Brexit, Grexit And Euro Drama For Investors To Sort Through

Britain’s “Brexit” vote is now official – what’s the collateral effect to economies worldwide? Investors may have an avalanche of troubling questions post-Brexit. But FFP aims to alleviate some of the stress.

Here we go again.

First, we had the drama of the potential “Grexit” of Greece from the European Monetary Union. Now, in a referendum, the citizens of Great Britain have voted to leave the European Union – also known as Brexit.

You may be wondering if there’s any end to it in sight as well as what other potential exits really mean for economies around the world, including our very own here at home in the U.S.

From the press, we will get “white knuckle” reporting on the economic and financial market reaction to the vote – making sure to incorporate a great dose of fear and panic. In turn, we’ll do our part here at Fiduciary Financial Partners to counter that by giving you some context to Brexit and perspective in an effort to help you breathe.

 

EU And European Monetary Union:
Same Thing, Right? Wrong.

Let’s start with an important distinction to make between two different entities.

You’ve likely heard of the European Union or the “EU” by this point in time. It’s the political union of 28 member states (and consequently, about 508 million people). There’s an actual government in Brussels that countries send taxes to, even though this type of government is much smaller than their own national governments.

Member states of the EU enjoy a free flow of goods, services and capital without tariffs. The free flow of people (immigration) without passports seems to be one of the major issues that British citizens had with their membership in the EU. You may notice a similarity with Donald Trump’s talking points (or yelling points).

The European Monetary Union is comprised of countries that use the Euro currency. Great Britain does not use the Euro currency. It uses the Pound as its national currency.

Brexit may send a signal to other countries such as Greece, Spain, Portugal and Italy that if an exit from this fairly large European “club” is feasible for Great Britain, it may be worth stronger consideration. They may think to themselves, “Britain left after decades of membership and has its own currency! Maybe we should follow their lead by exiting and returning to our own currency too!’

That’s certainly not the kind of momentum that the region needs, especially since it hasn’t had a lot of positives in the last six years.

The effect of Britain leaving the European Union, in the most dire of scenarios, is that we could see a banking crisis that spreads around the world, a rise of anti-establishment parties and a lot of destabilization in the financial markets. As much as we’d like to, we can’t completely rule those possibilities out.

  

The More Likely Impact To The U.S.

From both a present day and long-term view, here’s some much-needed perspective to keep in mind, despite everything you hear from the talking heads on TV about Brexit.

 

Here And Now:

Relative to the U.S.:
The U.S. exports about $56 billion – or roughly 4% of all exports – to Great Britain. That represents about .35% of the US economy.

That’s right. Not 35%. Not 3.5%. We’re talking .35% of the U.S. economy.

Additionally, these exports will not suddenly evaporate. U.S. exports to the UK will get more expensive with a stronger Dollar / weaker Pound. So while we don’t want to minimize the problems caused by a Brexit, we have to be careful not to overstate the implications to our economy here in the U.S.

Relative to Global GDP:

UK output is 2.5% of global GDP (at market prices, 4% on a Purchasing Power Parity). However, Britain is a global financial powerhouse, so its current account deficit (think trade deficit) and the exposure of the British banking system to property values risks both financial and economic contagion to the rest of Europe.

 

Short-Term:

Rarely, if ever has a G7 currency falling by -10% in a single trading session, as the Pound did, at one point trading at its lowest level against the U.S. dollar since 1985.

Let’s pause here and think about how markets and economies adjust. The UK economy is 25-30% exports and these companies just got a HUGE benefit from a weak Pound. Imports get more expensive, which can cause inflation, but inflation has not been the problem. Deflation has been the problem. A little inflation may actually help.

 

Long-Term:

Most people probably don’t remember the big exit the UK made in September 1992. Do you? This was when George Soros made his name and fortune.

We remember. The UK decided to move away from the European Exchange Rate Mechanism. At the time, it was a gigantic development. The Pound lost a lot of value as a result. The doom and gloom press was out in full force.

Then, a funny thing happened on the way to market turmoil. The Pound not only rebounded – it came back stronger than ever when made to compete with market forces.

 

Political Impact:

We believe the EU is a positive for Europe and the world as a free trade club. The European Monetary Union, however, does not seem likely to last in the long-term. Sharing monetary/banking ties but not sharing political ties does not appear to work. The problem is that economies that need to adjust via a lower currency value cannot (Italy, Greece, Spain, Portugal) because they are tied to the Euro.

Think of the great vacation to Greece that we would all already have taken if Greece had left the Euro. They would already be recovering. In Illinois, do we care about the budget of Wisconsin or Indiana? No, but in Europe they must care about the finances of their neighbors, even though there is no political control.

Perhaps this vote leads to a breakup of the Euro currency region, which would certainly be painful, but may just be necessary.

Portfolio Impact:

The UK falls into the developed non-U.S. or EAFE category (European, Australasian and Far East) where it is about 25% UK stocks. EAFE is about 40% of the world stock index, so the UK is about 10% of Global stocks. We have about ½ weight to EAFE, so our portfolios are about 5% invested in the UK. For a portfolio that has only 60% stocks (for example), this would be only 3% of a total portfolio.

 

Agreements Come And Go.
Competitiveness Is The Key Factor That Must Remain.

We’ll likely see other countries threaten to depart the EU and EMU over time. Agreements of a political, economic, financial and currency nature can change and evolve. That’s not terribly new. What’s of far greater importance to watch is the competitiveness of countries like Great Britain based on the talent, skills and ability of its own people. The UK has a long line of talented workers trying to get in, much like the U.S.

Let’s also remember that agreements like the EU can relate to cetain rules of capitalism – but they don’t define or re-define capitalism. Rules can change. Capitalism will go on. Competitiveness will go on. Financial markets will go on. There is little evidence to suggest that the single event of a Brexit, Grexit or any other exit will drastically alter that, even if market prices can and do swing in the short-term.

  

Don’t Get Financial Advice From A TV.

Sure, experts on a TV panel can talk a lot about Brexits and speculate morning, noon and night. But they can’t talk to you about your portfolio and your goals.

At Fiduciary Financial Partners, we know we’re not the only ones who can do that kind of talking. However, our independence helps ensure that the insight we’re providing is without special incentives. And our decades of experience in investment management considers the global perspective while understanding the context of where you want to be in life right here at home.

If that’s more of the kind of talk you could use, let’s start the conversation by taking an unbiased view of your financial statements. Confidently Embrace Your Financial Future by calling FFP today at 630.780.1534 or emailing us at info@fiduciaryfp.com.

 

 

 

 

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