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Simple Explanation of Brexit
Whether you like the news or not, you would have come across this word of late – Brexit. Because of the larger than life news it made, it may sound like a terrible thing that happened just like a bomb blast or an airplane that disappeared midway into a journey. In reality it isn’t that bizarre. Brexit explained simply is Great Britain leaving the European Union (EU) as it was earlier part of the EU. If you would like to use another fancy word, you could say that Brexit is the opposite of Bremain. Just for the record, who is Britain’s Prime Minister? Not David Cameron as he resigned post Brexit. It is Theresa May, the first woman Prime Minister of the UK after Margaret Thatcher (second overall) and guess what, she vouched for UK to remain in the EU as opposed to supporting a Brexit. Now, this post isn’t on why she was elected to be the Prime Minister when she supported a Bremain. This post seeks to give thoughts on the basic questions regarding Brexit.
Why did Britain leave the EU? What happened between them? Wait a second, how did UK feature in the EU in the first place? We will look at these issues and explain Brexit in very simple terms for studnets and professionals.
- The European Union
- The Vote
- Is the UK out of the EU?
- Is Brexit for the good – Why did people vote such?
- Post Brexit impact – Short term
The European Union
In 1967, the European Community (EC) was formed. This was an economic project in Europe that existed before the EU was formed and UK joined them six years later. This was basically formed to get over the World War II so that trade binds different nations and thus can prevent future wars and bring co-operation.
Many things happened since then and in 1992 the members of the EC signed the Maastricht treaty which lead to the formation of the EU, the focus being that a single common currency be established for the member nations. Yes, the topic of economic trade and co-operation was also an important part of the EU. UK wanted a modification on this area of the agreement. They wanted to keep their currency (GBP – Pound Sterling) and not club it with the common currency. Earlier, each country in Europe had their own currency – the French, Francs; the Germans, Deutsche Mark; the Italians – Lira and so on. While nations like these agreed for a common currency UK opted out of this clause but wanted to remain part of the EC then.
The EU was formed in 1993 and nine years later the ‘Euro’ was established as the common currency among the EU member nations. The EU evolved such that member nations became like a ‘single market’ where trade/goods and services, and people were freely (without tariffs) able to move from one country to another as if all nations were a single country.
It was decided that a referendum would be held in the UK on June 23rd 2016 and those eligible to vote would do so. While the media, notable businessmen and political experts had stayed calm and confident, they clearly believed that the UK would not vote to move out of the EU. The people who were the voters having a real say of things to come, did exactly the opposite and shocked the entire world. Whether they knew what they were doing or not is an entirely different topic, but the fact is that they had voted 52% for ‘leaving’ the EU as against 48% to ‘stay/remain.’
Is the UK out of the EU?
No. The EU currently has 28 members and since UK had voted out of the EU on June 23rd 2016, they have two years to leave – they have to negotiate certain things before leaving. You know, it’s not as if they’re being boxed out of a match and just walk out! The UK is still governed by the laws of the EU.
The UK still has two years. The current Prime Minister, Theresa May has said that the exit process will begin in full flow from 2017 onwards. Meanwhile negotiations on trade, immigration etc. will do the rounds. What is likely to be the outcome no one knows, but it is safe to assume that both Britain and the EU would lose out on some areas and gain in others – they both would take the best out of the agreement to benefit their nation(s). To make things worse, given that there are 28 members in the EU of which UK is one of them, 27 of them would have to agree on the terms of UK’s exit.
Is Brexit for the good – Why did people vote such?
For now, no one knows whether Brexit is for the good or not. If anyone claims they do, it is a lie. Before the referendum, many ‘knew’ that Brexit would not happen until it did! Let us try to understand he possible reasons as to why the people of England voted for them to leave the EU.
- This was not mentioned earlier but each member nation of the EU pays an amount to the EU annually to continue their membership. As regards the UK, the amount is around $12 billion (converting it to dollars – around £9 billion). Well, this would be even more in Sterling Pounds now since it has depreciated quite a lot since the historic vote. This big annual commitment could be one possible reason for a ‘leave’ vote where the money can be spent for domestic purposes. This would also be able to reduce their budget deficit.
- Immigration is another factor. London is the financial capital of Europe and there are people from different nationalities working in the UK, not only in London. Many of these would be immigrants who work there probably live there – they are probably residents of the UK as they would have lived for 5 years in the UK. One of the many principles laid out while forming the EU was that of being free members where people can freely move and live in another EU nation without the hurdles of getting a visa. It is believed that almost 1 million people have moved to the UK due to the free labour laws. Britain also gives child benefits and it is believed that many of these migrants are transferring that money to their children who aren’t living in the UK.
There might be many other reasons due to which the voters made such a choice. One could just be voting for fun! Believe it or not, quite a number of voters said that if given a chance to re-vote, they would have voted for the ‘stay’ campaign since they did not know the ramifications that would befall.
Post Brexit impact – Short term
Regarding the long term impact of Brexit I doubt if anyone is sure about anything yet. As I said earlier, no one really knows. But we have already seen the short-term impact:
- The value of UK’s currency plummeted to extreme lows. The GBP was falling ever since the word about the referendum was made. It was a possible clue we can say in hindsight, about the fear of an actual Brexit apart from crowded currency trades. Here’s a chart indicating how much the Pound Sterling fell. By the way, such a fall was only expected if Brexit happened which wasn’t expected!
- Stock markets across the globe fell due to panic selling. Not a single stock market was spared in the process. As regards the bond markets, US Treasury yield dipped to lows not seen for a long time and fell below 1.50% on the 10 year bond whereas the 10 year German Bund fell into negative territory. Gold had a massive rally post Brexit and all other commodities fell. Of course, not to mention that the Pound Sterling had a dramatic fall versus the US Dollar and Japanese Yen in particular. Anyone buying stocks anywhere in the world got an opportunity to ‘buy the dip’ as so called ‘experts’ say!
- Another issue is that UK consists of England, Northern Ireland, Wales and Scotland. Brexit was supposed to be the ‘leave’ vote of all the four but Scotland and Northern Ireland had voted to remain with the EU. Scotland felt it unacceptable to be pushed out of the EU since they had voted for the ‘stay’ campaign – it is now quite likely that they will have a second referendum so that they can vote to stay in the EU. Northern Ireland have the choice to go for another referendum to stage their will to remain in the EU. So, right now only England and Wales have voted out of the EU!
- The English economy isn’t in good shape. Interest rates have been low with the policy rate at 0.5% for quite long, inflation being subdued and growth being flat. Brexit has caused a cloud of uncertainty on where their economy is going – forward or backward. Rumours have indicated that a Quantitative Easing (QE) program may be on the cards if UK weakens. If Brexit eventually leads to a strengthening of the UK, they could be on the verge of higher rates soon affecting mortgages.
- Britain lost its sovereign credit rating of being an AAA nation. They were downgraded to AA with a negative outlook by S&P and to Aa1 with a negative outlook by Moody’s, two leading credit rating organizations. This makes it costlier to raise government debt and in the process leads to a higher hurdle rate of interest the deeper we go down the risk ladder.
- Rumours have also made news by saying that France, the Netherlands and a few others would opt for their own referendum taking a cue from Brexit. This is worrying because the EU would be at stake if member nations opt out of it.
- Just when so many thought that Brexit has caused a collapse in global growth, harmed Britain’s economy and so on, markets have stabilized. After the initial pounding in stock markets world over, these markets have of late touched record highs. Right from the S&P 500 to the BSE Sensex, we have seen record highs being touched in a way implying that the repercussions of Brexit fears are no more whether this conclusion is true or not.
- Many big companies have to figure out their plans where they have a business unit in the UK. Tata Steel, an Indian major had to rethink its plans of selling its UK unit. Several other companies too have had to figure their plans out.
- Students coming from abroad who are studying in the UK would also get affected. This could be part of the immigration reduction campaign mentioned earlier. Students would have to pay a higher fee to be international students and visa restrictions would also add to their woes. Also given that the UK has some of the most prestigious universities like the University of London where the London School of Economics (LSE) is a part and several other universities, they would also get impacted apart from the students due to their own reasons. Currently there are more than 100,00 students outside of the UK studying there.
Brexit has affected multiple economies and not just the UK’s economy. Although it’s after effects seem to have stabilized, it remains to be seen if this smooth and low volatility environment will prevail for long. Once the negotiations get deeper and as more information comes out in the media, we are almost bound to see volatile reactions across economic, political and financial centres. Given the globalized economy that we all live in, this is a reminder to all of us that one economy can have implications on other economies. Systemic effects have never been so close for long. As time progresses we can look at different charts to give us a better indication of what Brexit has done. Wait for time to give you an indication of what is to come. After all, what we can do is only to wait rather than make a terribly wrong prediction!
This has been a simple explanation of Brexit for students and professionals, is it good or bad and its short term and long term impacts. You may also have a look at these following economics articles for further learnings