Brexit Would Matter for the U.S. Economy
NEWCASTLE, UK—One has to be struck by the remarkable degree of complacency in Washington policymaking circles, including at the Federal Reserve, about the forthcoming Brexit referendum. This is especially the case considering the potential that a vote in favor of Brexit has to derail the U.S. economic recovery and to further ratchet up the rhetoric against globalization in the run-up to the November presidential election.
Among the reasons why US policymakers should be concerned about the UK’s June 23 referendum is that it will be taking place at a highly inauspicious time for both the United Kingdom and the global economies. As Bank of England Governor Mark Carney recently reminded us, the United Kingdom is presently running some of its largest external current account deficits in the post-war period. That makes the United Kingdom uncomfortably dependent on “the kindness of strangers” for the financing of that deficit. At the same time, the United Kingdom is currently riven by strong separatist tendencies, especially in Scotland, whose electorate overwhelmingly would like to remain in Europe.
The global economy is also not in a particularly robust position to withstand a blow from a British exit. China’s economy is slowing; the emerging market economies are struggling both with low international commodity prices and with a reversal in international capital flows; and Europe and Japan are having difficulty in resisting deflation. To compound matters, the Bank of Japan and the European Central Bank are actively engaged in policies aimed at weakening their currencies in an effort to boost export growth.
After recklessly having committed the United Kingdom to a referendum in the first place, Prime Minister David Cameron is now correctly warning that a vote to leave Europe would be to take a leap into the dark. This is not least because of the heightened investor uncertainty that would inevitably follow during the expected two-year period of renegotiation of the United Kingdom’s relations with Europe. Investors must be expected to fear that after having been spurned, Europe is highly unlikely to readily grant the United Kingdom favorable terms in those negotiations.
In the event that there were to be a Brexit, the United Kingdom should brace itself for a full-blown sterling crisis that would seriously cloud the country’s economic prospects and offset any possible long run benefits from leaving the union. In a climate of heightened uncertainty, investors must be expected to balk at financing the country’s gaping external current account deficit, especially at a time that important parts of the City of London might be relocating to European capitals upon loss of their “financial passport” to the European market. More serious still, the United Kingdom should brace itself for calls for another Scottish independence referendum that could very well presage the dissolution of the United Kingdom in its present form.
Brexit would also be very bad news for the United States and the global economies. The last thing that the global economy now needs is the collapse of one of the world’s major currencies. That could be the last straw that moves the world to an outright currency war and to rising trade barriers. This is especially dangerous in the context of a heated U.S. presidential election campaign where the rhetoric against trade and globalization has already been shrill. Similarly, the last thing that the emerging market economies now need is an event that would heighten global risk aversion and that would exacerbate the capital outflow problem that these countries are already facing.
Sadly, any attempt by U.S. policymakers to influence the Brexit referendum is likely to prove to be counterproductive. Seemingly, all that U.S. policymakers can usefully now do is to pray that the British electorate has the good sense to vote against the country taking an inordinate risk with its economic future.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
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