‘Brexit’ strengthening the forces that are already haunting global economy
London (Jun 28) Sometimes, something bad happens, and it creates huge financial market swings and long-lasting economic ripples. The Sept. 11, 2001, terrorist attacks were an example, as was the 2011 Japanese nuclear disaster.
But the so-called Brexit is different.
The immediate financial downturn after Britain voted Thursday to leave the European Union resembles the fallout from those disasters. But the other events were largely disconnected from the broader economic currents of their time. They were one-offevents, at least in terms of their economic ramifications.
What makes Brexit so concerning is that it accentuates and deepens global forces that have been building for years. So far, governments have been unable to limit any of it. And those forces have self-reinforcing, vicious-cycle dimensions that make it a particularly perilous time for the global economy, even though the type of full-scale panic that followed the collapse of Lehman Bros. in 2008 looks unlikely.
Britain accounts for less than 4 percent of world GDP. Most people on Earth don’t have a rooting interest in the exact details of the nation’s trade relationship with the rest of Europe. But its decision to leave the European Union is making more powerful six interrelated forces that already weigh on the global economy:
— Low inflation.There is a glut of global commodities, particularly oil. There is a glut of labor, with elevated unemployment in much of the world. Inflation has been persistently below the 2 percent mark that major central banks aim for, and shows little sign of rising.
And since the Brexit decision, markets are signaling that those forces have become even more energized.
The price of oil fell 7.5 percent from Thursday’s to Monday’s close, despite little reason to think that the British referendum will cause any major changes in, for example, the supply of oil from oil reserves the nation controls.
And bond markets are priced at levels that imply the years ahead will have lower inflation that was priced in before the Brexit news. While high inflation is often viewed as the greater threat, in the last few years economists have viewed too-low inflation — which can discourage spending and investment and make debts more onerous — as the more pressing concern.
In the United States, bond market prices imply that investors now expect annual inflation of 1.37 percent a year through 2026, down from 1.55 percent on Thursday before the vote’s results, a drop of 0.18 of a percentage point; in Germany, the drop was 0.13 of a point and in Japan 0.10 of a point. (The one exception: Britain itself, which will almost certainly see much higher inflation in the coming years because of a drop in its currency.)
— Strong dollar. The U.S. dollar has been on a tear. The dollar index, measuring its value against six other major currencies, is up more than 20 percent in the last two years.
Some of this reflects good health: The U.S. economy is reasonably strong, with steady growth since 2009 and a 4.7 percent unemployment rate. That has led the Federal Reserve to raise interest rates once and contemplate further moves.
Some of the dollar rally reflects a more negative global outlook. The economies of Europe, Japan and many emerging markets have remained exceptionally weak, making the U.S. look comparatively fantastic. Factor in the United States’ traditional role as the beacon of stability in turbulent times and U.S. assets look more attractive than their underlying economics would suggest.
Most worrisome is that there are some feedback loops between the strong dollar and economic weakness abroad. Many international companies, especially in China and emerging markets, owe debt in dollars, so a stronger dollar makes their debts more onerous and creates spillover economic weakness. And the stronger dollar is undermining American exporters, slowing growth in the U.S.
Brexit is only accentuating this. The dollar index is up 3 percent since Thursday, most significantly because of the collapse in value of the British pound, but it is also up against the euro and the yen.
— Impotent monetary policy. The world’s central banks are well aware of these forces, of course, and are trying to combat them. The European Central Bank and the Bank of Japan are in the middle of huge programs to try to pump money into their financial systems by buying assets. The Federal Reserve and the Bank of England have been delaying interest rate increases in hopes of achieving higher inflation and more solid growth.
So far it has not been enough to get inflation persistently up to 2 percent or achieve sustained strong growth. And it is an open question if more of the same will change anything, particularly given that the economic challenges emanating from Britain are more because of existential questions of national identity than because of a garden-variety business slowdown.
Nonetheless, in the aftermath of Brexit, analysts and financial markets are now pricing in even slower interest rate increases for the Fed and the Bank of England, and a real possibility of yet more easing programs by the ECB and the Bank of Japan.
— Low interest rates. Remember back in December when the Federal Reserve raised interest rates? That day, 10-year Treasury bonds were yielding 2.3 percent. Those bonds had fallen to 1.74 percent by Thursday (the Fed controls short-term interest rates directly, but longer-term rates are set in the open market).
In the two trading days since the Brexit vote, that rate has fallen to 1.44 percent. Other bond markets, including across Europe and in Britain itself, have also experienced falling longer-term rates. Germany, Switzerland and several other European countries even have negative long-term interest rates, meaning a person who buys a bond and holds onto it will lose money.
That is very much related to the decline in investors’ expectations for lower inflation and more central bank activism. But it may also reflect a “fear premium” as investors throw money into anything that seems safe — even if it means they are guaranteed to lose money.
— Weak growth. This is the underlying story behind all of these other market currents. Europe is only now returning to its 2007 level of economic output; Japan’s growth is so low it is constantly bouncing in and out of recession status. In developing markets, Brazil is in recession and China is slowing. Britain and the United States are doing better, but only by the diminished global standards of the 21st century.
You can have endless debates about the underlying causes. Is this the inevitable result of a lull in productivity growth, a result of bad policy or bad luck, or some mix? Either way, the reality is that the global economy seems locked into lower growth than had been the norm in the decades before 2007.
Britain’s EU vote raises the risk of further dragging down that growth rate, particularly if there is a prolonged period of uncertainty around the country’s fate or a permanent breakdown in the trade ties that make an economy richer.
— Political instability. All of this is creating a toxic political environment in much of the advanced world, driving greater polarization and the flocking of voters to candidates outside the mainstream.
Brexit is the most recent example, supported as it was by Nigel Farage and Boris Johnson. The rise of right-wing nationalist parties in Continental Europe is another prime example, as are the popularity of Donald Trump and Bernie Sanders in the United States; Jeremy Corbyn in Britain; and the far-left Podemos party in Spain.
Of course, less conventional politicians could turn out to succeed at generating stronger economic conditions where parties of the center have failed. But if nothing else, the widening of the ideological spectrum creates a wider range of possible outcomes — including some that would surely be very negative for financial markets and the global economy.
Again, none of these stand in isolation. Each is deeply related — either as cause, effect or both. And each has been pushed further by Britain’s choice. Where the cycle ends, and when, no one knows.