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Things Fall Apart? Thoughts on the Brexit Vote

Written by Brad McMillan, CFA®, CFP® | Jun 10, 2016 7:38:06 PM

On June 23, Britain will vote on whether or not to leave the European Union, popularly known as Brexit (British exit). As the date approaches, concerns have been rising that the referendum might actually pass. What would it mean if it did?

Although I haven’t weighed in much on Brexit so far, it’s certainly worth thinking about. The consequences could be severe, but not for the reasons many people would think. The timeline could also be very different from what’s expected.

Remain or leave? The current odds

As I write this, the prediction markets have two-to-one odds on a Remain vote—down from earlier levels but still pretty overwhelming. The most recent poll-tracker numbers from the Economist show Remain up by 2.8 percent (46.8 to 44) over Leave, with 9.8 percent undecided.

Let's consider what these numbers mean. The odds based on people betting real money are still strongly on the Remain side. And, with almost 10 percent undecided, I think most will opt for Remain simply because it's safer. People who don’t have strong opinions may be less willing to take risks and more likely to maintain the status quo. The numbers, then, seem to show that Remain is likely to win.

If it does, the story is over (at least for the moment). I suspect it won’t be quite that simple, but in the short term, the issue will be settled.

What would happen if the Leave vote wins?

Here's my take:

  1. The departure wouldn't be immediate. Any British exit from the EU would involve so many outstanding issues and questions that a Leave vote would just start a new round of negotiations—not all that different from what the EU normally does.
  1. The vote wouldn’t necessarily stick. There are strong political and economic forces on the Remain side that would push (probably successfully) for a rerun. This has happened multiple times in the past, when countries voted down EU-related questions. So an initial Leave vote would by no means be final.
  1. The UK would likely redefine its ties, not cut them. Given Britain's economic and military heft, both France and Germany would want to maintain some form of political and economic relationship. And the British would, too, as there are substantial political and economic reasons for doing so. There will be a continuing relationship, and negotiations are unlikely to be unduly harsh.
  1. A good model might be Norway, which has been successfully operating in the kind of setup that the more moderate Brexit supporters have been proposing. Although the extreme factions would no doubt prefer a much more limited relationship, given the coin-flip nature of the referendum, it's doubtful that a radical withdrawal would have public support.

Long story short:

  • Britain is likely to stay.
  • Even if it votes to leave, that is unlikely to be final.
  • And even if it does leave, it is likely to stay at least halfway in.

That said, however . . .

  1. Continued speculation and market turbulence is to be expected until the referendum and thereafter. A Remain vote will not end agitation in Britain or other countries, and this is where the real risk lies—if the Brexit idea metastasizes around the continent. Even if it does, the situation is likely to play out over the next two years, rather than immediately, and to offer lots of warning before things turn seriously bad.
A systemic crisis isn't likely

The best way to think of it, I believe, is to remember the Scottish referendum to leave the United Kingdom not all that long ago. Despite all the uncertainty, risk, and market disruptions, nothing happened. On the other hand, the Scottish independence movement has not gone away.

Had it passed, there would have been further market volatility and potentially extended effects on regions like Catalonia. We would now be several months into detailed and boring negotiations between the parties, however, and I suspect the markets would have calmed down. The Brexit referendum is likely to be very similar, with the Remain vote winning and largely forgotten in a couple of months.

Even if it passes, though, there's no real reason for a systemic crisis, despite all the hype.

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