Welcome to the end of the world as we know it.
The Brits, in one of the most self-absorbed acts in mass myopia, voted to flee the European Union (EU). It shocked the world, but only because the world wasn’t paying attention. I’ve been saying that the Brexit vote posed a greater risk to global well-being than the media and investors presupposed. That risk was precisely why I recommended late last week that you buy put options on the SPDR S&P 500 ETF (SPY). A Brexit success, I warned, was sure to rip across the globe.
And it did – in historic fashion. (Those put options I recommended generated gains of as much as 62% in just a week.)
Like I said originally, Britain might be an island, but the fallout was never going to be contained singularly to its shores.
Now, however, Brexit is in the past. And that past is prologue to a radically altered world we all now confront as investors.
I originally laid out the path by which a Brexit success would boomerang around the world… the dollar would rally, the pound would sink, the yen (a haven currency) would soar and Asian markets would get slammed because of expectations that the strong dollar will create the environment that could lead to a currency crisis. Asia has loaded up on dollar debt since 2008, and a strong dollar makes repaying that debt increasingly difficult.
All of that happened overnight.
The dollar index gained more than 2%, a mercurial daily move in that index. The pound fell to levels not seen since 1985. The yen sank below 100 to the dollar at one point, a sharp appreciation versus the buck. And investors fled Asian stocks, with Japan down 8%.
Now comes the day after…
And it promises to be worse than the event itself.
So let me tell you what we can expect as the ripples of Brexit spread around the world.
The Destruction of Europe
First, there’s a very good chance that Brexit will do what Greece’s debt crisis couldn’t – tear asunder the European Union.
In acting selfishly, the Brits have given fire to a collection of far-right extremists who see Brexit as their clarion call. They’re now in pursuit of Frexit (in France), Italxit (in Italy) and Nexit (in the Netherlands).
German right-wingers are sure to push for a split, too. We might even see a stronger push for Catalonia’s separation from Spain and Venice’s departure from Italy.
If nothing else, the English who voted for Brexit (as opposed to the British as a whole) have all but assured the dismantling of the United Kingdom. Scotland, solidly in the “remain” camp, will, I guarantee, seek a new referendum on sovereignty, and it will succeed by a substantial margin. Northern Ireland will follow suit, and for the first time since 1921, the Irish isle will be unified.
The upshot of all these chess pieces now in motion is that Brexit could very well portend the end of the European Union – and if you’ve read anything I’ve written over the last five years, you will know that I have consistently asserted that all the talk of an EU split was nonsense.
Now it’s not nonsense. Now it’s a significant, foreseeable risk.
And if the EU’s structural integrity is in question, then the euro’s very existence is in question. And that means the dollar has no peers – and investors the world over have no interest in holding a terminally incurable currency.
But a strong dollar rips apart the American economy.
Brexit Vs. the Fed
I read an article online in Forbes overnight that explains why the mainstream media is a borderline-useless source of analysis. The writer claimed Brexit wouldn’t mean much to America because our trade with the U.K. is relatively picayune. So very wrong!
Events like Brexit are not measured in their direct effects. They’re measured in all the varied knock-on effects – such as the weaker pound, destabilized euro and the stronger dollar, and how those flow through economies.
U.S. manufacturers and exporters already suffer from a strong dollar that has caused corporate profits to contract and has created a drag on GDP growth. That will now worsen – so much so that there is no way the Federal Reserve will have any opportunity to raise interest rates until well into 2017 or later.
In fact, the probability of a rate cut here in America is now greater than a rate hike.
Consider that the Japanese central bank will have to intervene in currency markets in some fashion to weaken the yen… that the Bank of England is talking about a rate cut to support the economy in the wake of Brexit… that the Danes are talking about pushing their rates deeper into negative territory to stanch the flow of money into the krone – a haven currency in Europe… that the Swiss National Bank has promised to defend the franc by weakening it, too… and that Brexit will certainly slow the EU economy as a whole, which means the European Central Bank will act as well to undermine the euro to, somehow, spur growth.
A snowball has a better chance of surviving a week in hell than the Fed has at raising rates in a world where interest rates elsewhere are falling and central banks are purposefully weakening their own currencies. That would just engender an even stronger dollar, boosting the headwinds buffeting our economy.
Don’t Forget China
China will also suffer. The Chinese market didn’t reflect that overnight, falling by a marginal 1.3%. Then again, investors all week were certain that the U.K. would remain a part of the EU…
But make no mistake: China is hurt by this.
The yuan still has ties to the dollar. As the dollar rises, the yuan rises. As the yuan rises, Chinese goods are less and less competitive. Chinese exports slow, manufacturing shrinks, layoffs are rife, unemployment escalates, imports decline, commodity prices fall and commodity economies crash.
So what we have is this:
China falls into recession for reasons I just laid out.
The U.S. falls into recession because the dollar is simply too strong.
And Europe, it goes without saying, falls into recession because Brits – their currency crushed relative to the euro – can’t afford as much from Germany (hitting the German economy hard) and because of the loss of white-collar and manufacturing jobs that are soon to leave the U.K.
In short, the global economy will gear down – yet another reason the Fed has no hope of raising interest rates… and a primary reason, by the way, that we all must own gold. (And gold rocketed higher as the votes increasingly showed that Brexit would win – an upward bias that will continue.)
So as we Yanks head toward Independence Day, let’s reflect on what the leader of the “leave” campaign, in claiming victory, has called Britain’s Independence Day.
Britain went in search of a misguided vision of sovereignty and, in doing so, set in motion actions that will dismantle the United Kingdom, potentially destroy the EU and the euro (which has far more positives for the Continent than negatives) and which will knock the legs out from under an already feeble global economy, setting us off on another decade of Japan-like anemia in America and Europe.
Bad form, England. Bad form, indeed.