June 24, 2016 | By

Brexit Is Not Just a British Problem

Rates of currencies, including British Pound, are displayed after Brexit referendum on an electronic board. REUTERS/Kacper Pempel

Anyone who thought seriously in advance about Britain’s departure from the European Union would have expected plunging financial markets. And plunge they have. But there are some surprising aspects to the way in which markets reacted in the immediate aftermath of the June 23 vote.

First, the vote itself was a surprise. Markets had been fairly sanguine in the lead-up. Perhaps this was because, ex ante, the story seemed like a very familiar one. Europe faces a great peril; the crisis comes to a head; and Europe finds a way through. We saw this with Greece, with Cyprus, with the Scottish independence vote, and, in less focused fashion, with the European migration crisis. It began to seem like a serial in which the hero would always survive in some improbable way; you just waited to see how. So markets looked at toss-up poll numbers in advance of Thursday’s Brexit vote and figured that this was just another episode.

The danger is that a loss of confidence could have more serious effects. None of the previous European crises were really solved. The solutions were temporary and the problems deferred. The deferrals worked because market participants believed they would work. If that belief is shaken, crises could flare. As but one example of this, if investors believe that Greece and Spain will stay in the euro zone, they will be content to leave their money in Greek and Spanish banks. That forestalls a banking crisis. If investors begin to worry that the countries might leave, they can pull their funds, which induces a banking crisis and may cause the very departures that they feared.

The second interesting aspect of the markets’ response on the day after was the distribution of the pain. It was no surprise that the British pound fell – it dropped to a 30-year low. Nor that the main British stock index dropped; after a steeper initial plunge, it closed down 3.15% for the day. But it’s only down 1.66% year-to-date. The surprising thing was how much more other big markets dropped: Japan fell by almost 8%, France by over 8%, Germany by almost 7%, and Spain by over 12%.

It’s a bit early to draw firm conclusions, but the market reaction would seem to caution against treating the Brexit vote as predominantly a British problem. Yes, Britain will have to come up with new trading and investment arrangements and faces a difficult time. But this also marks the first departure of a country from the European Union. The separatist vote has prompted calls for similar referenda in countries such as France and the Netherlands. Even if the remainder of the European Union stays intact, it is worth remembering that the United Kingdom is the world’s 5th (or 6th) largest economy and a major trading partner and financial center for the rest of the European Union. United Kingdom stumbles would mean European problems. 

Japan’s ties to the United Kingdom are less direct, but Japan epitomizes a country that has seemingly exhausted the readily available policy tools for stimulating its economy (structural reforms remain, but those have proven difficult to enact).  Perhaps Japan’s best hope was that other major economies would grow and lift the Japanese economy up through trade. With this blow to the global economy, that now seems less likely.

In the United States, markets fell roughly on par with the FTSE in the UK. The S&P500 dropped 3.6% on the day, but is almost unchanged year-to-date. Perhaps the most telling market move, though, was in the 10-year Treasury bond. Its yield fell to 1.56%, the lowest level since the second half of 2012. There are two possible interpretations, neither particularly good: 1) expectations of growth in the United States are falling; 2) panicked investors from around the world are turning to US Treasuries as a safe haven.

No one should read too much into immediate market reactions. There is enormous uncertainty about how Britain’s departure from the European Union will play out. But the early theme seems to be that the problem is a global one. 


Phil Levy is senior fellow on the global economy at The Chicago Council on Global Affairs. Previously he was associate professor of business administration at the University of Virginia’s Darden School of Business. He was formerly a resident scholar at the American Enterprise Institute and taught at Columbia University’s School of International and Public Affairs. From 2003 to 2006, he served first as senior economist for trade for President Bush’s Council of Economic Advisers and then as a member of Secretary of State Rice’s Policy Planning Staff, covering international economic matters. Before working in government, he was a faculty member of Yale University’s Department of Economics for nine years and spent one of those as academic director of Yale’s Center for the Study of Globalization.

His academic writings have appeared in such outlets as The American Economic ReviewEconomic Journal, and theJournal of International Economics. He is a regular contributor to Foreign Policy magazine’s online Shadow Government section and writes on topics including trade policy, economic relations with China, and the European economic crisis. Dr. Levy has testified before the House Committee on Foreign Affairs, the Joint Economic Committee, the House Committee on Ways and Mean, and the US-China Economic and Security Review Commission. He received his PhD in Economics from Stanford University in 1994 and his AB in Economics from the University of Michigan in Ann Arbor in 1988.