Brexit: Cataclysmic Roar

BrexitLast week I woke up to a Cataclysmic Roar which reverberated across the globe. Well its not Katy Perry’s Roar but after effects of Brexit, name given to the referendum in UK to decide the future of UK within EU. It wiped more than $3 tr from stock market and brought in evermore uncertainty to the world. I was myself shocked that majority of people would vote to exit European Union considering it did not make Political, Economic or Humanitarian sense. I had planned to write a detailed report but with so much of information freely available on internet and almost a universal consensus among Economists and leading intellectuals, it does not make sense to research for another one but a brief look at some concerns highlighted in the referendum. Pic source: http://wccftech.com/Politically it does not make sense to leave the EU for UK since the best way to pass pro liberal reforms within EU was by staying within the system. England is unarguably the most liberal economy in Europe and most important along with Germany and France within the EU, loses its most decisive advantage by leaving the European Union. If UK does choose to implement the verdict of referendum, it will forever end the most decisive advantage it ever had in the western world. Further an exit from EU signals the end of UK with Scotland and soon Northern Ireland would pass referendum to exit UK to stay within EU. The threat of immigration to persuade people to exit EU does not make sense since approximately 2mn people from UK work outside UK but within EU and about 3 mn people from EU work within UK.

Brexit-1-graphAccording to a report by Swati Dhingra and Thomas Sampson of LSE, to leave EU doesn’t mean UK will not pay into EU budget since Norway which is not a part of EU but part of European Economic Area pays about 83% anyways while Switzerland which works on bilateral deals pays 40% as much as UK but without any agreement on free trade on services, which is so critical for UK since UK is a major exporter to EU. A weaker pound hurts UK by making imports more expensive while importing inflation. England was not a part of Euro so monetarily it was quite sovereign considering Bank of England could use of monetary measures to boost it economy among others increasing or decreasing interest rates which is not true about other countries which have Euro as their currency. (Euro is a fixed currency with all members fixed to Euro although it trades freely globally). Interestingly UK receives lot of funding from EU especially under agricultural policies which includes regions like Wales and Northern Ireland. The net outflow in UK i.e. the contribution towards EU budget and the amount UK receives in grants is not more than 1% of the GDP which is hardly a viable factor to cause any hindrance for economic well being.

According to an article published by poundssetrlinglive.com, RBC Capital markets estimates Euro area GDP is almost five times UK GDP which suggests that the UK economy is more exposed to the euro area than vice versa. But there are still a number of channels through which a20151017_SRC804 Brexit would impact on the euro area.  The main impact of Brexit on the euro area would be felt via the trade channel – the UK is the euro area’s largest export market accounting for 15% of external (goods) exports and making a positive contribution to the growth of euro area exports.

Economically there are a million reasons to enunciate for UK to stay within the EU, prime of-course London with respect to England. Northern Ireland and Scotland voted to remain within the EU. London, world’s leading financial capital (along with New York) of the world loses its prime access to EU financial markets. England has more European headquarters for a diverse range of Global Conglomerates than all the major cities in Europe put together, a fact which helps to generate a lot of employment with UK especially for people who belong to UK. A Brexit will over a period of time relocate offices of these companies to other countries, taking with it jobs primarily of people from UK. It would lower the earnings within the country leading to decrease in consumption, a key factor to considering the slowdown in today’s world. Britain exports 51.4%of goods to EU a much larger share of its GDP component while EU exports only 6.6% of its goods to Britain. Single market system helps Britain immensely (UK includes Northern Ireland, Scotland, Wales and England while Britain does not include Northern Ireland). The growth in wages depends on the productivity within the system so the only way to increase salaries within UK is to increase the technological know-how. UK is one of the most brexit-is-the-nerve-center-of-economicsEntrepreneurship dominated economy backed by technology in the World, a Brexit will undermine its innovation to certain extent as companies expand to other areas in Europe considering companies would like to be EU compliant on their product and services. According to Shelly Palmer, a technology expert Brexit has lot of ramification about Data Transfer and Personal Information as US and EU negotiate a new deal with EU considering Privacy Shield. Going forward the data policies will differ in UK and EU, so companies would have to adjust to higher expenses to comply with both standards of protocol. Furthermore, an exit from EU also reduces funding for many universities in UK which would have direct reverberation in research and innovation.
An exit from EU will isolate Britain and make it less competitive. One analyst rightly pointed out that airfare is cheapest in Britain since the genesis of budget airlines in Europe started with Ryan Air in Britain. Proliferation of budget airline helped start up more competition among other airlines making prices and services more competitive. In the end it brought a decisive power to consumers which helped in promoting tourism and business travel generating revenues for the government. Source: graphs.net

London is one most important centers of the world in terms of art, creativity, liberalization and rights. It symbolized free mixing of people from around the world and from all walks of life. Its success depends on its ability to attract the best talent from around the world which helps in assimilating tolerance and mutual respect among all
apart from innovation and increase in productivity. Brexit in the end hurts the very foundation on which England developed into one of the foremost economies of modern eraLondon serves as global financial & entrepreneurship hub which aids in its plan to
make Britain a high tech industry with thriving start ups. To understand the start up culture best magnified in modern terms in Silicon Valley aka California you need an ecosystem. London is ranked 6th worldwide in 2015 Global Start Up report by Compass as a place for Global Start Up Ecosystem.

To aid the ecosystem following parameters play a fundamental role.

To begin with ease of funding plays an important role which financial markets in London play a fundamental role. Angel Investors/ Venture Capitalist/ Accelerators play a pivotal role in not only funding but also initially mentoring viable Entrepreneurs. Second to attract talent within a milieu of creativity. California leads by mile but Britain is one of the best places in the world since it is meltdown of talent from around the world. It has legal and infrastructure support to aid ventures to nurture into successful businesses. Lastly it has an exit option for any ventures or venture funds to exit from their investments. A Brexit to a lot of extent hampers an amicable ecosystem for start ups & innovation which will play a pivotal role not only in increasing productivity, innovation, revenues GDP in Britain but also globally. To tide the current slowdown in the world, the world has to rely agovernment-spendingadvances in technology and entrepreneurship culture to add value in the economy. Pic Source: Scienceogram.org

London served as a halo effect for UK by working as a catalyst which resulted in further advancement in proliferation for business and education within UK. It served to develop UK as an educational hub in Europe while had an influence in a way in developing cities like Dublin as international business centers. Ancillary industries especially in services which range from advertising, sports and art flourished working as a global magnate like New York and California. It helped in forming global opinion backed by free thinking, rise of feminism and social equity. Marriages across different ethnicity and religion assimilated mutual respect across nationalities imbibing an era of progressive development. It gave hope to people who could have been born underprivileged…a hope that you could succeed in-spite of all odds if you were talented and willing to learn…Something which closely resonated with America. It stands today as a symbol of intellectualism and liberty.

Market Reaction 

One of the barometers to check market reaction to Brexit is to look at British 10 year government bond yields.

united-kingdom-government-bond-yieldRisk aversion in England rose to the highest level in more than two centuries when British 10-year government bond yields sunk below 1% for the first time since records began in 1729 highlighting panic. Investors tend to flee equities or other risky assets for more safe haven products like Bond or Gold since they are regarded safe. Bonds are fixed income instruments which pays a periodic payment of interest also known as coupon on the Principal invested. Bonds are of various duration ranging from short term bonds like 3 months to those of 30 year duration. Government bonds also refereed as sovereign bonds (10 years are considered benchmark since they are most liquid). Bonds generate interest in the form of coupons and since governments give an implicit backing to pay the interests as well as principal, bonds are safe if held till maturity. Generally bonds are not held till maturity but trade in the market and are open to duration, reinvestment and other risks.  Bonds are always designated in yield for trading purposes, which is the ratio of Coupon divided by market price of the bond. If you look closely to the graph it shows the yields even less than the levels seen during credit crisis or Euro implying the huge risk premium markets have allocated to Brexit.

Yield= (Coupon/ Interest) / Market Price of Bond

In case of risk aversion, the market price of the bond goes up due to considerable buying. Bonds are issued at par or face value which are usually issued in $100 and its incremental value in US or in different denomination in different countries. Although it might be hyperbole to say that Brexit is a Lehman Brothers effect since credit crisis was more to do with credit off-take freeze globally nevertheless Brexit is economic catastrophic in short and medium term considering the unprecedented nature of how trade and legal regulations will pan out if Britain does decide to leave EU.

Market reaction sums up the negative views of people around the world with respect to Brexit. It is very bad for both Britain and the world at large and brings forth implication far exceeding those in financial markets. The world has given the signal we can afford another crisis.

Unnecessary chaos is never good especially in the turbulent times we are living in. Nothing is perfect and a coin has two sides.One has to build on the positive side while consistently removing the negative aspects without giving jerks to the system. To over simply things as some politicians are doing in the Western world to gain their own vested interests which hardly empathizes  with worries of the common person.
The rise of intolerance is one of the most systemic risks which world faces today. According to Murphy’s law,  “whatever can go wrong, will go wrong.”Its best to address them soon before its too late considering there has been a resurgence of it around the world. Misplaced hatred never leads to anything good. The recent  killing of a  politician in Britain is an eye-opener of how things are panning out in the Western world. The results of the referendum also highlights maybe some genuine concerns of people around the world but the best way to resolve is to do so diplomatically within _90083274_eu_ref_uk_regions_leave_remain_gra624_sortedthe establishment. Brexit is an extreme position taken by many who themselves did not understand the consequences of doing so. With only 1.3 mn of advantage with voters who voted for exit considering about 72% who voted in the referendum leads to only 30 mn voters who exercised the option. This leaves 11 mn of voters who did not vote and even if 50% voted the outcome could have been different. London with 8 mn of voters with 60% in favor of staying within EU is still much less since the biggest hit of Brexit will be felt by London. A safe mechanism would have been to have at least 80% of minimum voting of eligible voters to vote in the referendum with at-least a 60% of majority for a exit vote to change status quo would have been judicious in the first place. David Cameroon has been one of the better leaders in the world who came on the back of overwhelming majority in election and championed the cause to remain within the EU shows how confused people are about the cause they are fighting for. It beats the very purpose of intellect since you should have faith in the person the majority has elected. Personally feel bad about David Cameroon since results of referendum hurts his legacy dearly and he should have been more prudent in implementing fail safe mechanism as discussed above. 

Whats Ahead

The treaty once executed is irreplaceable and gives two years for members of EU to negotiate terms of conditions with UK. During this time all rules and regulations would apply to UK but it would not take apart in any further negotiations in EU.The process is a bit more complicated and more can be read at lisbon-treaty.org. or refer to the link https://foreignpolicy.com/2016/06/24/heres-how-the-brexit-will-actually-work-lisbon-treaty-article-50/

Needless to say to invoke Article 50 of Lisbon treaty which would initiate the process of withdrawal from EU is suicidal for UK as well as setting up bad precedent for EU. The ! Nash equilibrium here (remember the movie Beautiful Mind starring Russel Crowe as mathematical genius Nash) would be to maintain Status Quo for UK which is good for both EU and UK. This would mean that UK will have to hold another referendum or maintain status quo ignoring the present one. (The referendum is not legally binding but many could argue that it is undemocratic not to enforce it). If both of these options do not work then enforcement of Article 50 is inevitable whenever UK does decide to enforce it. Option to join EEA is ruled out and we shall look at it at a later date in a separate article.

Brexit is surely a paradigm shift in geopolitical atmosphere especially in the Western World for all the wrong reasons. EU ultimately was formed on holisSir Isaac Newtontic principal to unite Europe on humanitarian grounds since Europe has had the bloodiest history of any continent for a very long time. Brexit will be a pyrrhic victory for those who voted to leave the EU considering the cost to UK and underlying cause which is based on Intolerance and Xenophobia which should not be the cause for discontent. This would have a domino effect globally which would give rise to maybe extremism and protectionism worldwide hurting economic, business and technological advancement. No economic superpower can either live or innovate in isolation looking at the global economic and trade linkages. Singapore a small city with 5 mn population became a financial and technological hub due to its ability to attract talent from around the world. No wonder 2 mn of its population are expats which does play a decisive factor in its dominance apart from other key factors.

I have met many people from Britain during my course of life especially during my spiritual sabbatical and I know for a fact that majority of them do not stand for underlying reasons which could have motivated Brexit while some of them could surely have been misguided. graph (1)To wrap up, it’s fair to say that Brexit is one the reason for England’s exit from Euro Cup considering the turmoil Brexit caused did affect England’s team performance adversely. There is still time for people in UK especially England to sit together and work out the best possible way to address the issue at hand and surely Brexit is not one of them. It’s but obvious to conclude that if another referendum is conducted within EU, remain vote will win by a mile. The answer in the end lies with people from Britain and they have to understand what they stand for and understand both immediate and long term consequences of their action. Britain home to greats like Sir Issac Newton, Alan Turing, Shakespeare, Charles Darwin, George Orwell, P G Wodehouse to name a few, laid down the foundation of scientific, literary and economic development inspiring generations forever. They above all stood for tolerance, brotherhood and proactive attitude, its time for Britain to decide what legacy they would like to leave for their progeny.

Source Graph:  https://www.tes.com/news/school-news/breaking-views/tes-eu-referendum-round

! According to Investopedia “The Nash equilibrium is a concept of game theory where the optimal outcome of a game is one where no player has an incentive to deviate from his or her chosen strategy after considering an opponent’s choice. Overall, an individual can receive no incremental benefit from changing actions, assuming other players remain constant in their strategies. A game may have multiple Nash equilibria or none at all.”If you design a matrix which includes rows and columns with outcome of two players as two parameters it would be the row or column which economies the best for both. In the present case of Brexit there is only one Nash equilibrium.