Brexit is not about Britain, #2
By Scott Sumner
It’s less that 3 months since the Brexit vote, and thus too early to form any firm conclusions. But one recent article points to the growing belief that Britain may have dodged a bullet, which hit the eurozone instead:
Brexit ‘shock’ threatens to do far more damage to the European economy than to Britain
. . . As is now abundantly clear, the immediate post referendum shock to the economy wasn’t nearly as bad as many forecasters, including the Treasury, the Bank of England and the great bulk of City economists, feared it might be.
Thanks in part to a sharp devaluation in the pound, even the manufacturing sector seems to have weathered the storm in much better shape than generally anticipated. The litmus test will be this week’s Markit/CIPS Purchasing Managers’ Index (PMI) for the much bigger services sector, but anecdotal evidence already suggests that this too will look reasonably encouraging. Only in construction can we be sure of a bad set of numbers.
The upshot is that despite the turmoil of the last several months, it is now eminently possible that Britain will show a higher rate of growth in the post-Brexit third quarter than the Eurozone. Few if any would have predicted such an outcome.
The British economy sails on as if nothing has happened, but the European one continues to stagnate. It is as if the Brexit shock has been more powerfully felt in Europe than in Britain. Both France and Italy showed no growth at all in the second quarter, and now even the data from Germany is starting to look poor. [emphasis added]
“Few if any would have predicted such an outcome”?
I did not predict this precise outcome, but my knee jerk reaction immediately after the Brexit vote is starting too look a bit less crazy:
Brexit is not about Britain
I’m seeing a lot of confusion about the implications of Brexit. Here are two common misconceptions:
1. Some people see it as a real shock, whereas it’s primarily a monetary shock.
2. Some see it affecting Britain’s economy by disrupting trade, whereas it actually hurts the eurozone more, by depressing expected NGDP growth. The real effects are often overstated; Norway and Switzerland do fine outside the EU.
In some respects, this is quite similar to the British decision to leave the gold standard in September 1931. That decision also hurt the continent of Europe more than Britain (indeed in that case it actually helped Britain.)
This time around the UK was probably hurt somewhat; British stocks are down around 4% as I write. But French and German stocks are down 7% to 8%. The markets in southern Europe are down 10% to 15%. Brexit’s most powerful effect is to make the eurozone crisis worse, by increasing doubts as to whether the eurozone will stay together. By analogy, the 1931 UK decision to leave gold made things worse for the rest of the gold standard, indeed a surge of public and private gold hoarding over the next few months drove global commodity prices sharply lower.
Most pundits viewed the Brexit vote as a massive negative “uncertainty” shock. There’s nothing the central bank can do about real shocks. In contrast, I viewed Brexit as mostly a monetary shock.
It’s beginning to look like the BoE eased policy enough to prevent a recession, at least in the short run. Just to be clear, I’m not claiming any crystal ball here. I think recessions are mostly unforecastable and I won’t forecast the next one.
But my view that this was more a monetary than a real shock is beginning to look increasingly plausible. I’ll do more updates as new data comes in. You don’t get “uncertainty” experiments much more dramatic than the Brexit vote.
PS. As usual, let me remind readers of the difference between Brexit uncertainty, which happened immediately, and the actual Brexit event, which is probably going to occur in 2019 at the soonest. I’m still mildly anti-Brexit, as the UK government has moved modestly away from an “open” stance, with the replacement of Cameron by May. So my fear that this would be tied in with a growing trend toward nationalism and statism has not entirely disappeared. On the other hand I’ll keep an open mind on this. Ten years ago I might have favored Brexit, so let’s see how it plays out over time.
PPS. My knee jerk reaction was somewhat flawed due to my use of the FTSE100 stock index, which (I didn’t know at the time) was driven heavily by overseas profits. This was dumb luck on my part. With the correct stock data, my initial analysis would actually have been a bit less accurate. But even so, the southern European indices were hit the hardest.