Unfolding the Brexit

“UK votes to leave EU” – the glaring headline that graced my Facebook news feed on Friday 24 June 2016. The Brexit has happened and chaos follows the financial markets worldwide.

The shocking result stunned the political establishments worldwide. Hysteria took over as the shock reverberated through the financial markets across the global economy. According to Time magazinethe pound sterling slid dramatically against the dollar……lost about 12% of its value against the dollar in the course of 6 hours, marking the steepest plunge on record”

The result has shocked the global economy and many predictions have begun in the wake of UK departure from EU. It is a historic and an unprecedented event. For UK to leave European Union after 43 years is no laughing matter. While the media, analysts, financial and political figures discuss the fallout of the result, it is important to note that in the time of economics crisis, any policy decision in haste has the potential to further complicate a tense situation. In times of economic chaos, it is critical to watch how the financial markets unfold and let the market take its full course. Economies act very differently. During crisis, political, economical and social issues could become a toxic cocktail, which could have  either desirable or disastrous results for all.

What is required at this time is to understand the underlying currents that gave way to the Brexit and the stakes now involved with the result. Some thoughts to consider.

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This is not the first time for European Union to face a crisis. Before European Union was formed with Euro as the currency, the inception of the idea had dealt with hard-core feelings of the member countries’ fearing loss of sovereignty and voice should European integration went ahead. The integration went ahead and benefits realized were larger than the costs. However, the underlying faults (political resentments, different political and economic motives of member states) remained, especially, as Germany was seen the power player in the Eurozone. The nationalistic seeds were always present.

The US financial crisis of late 2008-2009 cracked open the faults within the EU. The Greek financial crisis unraveled and shook the Union at its core as Euro came under threat. Four years ago, I had written a post on Greek crisis and how the future of the Euro zone is bleak. At the time then, the fear of Greece exiting the Euro was very much real as there was a prediction that the exit would be catastrophic as the crisis would spread to weaker economies such as Italy, Spain, Ireland and Portugal and these economies will also think of leaving Eurozone. The very existence of Union was under threat. There was upheaval in the economies as the austerity policies took effect.  The political resentments resurfaced as Germany was reluctant to help out Greece on  such a massive platform. The German population believed that Eurozone will be better off if Greece were to exit. The same sentiment also existed on the British side, although, it was mute. Greece continues to reel not only from the conditions of the bailout, but also, from the policies it has had to take to get its house back in order.

On the other side, the Middle East crisis began to unravel in full force as ISIS took over key cities in Iraq and Syria while Libya and Tunisia continued to be politically unstable. The mass refugee exodus from these countries  due to terrorism became the migrant crisis of Europe. To this day, more and more migrants arrive in Greece and Italy only to find their way and travel to other European member countries for a stable and secure life. Germany, Netherlands, Sweden, France became hosts to refugees and so did Britain. The Eurozone crisis, the migrant crisis and the stand with Russia over Ukraine became a deadly combination.

As the European Union faced these scenarios, Britain faced its own set of problems. Scotland’s independence referendum in 2014, economy facing recession, surging immigration, higher tuition fees and students protests – the bitter cocktail that politicians are now facing. The surging immigration gave way to fears of loss of identity. At the EU level, it was the loss of sovereignty with Brussels seen as the  ultimate power. On the other hand, the austerity economic policies slowed economic growth, causing resentments among the population that faces the challenges of unemployment and higher prices.

Under such circumstances, it is not surprising to see countries taking protectionist measures, whether in the form of limiting trade or immigration. The scenario was similar to what had occurred during the US Financial crisis, where many countries opted for protectionist trade policies. In such times, protecting one’s own interests and national security becomes a critical agenda. Thus, to hold referendum in such a background was only bound to lead to such a result.

So now that Britain has voted to leave EU, what next?

UK Prime Minister David Cameron

Some interesting points to note are:

  • UK Prime Minister David Cameron has resigned and so far, Article 50 of the Lisbon Treaty has not been invoked despite the EU leaders calling for Britain to speed up the process.  The EU leaders want the process of Brexit to begin, but UK will take time. Firstly, the resignation of the David Cameron means there is a political void that needs to be filled, that is, a new prime minister must come in to take the lead on Brexit process. For the new prime minister, this task could be the death of their political career for good.  Secondly, perhaps, but it seems that the opposition had no plan in the line should the Leave campaign win and under the present circumstances, some critical questions must be answered even before Article 50 is invoked for e.g. the status of Britons working in other EU states, new trade deals and the kind of relationship UK will want with EU in the future after the exit. Clearly, UK will take time much to displeasure of EU, to think thoroughly on these matters and needs a “captain that can steer the ship” effectively.

 

  • Currently, it now seems many voters who voted for the exit are backpedaling. The reports that after the vote, there was a spike in the Google search for “What is EU?” is alarming. It places a question mark on the knowledge of the voters on what it actually meant to leave or remain in EU. Secondly, it is widely claimed that it was the older segment of the population that caused the Leave campaign to win, effectively shutting out the voice of the young generation who voted to remain in EU. Thirdly, with key leaders of the Leave campaign backtracking their statements could be indicative that the Leave campaign was based on misinformation and even deception. With these developments, it would be interesting to see if there could be second referendum on Remain or Leave EU again under the circumstances. This is bearing in mind that the pound sterling has slid against the dollar and Moody’s has already downgraded UK economic outlook from stable to negative, indicating that UK not only faces uncertainty, but also, will face negative consequences for its economic growth.

 

  • Then there is Scotland and Ireland with the possibilities of their own referendums on the plate. With Scottish Prime Minister Niclo Sturgeon announcing the plan for second independence referendum (Scotland voted to remain in EU) and with Ireland unification referendum plans, UK stands not only to lose EU, but also, Scotland and Ireland that could potentially alter the economic and regional picture. The possibility that referendums (if credible) could act as deterrent remains to be seen.

 

For the time being, the UK economy will face challenges, but only in the short run. In the long run, there is a possibility that the shock could actually lead the economy towards recovery as such is the nature of economics. Economic theory could point towards one way, but, in reality it could go the other way. On the political end, things could take an ugly turn should the referendums of Scotland and Ireland go ahead and the results are the opposite. That could unleash another wave of shocks to the global economy.

However, the crack within the European Union is wider now. The political discussions around Brexit will not be easy.  Brexit has effectively paved the way for other member states to call on their own referendums (France, Holland, Sweden and The Netherlands have already had a call to hold referendums on remaining or leaving EU). With weaker economies still reeling from the austerity policies effects, such economies will re-think their stand on remaining within the EU, thus putting the whole union and the Euro at stake.

According to American economist Nouriel Roubini,  “Britain’s decision to leave the European Union (EU) could be the beginning of the disintegration of the bloc of countries or the United Kingdom” 

But could it be disintegration for both EU and UK?

 

Euro: The Clock Ticks

Will Euro Be History? - by alf.melin flickr

The clock is ticking. The fate of Euro now stands by a thread. Markets are shaking with the prospects of a possible Greece exit from the Euro zone. The next coming days (maybe even hours?!) are crucial. Noted economist Paul Krugman has  announced his predictions about the euro (which are seen as being too sensationalist). Yet, European central bank and governments are doing nothing to quell such prospects as this recent news shows. The situation requires an analysis of some aspects that could explain the situation Europe finds itself today in.

The Greece crisis, indeed, opened a Pandora’s box for Europe. A crisis that was thought to stay contained in one country, rapidly spilled over in other European countries such as Spain, Italy, Ireland and Portugal and other states. However, the crisis gained intensity when the cracks started appearing within the zone members . The cracks played out in public, but , did not receive much attention when they were indicative of the future.

Austerity – Too Soon, Too Fast, Too Harsh?

Perhaps, the most disliked word of  the year 2012 would be “Austerity” and every single negative connotation will be associated to it.

The Greek debt levels were unsustainable from the beginning. Further, Greece deals with Goldman Sachs coming under intense scrutiny damaged Greece’s creditability. Euro zone members, in particular Germany and France, asked Greece to sort out its house by embarking on the austerity program. The bailout to Greece came attached with condition, similar to World Bank and IMF conditions when they provide financial assistance to countries. The contagion soon spread to countries like Spain, Italy, Ireland and Portugal when their debt levels crossed the  Euro deficit limits.

But in the midst of all this, an important question is: did the austerity steps came in too soon and too fast?  In economics, theoretically, contractionary policies whether fiscal or monetary lead to certain effects in the economy. But in real life, policies always face a ‘time lag’ – it takes a certain period of time for a particular policy to gain objectives whether it is growth or price stability.  In the case of Euro zone, the fiscal austerity is fast leading to fast contraction of the economies as spending cuts and higher taxes eat away the disposable incomes of the people. The more spending cuts and increase in taxes come along, the lower the disposable incomes and the lower the aggregate demand.

Greece Riots - by Jack Zalium Flickr

On the other hand, ‘Germany’s refusal to allow ECB to create a new money in order to buy government bonds from at risk countries, fearing rampant inflation’  is fueling the crisis. A contractionary monetary policy along with fiscal austerity will only lead to a deeper recession. The riots in Greece, Spain and Italy are testament to the fact that austerity is hurting people, and that a particular part of population is getting more hurt than the others.

The euro zone embarked on austerity way too fast and in the process, it has only become harsh.  In times of crisis, austerity is not always the best answer and if it is to be pursued, has to be done cautiously and slowly. Austerity, contractionary monetary policy and structural reforms all at once is a recipe for disaster. Not everything can be done at once and fast, especially, if a different set of reasons is causing the crisis. In Spain, the problem of unemployment, especially that of youth, and the housing bubble burst  along with the need to recapitalize the banking sector are the top reasons for their crisis. Italy faces a similar scenario. Greece was another case altogether as the economy was thoroughly mismanaged. France’s President Hollande and ECB President Mario Draghi  both realize only now that growth and fiscal austerity must go hand in hand together.  Yet, both didn’t pan out exactly how a growth policy would be composed alongside of fiscal austerity and no where is growth policy is in sight. Further, I believe that President Francoise Hollande will actually take the path of austerity, which, will not sit well with French voters.

A Division in Political Realms 

When political divisions begin to arise and do not abate, that is a subtle sign that issues lingering from the very day of inception will make a BIG comeback.  From the start, Germany was reluctant to help out Greece on a massive platform. “53% of Germany population believes that Euro zone will be better off without debt crippled Greece and that Greece should return to its currency drachma”. The sentiment on the political reflect this thought. In addition to this. Germany’s record of price stability and controlling inflation provides it a superior (and perhaps a dominant) position in the management of a credible monetary policy. And that has created problems.

There is a refusal (or outright denial) on Germany’s part to acknowledge that economic circumstances for each country can be different. Germany’s economy minister Philip Roesler ‘called Athens to surrender control of its budget policy to outside institutions if it cannot carry out the reforms required under the euro zone rescue package” reflects the thinking that Germany considers itself  superior in the policy making arena.

Greece had countered back angrily stating that they will not allow any interference in their country’s economic policy decision. The statements made is a subtle indicator that despite known as the ‘Euro zone’, with each member country the concept of national sovereignty still exists and is strong. This notion plays a strong role in political outlook as not many Euro members share the same policy sentiment as that of Chancellor Angela Merkel or Nicolas Sarkozy.   This is in contrast to the time when one of the  main motive behind EU was ‘the desire for ever greater prosperity”. That prosperity could only be attained through economic integration as the ‘economy was the most promising domain for cooperation’ (and perhaps now is the biggest domain for breakup?). But now the deep and fast austerity measures, in places where it is not required for the time being, ‘entrenches a bizarre halfway integration that’s ultimately doomed to fail’. The collapse of Romanian and Dutch government on failing to agree on cuts and with failure of Greece recent election is a strong evidence that the divide is only getting deeper.

Merkel and Sarkozy - by Chesi - Fotos CC Flickr

In the times of crisis, when political visions becomes divided in addition to economic issues, it becomes a bomb which upon explosion only brings destruction.  Delors – one of the main architects behind the EU has openly blamed Germany as ‘the biggest stumbling block in finding a swift solution to the crisis”. If euro zone members do not unite on the political front, euro’s survival is in questions.

What Now?

The biggest damage to the union is the admission by Delors that the ‘euro zone was flawed from the very beginning as the political figures at the time were unwilling to recognize such possible scenarios’. The political leaders of the time, perhaps forgot that some scenarios no matter how undesirable or unrealistic maybe, one fine day, would come back to haunt their economies and will the test the union in unimaginable ways.

Chancellor Angela Merkel clearly stated that ‘future of euro is indivisibly linked to unification of Europe”. But so far the signals on the other end have been the opposite.  The continuous warnings to Greece, the continuous statement that Greek can default along with the claims that Greece will remain the Euro zone have only strengthened the believe that Greek will default. Greece is under pressure as a recent statement by Christine Lagarde – IMF Managing Director indicates. And the pressure is dictating only one  picture: do or die.   With tensions at the domestic front along with a political and economic dire situation and that ECB and IMF are preparing for the Grexit scenario, the odds are higher that Greece will exit the eurozone despite it best attempts to remain in it. And there will be consequences for the euro zone. According to Soros, the break up of Euro zone will be catastrophic. The exit of Greece has the potential to bring under pressure (or even spread the contagion) the other weaker economies such as Spain, Ireland and Portugal and could have implication for the euro zone, not only as a region, but also in terms of single monetary union.

The 2 questions at this time:  will euro zone break and will euro survive –  remain unpredictable. Tables could actually turn if political and economic thinkers come together to avoid the split.

For now, I can only say that the future of Euro zone and Euro is bleak.

Sources

AlJazeera (Dec 2011) “Euro Flawed from Start says Main Creator”

Reuters (Jan 2012) “Greek PM Seeks backing for reforms, debt deal near”

Spiegel Online (Feb 2012) “Germany Power ‘Is Causing Fear’ in Europe

Nouriel Roubini (April 2012) “Europe’s Short Vacation” http://www.project-syndicate.com

Economist (May 2012) “The Euro crisis: The Unwinding”

Kemal Davis (May 2012) “Rebalancing the Euro Zone” http://www.project-syndicate.com

Reuters (May 2012) “Greece must stick out to bail out terms: Lagarde”

The Greece Crisis and the Volcanic Eruption. What’s Next for Europe?

Volcano Eruption

Europe is gripped by a series of unprecedented events and has become the focus of the world. The Greece Crisis hasn’t left the scene as yet when Mother Nature decided to intervene as well. The eruption of Icelandic volcano has spewed tremendous amount of volcanic ash and gases in the atmosphere and has caused worldwide ch aos.

The busiest airports; London Heathrow and France’s Charles De Gaulle have become ghost airports. Flights to and from Europe were cancelled on a world-wide scale. Passengers are stranded in different parts of the world. Airlines and Tourism industry are incurring losses of billions on a daily basis! And, yet the volcano shows no sign of slowing down. In the midst of all this chaos, the Polish President along with his wife were laid to rest in a state funeral.

The attention although remains on the economic costs brought about this eruption, but, there is another question that should be thought about; what impacts will this eruption have on the climate?  The question is important as the world organizations scramble to get a grip on the effects of climate change, Mother Nature, it seems, is set to take on a different course altogether.

Volcanic Eruption and its Impacts on Climate

Mother Nature is unpredictable and the last four days are a formidable example of its unpredictability.  The Icelandic volcanic eruption has captured the world with its immense power and ability to disrupt the global processes for hours and days. Indeed, it has brought not a part but the whole world to a standstill.

Volcanic eruptions are well-known for their effects on both the ground and atmospheric level. The Icelandic volcanoes are specifically known for their effects on climate. An example is in 1783, when an ‘enormous eruption of the Laki fissure system (a chain of volcanoes in which the lava erupts through a crack in the ground instead from a single point)’ caused massive disruptions in the climate. It produced a cloud of ash that reached the stratosphere, caused economic costs in Iceland in terms of livestock and population and led to reduction of winter temperatures in the Northern Hemisphere overall.

Volcanic eruptions are critically watched over because they are known to emit gases like sulfur dioxide (SO2), hydrogen chloride (HCl), hydrogen fluoride (HF) and major quantities of carbon dioxide (CO2).  It is argued that out of all the gases, it is the sulfur dioxide which is worrisome for it is the key ingredient of acid rain and haze. ‘The sulfur compounds are gases that rise easily unto the stratosphere’ and once combined with water, they form a haze of sulfuric acid. This haze can remain for months or even years as the stratosphere is dry. The haze has the capacity to reflect a great deal of sunlight.

On the other hand, the release of carbon dioxide gas means the ‘heat radiation emitted by the ground’ will be trapped in the atmosphere, having an adverse effects on the temperatures.  The eruptions also lead to haze further contributing to adverse effects on climate.

Then there is a danger of how the ozone layer will be affected by this eruption. ‘Satellite data after the 1991 eruptions of Mount Pinatubo and Mount Hudson showed a 15% – 20% ozone loss at high latitudes‘.  Thus, the more reasons for monitoring this eruption.

The Economic Impacts

For now, the volcanic eruption has given the European economies a setback by halting their airline and tourism industry for a few days. However, the analysis cannot stop here simply because the eruption will leave behind its marks on the climate and in turn on the economies.

There will be an impact on temperatures that could have adverse effects. The temperatures could either increase or decrease in summer depending on the amount of carbon dioxide gas emitted by this eruption. Whether there is a formation of haze afterwards also remains to be seen.  However, winters could be worse for there is a possibility that there could be a further drop in winter temperatures, especially in Europe. The temperature drop could then put a pressure on the energy sector and this could have multiplier effects throughout the economy. A colder than usual winter could have impact on food prices as well which can further ripple across the economies through various channels. The economies are already in the recovery mode from the financial crisis and at such juncture any adverse shock even in terms of climate could swing the pendulum of the economies to the extreme.

What’s Next for Europe?

For the next few months, Europe will remain under a critical global attention. Britain’s looming elections are crucial as already the public is not at ease with economic situation and the fate of politics hangs in balance depending on the policy agendas that satisfy the public. On the other hand, while a bail-out package is being worked for Greece, the situation has accelerated the rumors of Europe breaking up. Such a situation will reverberate shocks throughout the globe and will bring its own consequences. In addition to this, what marks will this eruption leaves behind is also in question. But more importantly the question whether there be more eruptions of such nature has become significant.

Another volcano in Iceland is already under surveillance and so far no volcanic activity has been recorded. On the far end, in Alaska, it is believed that Mount Novarupta which erupted last in 1912 ‘lies on the active convergent boundary and could erupt again’.  The eruption of Mount Novarupta has immense capacity to change the global climate and temperatures.  With climate change already causing havoc in some parts of the world, one can only hope that there are no further eruptions of such nature for it will not only threaten the climate, but also, the whole global system.

For now, Mother Nature is taking its own course and one can only hope that the course does not leave behind ugly marks.

The Greek Crisis: Lessons for GCC Monetary Union

The Greek economic crisis is a testing time for Europe in various ways. Scepticism that Greece will give into powerful unions than take tough economic steps, the possibility of creating IMF like institution (EMF) and the speculation that this particular crisis will lead to a breakup of Euro-zone are being highly debated. How the crisis will be handled in the coming days is critical especially when the GCC countries are also heading for the same path: the GCC Monetary Union expected to be formalised by this year.

A monetary union integrates the economies and opens up a realm of possibilities and opportunities for growth. But it also creates cultural, social and economic dynamics that can no longer insulate any one member country from the events and policies of other member countries. These dynamics are felt through multiple channels that affect the countries’ in various ways. In such a dynamic environment, policy making becomes a delicate game as it can lead to multiple desirable and undesirable results.

The Euro crisis is important for it provides an insight into such dynamics of a monetary union. It cannot be denied that Euro was created because of the strong political will of the EU states. For any monetary union to be successful, strong political will is required along with the acceptance of the results of the entire package. The GCC Monetary Union has already achieved most of the convergence issues, but the important question is: are the member countries ready to accept the consequences of the entire package, especially, in terms of economic outlook?

The question is important in the wake of political and economic outlook differences that exist in the Arab region.  Each member country has different economic priorities in terms of their development and growth. Therefore, any policy enforced in one country will have effects rippling across other member countries’ which could be undesirable for some. A case in point is the surrounding speculation of the Dubai World and Dubai’s debt. Such events will have their effects on other Arab economies through channels such as stock markets and financial institutions.  Thus, any unwillingness on the part of member countries to accommodate such differences can actually become the very reason for the monetary union to fail. The union will require an immense political will to accommodate differences in social and economic perspectives.  Perhaps, United Arab Emirates, the second largest economy in the Middle East, foresees that such differences will exist and a Greek-Euro scenario could well occur in this region as well. Therefore, it has backed out of the monetary union.

As the world watches the Greek- Euro crisis unfold, it provides an insight into the whole political and economical dimension. The crisis could prove useful for the GCC countries to keep such scenarios and possibilities of differences in outlook in perspective while preparing for the GCC Monetary Union.  Such an analysis is necessary if the Middle East as a region wants to reap most benefits out of such a union in terms of growth and development.