As historic events go, the UK’s decision to leave the EU is up there with the two world wars of the twentieth century and the much earlier battle of Agincourt. Britain’s turbulent relationship with the EU has in the past involved much violence; this latest twist may have been thankfully bloodless but will now involve financial convulsions that will hurt all of us. This is a rupturing of the political and economic order.
It needs to be said at the outset that despite the claims to certainty made by both sides during the campaign, we have little ability to forecast with any precision what happens next. There will be many surprises along this very strange journey. But the point made by the more thoughtful remain campaigners still stands: this was a vote for the UK to be poorer, both in the short and longer term. There is nothing positive in that for the rest of us.
My best guess is that the UK Treasury and other forecasting bodies were right: Britain will now enter recession. It is absolutely impossible to guess how deep or how long that downturn may last. A period of much slower growth is bad enough but the even bigger question revolves around the likely shock to the world economy and its financial markets. Could this, as some have suggested, be another Lehman-style crash?
The only honest answer is that we don’t know. We can certainly hope that preparations made by policy makers around the world will, unlike in the aftermath of the failure of Lehmans, be enough to forestall a global slump. The big concern is that we may have been somewhat prepared for Brexit but there is so little ammunition left in the policy armoury, the authorities can only be bystanders with regards to what happens next.
Interest rates are effectively zero - or even negative - pretty much everywhere and governments around the world have set their faces against fiscal expansion. In Europe, fiscal consolidation remains the orthodoxy: could this be the event that prompts even the Germans to loosen the purse strings? Given all that we have seen in Europe over the last few years it would seem prudent not to expect too much; pre-emptive, well directed economic policies have been noticeable by their absence, at least since the inception of the euro. If there is to be a change of direction in Europe, the euro crisis should have been the catalyst.
This amounts to a negative economic shock of unknown but potentially massive size. The correct response would be to adopt strongly expansionary policies. The fact that European governments either can’t or won’t do the right thing is just one more reason to be concerned.
The UK, by contrast, could cut interest rates as early as today. Whether or not that happens, speculation will build about “helicopter money”: the final instalment of quantitative easing, essentially involving direct financing of government spending by the simple act of the central bank printing money. This is the ultimate German nightmare: it is hard to imagine the ECB indulging in a similar policy. At the very least, it is illegal in EU law.
Politics and economics will interact. One casualty is likely to be the UK Chancellor, George Osborne. Will his brand of fiscal austerity go with him? Again, we don't know, but change looks to be inevitable.
Financial markets everywhere, but not least sterling, will go up and down, probably by a lot and, in the short term at least, more down than up. It isn't going to be pretty. Central banks everywhere are going to have to remember how to act as lenders of last resort to strained financial systems. Again, the biggest concern is over the willingness and capacity of the European Central Bank to do the right thing.
The Irish government issued a spring statement this week based on rosy economic forecasts. Those forecasts are already null and void. There is no point trying to replace them. All that can be done now is to respond as best we can to the inevitable turmoil, taking direction from our European masters. We only hope that this crisis is better handled than the last one.
