In a referendum felt
’round the world, UK voters decided it would be best to leave the European
Union. By a vote of 52-48, the “Leave” supporters have won and have thereby
disrupted the trend towards progressively greater European integration that has
been in place since World War II. The immediate repercussions of the decision
were dramatic: UK PM David Cameron resigned, global stock markets swooned, and
safe haven assets like gold and the US dollar surged. The answers to the
political question of “Why?” run from immigration to globalization to anti-EU
regulations. In 2013, Cameron made a promise to the anti-EU wing of his
Conservative party to hold a referendum on this issue. Cameron campaigned
vigorously on “Stay,” but couldn’t convince a majority of UK voters.
Brexit occurred
despite dire warnings of major negative impact to the UK economy from a wide
range of groups from the Bank of England to the European Central Bank. The UK
Treasury issued a report on Brexit predicting GDP would be 3.6 per cent lower
after two years than if the UK voted to remain, unemployment would be 520,000
higher and the pound would be 12% lower. [HM
Treasury Analysis (pdf Page 8), May 2016] Britain must now hold formal talks with the European Union on
exiting the group. While the UK has up to two years to formally request the
exit, leaders in Europe are asking to accelerate the process in order to reduce
uncertainty.
It should be
remembered that Brexit is a predominantly political shock to global financial
markets and commerce. Unlike the 2008 financial crisis, Brexit doesn’t have a
financial payment or settlement crisis as part of the event. Consequently, it
is unlikely to have similar, catastrophic ramifications across the globe. The
coming days and weeks will be volatile in the markets due to uncertainty
associated with the Brexit decision. I expect global political and financial
leaders to provide some reassurance with public statements and possibly with a
central bank easing of financial conditions to smooth out the coming period of
uncertainty.
Why does this event impact the US?
When a major global
disruptive event occurs, the world’s currency markets are usually the first
global barometers to reflect the economic importance of the event. In this
case, the British pound fell 11.4% against the US dollar in 24 hours, before
recovering to end the day down 8.04%. This creates major problems for business
from several angles. First, it reduces the value of plants and equipment
located in the UK. Next, it reduces the revenues and profits from sales of
products in the UK. Third, it creates logistical and legal issues in the supply
chain for US companies exporting to the EU and to the UK. For instance, there
are likely US companies with contracts that assume an exchange rate on or near
$1.50/pound. Now that the pound has dropped significantly, you could see US
companies renegotiating terms
Here’s a brief list of
companies from the Midwest who have either significant operations or sales in
the UK: Abbot, AbbVie, Baxter International, Beam Suntory, Caterpillar, CDW, CF
Industries. Mondelez International, Navigant, Northern Trust, Tenneco, W.W.
Grainger Wallgreens Boots Alliance
For example, the UK is
AbbVie’s third largest market, with $688 million in sales in 2015. (ChiTrib)
AbbVie could potentially lose $57.8 million in sales value with the drop in the
British pound if they were not properly hedged. Even if companies are hedged
for current projected sales, they still lose on the value of their plant
investment in the UK and must go through the headache of trying to understand
the new legal arrangements between the UK-EU when they eventually take shape.
Clearly, the
uncertainty over what a new EU trade relationship will be is critical for the
UK. Prior to the vote, Britain had access to the world’s largest common market
with over 500 million people. Almost 50% of UK exports went to this market and
now they will have to renegotiate their relationship with the EU. While this
may not seem too disruptive, the EU may not negotiate terms even remotely
similar to those agreed upon under the previous structure. Moreover, the EU may
want to send a signal to other nations inclined toward leaving the union that
it would be expensive economically to do so. France, the Netherlands, and other
countries have political factions advocating resignation from the EU. Scotland
and Northern Ireland voted to stay in the EU and they may decide to hold their
own referenda on their national status within the UK. The potential for ongoing
political and commercial chaos is rising. And all of this foments the
uncertainty that is reflected the markets.
Yet, the markets are
not the only feedback mechanism for this event. The US political world is
impacted too. First, President Obama strongly advocated for the UK “Stay” vote
and warned that a new trade pact with the UK “could be five years from now, 10
years from now before we’re actually able to get something done.” (Guardian) Also, the Clinton campaign stated they
favored the “Stay” camp when senior policy adviser Jake Sullivan said: “Hillary
Clinton believes that transatlantic cooperation is essential, and that
cooperation is strongest when Europe is united. She has always valued a strong
United Kingdom in a strong EU. And she values a strong British voice in the
EU.” Lastly, Donald Trump took the opposite view and supported the UK “Leave”
movement stating, “they took back their country.” It’s too soon to tell what
the long-term impact Brexit will be for the US due to our own elections in
November. Obviously each party has very different tax and economic policies and
until we have a winner the total impact can’t yet be understood.”
What’s next?
The confusion created
by Brexit will continue in the days and weeks ahead. There are many problems
created by the UK-EU divorce. No country has ever asked to leave the EU so the
process has never been tested. Meanwhile, the financial markets will be assessing
how messy the divorce will be and how much foreign assets in the UK will be
worth. US businesses will be evaluating the potential disruption to their
supply chains, the potential decline in value in their UK assets, and the
potential hit to sales and revenues resulting from the drop in the value of the
British pound. This is the most troubling part of this event: companies can
only speculate how UK and EU politicians will approach the upcoming
negotiations.
http://affluentinvestor.com/2016/06/brexit-impacts-us-business-politics/
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