Ad Hoc Commentary – Brexit is the beginning of the disintegration of the EU
“Since the United Kingdom is the biggest European NATO ally when it comes to forces, military capabilities, it really matters what the U.K. does”
Brexit is a divorce between the Mr. UK and Lady EU. We have a shocked Uncle Sam looking worriedly from a distance. And we have charming Mr. Russia pondering his next move on Lady EU. Charming had violated Lady EU recently in Ukraine and denied any responsibility. Post-Brexit, 10 Downing Street would find it very difficult to come to EU’s help if charming Russia decides to put on another charm offensive.
A divorce as large as this affects many people. Though it is not obvious now, the global community will, over time, realize that the divorce is bad for lady EU, and after a period of uncertainty, good for UK. In yours truly humble opinion, Brexit is a symptom of the broader problem of unfaithfulness in the modern world. Both at the personal and international level, relationships that were once considered lifetime commitments had degraded into merely functional relationships. The phrase “for better, for worse, for richer, for poorer” had lost its meaning in our modern world.
For those of us in the markets, it is likely that GBPUSD will trade to parity in the coming years as the divorce terms and conditions are fought out in the open. A weak GBP is good for those who had borrowed in GBP, i.e. both the British government and the British people. However, it is unlikely that the new bout of currency weakness will result in significant foreign direct investment in the short run. There is too much uncertainty for businesses to undertake new investments during the divorce proceedings. Thus, it is likely that the brunt of the short-term adjustment will fall on the weakest of society because inflation from weak currency is not countered by rising wages from investments.
Lady EU would also suffer in the sense that she would have to defend herself from within against the Brexit-copycats; and from abroad against the Russian suitors. In both situations, lady EU would be holding the weaker hand. Unless the thinking heads in Brussels can come up with a viable plan against the crushing austerity emanating from the past debt burdens, we could very well see EU devolve into third-world pariah.
The prevailing thinking of ‘there is no alternative’ other than austerity must change. There are alternatives. It is not a choice between black and white; just as it is not a choice between debt and the devil. The ultimate choice should be in a shade of grey that does scare the daylights out of the Bundesbank:
“In September 2012, Jens Weidman, president of the Bundesbank, cited the story of Part II of Goethe’s Faust, in which Mephistopheles, agent of the devil, tempts the emperor to print and distribute paper money, increasing spending power and writing off state debts. Initially the money fuels and economic upswing, but, inevitably in Weidman’s eyes, the policy ‘degenerates into inflation, destroying the monetary system.'”
Page 13, Between Debt and the Devil, Adair Turner, 2016.
Lastly, as we mentioned in our last post:
“…The greatest headwind the S&P500 is the US dollar, and uncertainty around the next person to occupy the White House…. In any case, S&P500 will find it very hard to clear 2130…”
The Brexit divorce will give us US dollar strength through capital flight from Europe. The uncertainty on the White House will be cleared after the summer. In yours truly opinion, a Trump presidency coupled with US dollar strength will cause the S&P500 to jump, doubling or even quadrupling. This is mainly because the Donald has the willingness to default. For now, we will be patient, and enjoy the summer holidays. Mr. Markets will eventually give us the buy signal.
Good luck in the markets.