It is the "shot heard 'round the world" -- but updated for the 21st century.
The U.K. has voted itself out of the European Union. The irony is delicious; the country that has seen its global empire unwound by rebelling subjects is now the rebel unwinding another modern empire. We financial types are naturally focusing on the economic reasons, or at least the economic fallout, but the rationale for the referendum, and the driving force behind the "Leave" vote, is almost completely political.
Even European Central Bank President Mario Draghi cannot do "whatever it takes" to stop the unraveling. The limits of central bank omnipotence are being tested, thankfully. Here are my key thoughts regarding this historic decision:
- Today's global market declines simply undo the rally of the last week, which were driven by the markets incorrectly discounting Remain winning. So the markets now reflect the outlook as of June 16.
- The decline and volatility reflect higher uncertainty, rather than impending doom. Markets, business and the economy can deal with most anything thrown their way, but mainly they don't like uncertainty. So don't read too much into today's action in terms of predicting the economic future.
- Don't forget, at today's prices there are as many buyers as sellers. The media will spend the day harping about selling volume. Today's buying volume is precisely equal, so I can argue that optimism is rampant today.
- Brits were rubbed the wrong way by the EU politically, but the real implication here is emboldening the populace in Europe to retake control of their monetary destinies. The bell is now tolling for the European Monetary Union, one of the most misguided and destructive economic experiments of all time. I predict that the next surge of populism will appear in the most unlikely of places: Germany.
Pundits are naturally discussing whether this is the start of "contagion." In a word: yes. Although it may take a decade or two, the breakup of Europe as a single entity is inevitable for two reasons.
First, from a political point of view, the trend toward ever-larger governing entities is over, and the trend for the rest of our lifetimes is what I call "devolution." In democracies, people want their voices heard and want their governments to be responsive to their desires. Large governing bodies are not responsive, and people are going to fight to dismantle huge, unresponsive governing units. Yugoslavia started the trend; Catalonia and Scotland are recent entrants in the battle, and the U.K. has now lit a fuse that will embolden people that they can have a larger voice in their governance. What does this mean for markets and investment: more uncertainty and more volatility.
Second, from an economic point of view, this will embolden countries shackled to the euro that they can escape and survive. The EMU is a failed experiment that was doomed from the start for a simple reason. There are only two mechanisms to relieve economic imbalances between countries: mobility of labor and exchange rate adjustments. The EMU removed the latter, under the false pretense that the first would take over (as it does in the US). Europeans found that unemployed Greeks don't pick up and move to Germany to find work at BMW. Instead, they stay put in the country they grew up in and love. With neither F/X nor mobility of labor, the EMU was doomed from the start -- it just took a crisis to initiate its unwinding. What does this means for markets? EMU is dead. Bondholders should avoid European sovereign debt at all costs.
With our Independence Day celebration coming soon, Americans can sit back and enjoy the fireworks of independence booming on the other side of the Atlantic.