The French Elections
The far-right candidate Marine Le Pen made it into the runoff against the more moderate and European-centric Emmanuel Macron. The next vote on May 7 will determine the winner. With talk of “the republic, not the party,” both the socialist and center-right candidates who lost have thrown their support Read More »
Posts in category Global Economy
The French Elections
[This article is part of the World Economic Forum’s globalization series. You can read more here.]
The response from financial markets to the Brexit – Britain’s decision to leave the European Union – follows a series of swift and at times devastating market reactions to poor policy decisions.
The reaction to America’s first failed TARP vote in the heat of the financial crisis and the pummeling markets took when Greece threatened to opt out of the Eurozone last summer are just two other examples. They illustrate the market’s ability to reverse or sway ill-conceived policy-making – a role far larger than its historical one of disciplinarian.
Repercussions from the UK’s vote to leave the EU have been swift and dramatic. The pound sterling plummeted to a 30-year low as equity markets tanked and flight to safe assets outside of the country ensued. The government has dissolved in confusion following several high profile resignations, including that of Prime Minister David Cameron. This is adding to the unprecedented uncertainty about which direction the country will go in next.
What does this mean for markets?
Some of the power that financial markets have gained could be exacerbated in this unusual post-crisis world. US Federal Reserve Governor Lael Brainard has warned that cross-border financial transmission mechanisms, namely currency exchange rates, are more sensitive to even small changes in interest rates when rates are already at such low levels. The threat to already fragile emerging markets is of particular concern. China, already on thin ice, is struggling to defend its currency in the wake of the vote.
Barry Eichengreen of the University of California-Berkeley has also highlighted the undue burden that reserve currencies bear. A lack of high-quality, safe haven and liquid assets means that reserve currencies attract more than their fair share of bond purchases and currency appreciation. Remove the pound sterling from the basket of reserve currencies and the movement becomes even more pronounced. The sharp appreciation in the yen following the Brexit vote and the drag that places on Japan’s economy is evidence of this.
The financial crisis left markets more sensitive to external shocks, after it became clear just how interconnected we have become. Market participants have every reason to sound the alarm when a move as dramatic as the Brexit vote, which shakes the foundations of the post-World War II model of economic integration and diplomatic coordination, occurs. Extremism, populism, isolationism, whatever we choose to call it, threatens to take away in just one generation much of what we worked to establish after the carnage of two world wars.
In reaction, those British voters experiencing a kind of “buyer’s remorse” are looking for ways to reverse, or at least soften, the negative economic consequences of the Brexit vote. Constitutional experts are weighing the government’s options. Everything from a series of political maneuvers to a new referendum is being explored. For the sake of democracy, I side with acclaimed novelist Kazuo Ishiguro who argues that the country needs to hold a second referendum that clearly lays out the costs of leaving as well as remaining in the EU. As it stands, the democratic process has been hijacked by the one-dimensional referendum, which came about almost accidentally; three years ago, Cameron consolidated support for his leadership by shifting disagreement over Europe onto a future referendum.
A bigger role for markets?
Why does it matter? The world is undergoing a series of political identity crises, which means upheaval in the world’s largest economies could become the norm. Financial markets will react, which means market participants could end up with a larger say in the outcomes. Will that result in better policy decisions? Or will it merely punish and incense those left behind by those decisions? Violence against immigrants surged in the wake of the Brexit vote, revealing an underbelly of racism; it is hard to imagine this could be healed by markets alone. The tools of democracy, which take more time and evoke uncertainty, are still better suited for the job.
I take some solace from the fact that financial market participants are holding our elected officials immediately accountable for policy choices; someone should. The recent rise in nationalism, encouraged by fear mongering, is particularly unproductive, especially as it will most hurt the people who respond to it. There is no guarantee, however, that financial markets will make better decisions than our elected officials have. Financial market participants can be even more short-sighted than politicians in their time frame for returns. They bring with them their own sense of hubris and confidence that they, not voters, should control policy decisions. That could seed a whole new set of challenges.
We can’t undo or reverse globalization, but we can alter our path. Globalization and technological change have left major swathes of the population behind. Dealing with their plight must be part of any future model and will require major investments in human capital and infrastructure, something too many countries have neglected. Financial markets are no more likely to succeed at incentivizing that investment than our elected officials. Their push to determine near-term winners and losers could actually widen the gap that divides us. Democracies are about compromise, representation and equity. They operate with a conscience; markets do not.
The vote by the UK to opt out of the European Union (EU) has already triggered a sharp selloff in global financial markets. British Prime Minister, David Cameron has resigned, which will put the execution of the U.K.’s exit onto the next government and allow some time for markets to calm. The trigger of article 50, the beginning of the separation, will now occur in the fall. The vote was carried by voters over the age of 65; younger voters opted to remain in the EU but they will be tasked with the burden of living with the consequences of the decision.
The UK will likely dip into recession
Just one month after the European Central Bank (ECB) pushed interest rates further into negative territory and expanded its bond buying program, the Governing Council on voted to leave interest rates and bond purchases as is today. When ECB President Mario Draghi took questions from reporters after that announcement
The International Monetary Fund (IMF) meetings in Washington concluded with warnings about the fragility of the global recovery and the need for increased economic coordination over nationalism. The agency singled out the UK vote over whether to leave the European Union (EU) referred to as “Brexit,” for British exit from the EU, as a particularly large near-term threat. The vote is scheduled for June 23.
The IMF also warned of the need for more fiscal stimulus and reform, given the limits of monetary stimulus. The concern is that monetary stimulus has run its course, while the refugee crisis in Europe has triggered even more nationalism. No one wants to be told what to do, nor apparently do what needs to be done, to boost growth at this point in time.
The IMF also attempted to get member states to agree to avoid currency wars as a means to stimulate their economies. Japan pushed back, arguing that its currency is already too strong, which is true; the larger issue is that Japan has yet to launch major reforms to pull its economy from the stagnation of the past three decades.
One could argue that the IMF is making matters worse, instead of better, on the geopolitical front. Much of the backlash we are seeing to globalization both at home and abroad is being driven by lagging economic performance and a sense of loss of control; telling countries how to fix what they have done wrong from the ivory tower of the IMF only further infuriates populists Read More »