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Brexit a disaster for the UK, Europe and the world

Consumer demand, Currencies, Economic growth, Financial Events, Leverage
By Paul Hodges on 27-Jun-2016

Ring of fire Feb15

First, the good news.  It has long been recognised that the UK economy is over-dependent on financial services, and that its housing market – particularly in London – is wildly over-priced in relation to earnings.  The Brexit vote should ensure that both these problems are solved:

  • Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
  • There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
  • This will also undermine the London housing market by removing the support provided by these high-earners
  • In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven”

This is probably not the result that most Leave voters expected when they voted on Thursday.  These voters will also soon find out that Thursday was not the Independence Day they were promised.  It is already obvious that Leave campaigners have no clear idea of what to do next.  They are even divided about whether to immediately trigger the 2-year departure period under Article 50 of the Lisbon Treaty.

Leave voters have more shocks ahead of them, of course:

  • Most believed that the UK would immediately be able to “take control of its borders” and dramatically reduce immigration.  But as I noted during the campaign, the majority of immigration has always been from outside the EU – and could already have been stopped, had the current or previous governments chosen to do this
  • Nor will the National Health Service suddenly benefit from the promised £350m/week ($475m) by stopping UK contributions to the EU.  For a start, more than half of this money already came back to the UK from the EU, and so can’t be spent a second time
  • Even more importantly, nothing is going to happen for at least 2 years whilst the Leave negotiations take place

This, of course, is where the bad news starts.  What will be the reaction of Leave voters as they discover they have been fed half-truths on these and other critical issues?  And what will happen as house prices begin to fall, and jobs in financial services – as well as manufacturing – begin to disappear as companies relocate elsewhere within the EU?

BREXIT VOTE WILL HIT EUROPE AND THE GLOBAL ECONOMY
The bad news is, unfortunately, not restricted to the UK.  Already, alarm has begun to spread across the rest of the EU.  There are strong calls for referendums to take place in 3 of the EU’s 6 founding members – France, Italy and The Netherlands.  It is hard to see how the EU could survive if even one of these votes resulted in a Leave decision.

In turn, of course, this is bound to draw attention once more to the unsolved Eurozone debt crisis.  Can anyone now really continue to believe the European Central Bank’s 2012 promise to do “whatever it takes” to preserve the euro, as set out by its President, Mario Draghi?

The simple fact is that the Brexit vote is the canary in the coalmine.  It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis.    And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.

THE BREXIT VOTE, LIKE THE 2008 CRISIS, WAS NOT A ‘BLACK SWAN’ EVENT
I am used, by now, to my forecasts being ignored by conventional wisdom.  The Brexit vote saw a repeat of the complacency that greeted my warnings in the Financial Times and here before the 2008 financial crisis.  Thus my March warning was again mostly ignored, namely that:

A UK vote to leave the European Union is becoming more likely”.

Instead, like the 2008 crisis, the Brexit vote is already being described as a ‘black swan’ event – impossible to forecast.  This attitude merely supports the status quo, as it means consensus wisdom does not have to challenge its core assumptions.  Instead, it takes comfort in the view that “nobody could have foreseen this happening”.

Critically, this means that the failure of the post-2008 stimulus programmes is still widely ignored.  Yet these have caused global debt levels to climb to more than 3x total GDP, according to McKinsey.  As the map above shows, they have created a debt-fuelled ‘ring of fire’, which now threatens to collapse the entire global economy:

  • China’s reversal of stimulus policies has led to major downturns in the economies of all its commodity suppliers
  • Latin America, Africa, Russia and the Middle East can no longer rely on exports to China to support their growth
  • Japan’s unwise efforts at stimulus via Abenomics have also proved a complete failure
  • Now Brexit will almost inevitably cause a major collapse in London house prices
  • And it will focus attention on the vast debts created by the Eurozone debt crisis
  • It will also unsettle US investors, who have taken margin debt to record levels in the belief that the US Federal Reserve will never let stock market prices fall

TIME FOR STRAIGHT TALKING ON THE IMPACT OF AGEING POPULATIONS ON ECONOMIC GROWTH
It is therefore vital that policymakers now make a new start, whilst there is still time to avoid total financial collapse. Once people begin to realise that all this debt can never be repaid, then interest rates will soar and many currencies collapse.  This is not being alarmist – this is just stating obvious facts.

The critical need is to recognise that demographics, not monetary policy, drive economies.  A world with lots of young BabyBoomers in the Wealth Creating 25-54 age group will inevitably see strong growth.  And if more and more women return to the workforce after childbirth, this will turbo-charge an economic SuperCycle.

This is what happened between 1983 – 2007, when the world saw almost constant growth.  The US recorded just 16 months of recession in 25 years.  But last year saw global GDP decline by a record amount in current dollars, more than in 2009 – a clear warning sign of major trouble ahead.

The issue is very simple. Common sense tells us that the combination of a 50% increase in global life expectancy since 1950, and a 50% fall in fertility rates, means that the world has now reached the “demographic cliff“:

  • 1bn ageing Boomers are joining the low-spending, low-earning New Old 55+ generation for the first time in history
  • They will be more than 1 in 5 of the global population by 2030, twice the percentage in 1950

This is good news, not bad.  Who amongst us, after all, would not choose to have 20 years of life expectancy at age 65 instead of dying?  That is today’s position in the Western world.  And people in the emerging economies are catching up fast.  They can already now expect to live another 15 years at age 65.

The trade-off is lower, or negative growth.  People in this New Old 55+ age group already own most of what they need, and their incomes decline dramatically as they approach retirement.

But this simple fact of life has never been explained to voters.  Instead they have been told since 2008 that policymakers are confident of returning the economy to SuperCycle levels of growth.  No wonder they are growing restless, and starting to mistrust everything they are being told by the supposed experts.

CONCLUSION – TIME TO RESTORE TRUST WITH PLAIN SPEAKING
Policymakers and the media now have a grave responsibility, as do all of us.

It is critically important that policymakers now recognise they must immediately reverse course on stimulus policies, and come clean with voters about the real economic situation.

Of course this will result in very painful conversations.  But the alternative, of ignoring the warning provided by the Brexit vote, is simply too awful to contemplate.