic Trade and Investment Partnership, which is currently under negotiation between the US and the EU could become the biggest trade agreement ever formed. Should the UK leave the EU, it would have to negotiate on its own, for better or for worse, depending on one’s perspective.
Finally, while immigrant workers are seen as detrimental to the British economy by supporters of the leave faction, those who wish to stay claim young immigrants help spur growth which will only strengthen the country's economy.
Macro vs Micro
Everything discussed so far concerns the macro economy. But is there a way to prepare your individual portfolio for a possible Brexit? Yes and no.
It’s impossible to foresee all of the different ways 'Brexit' could affect one’s personal investments. However, there are ways to guard against—as well as hedge against—the possibility of a UK exit.
In part II of this series we take a look at how the pound sterling might be affected, as well as the US dollar and some of the other FX majors. Part III, considers the shock to stocks.