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If you’ve turned on the news in the last month, you have heard the term “Brexit.” The portmanteau has been splashed all over international headlines since early June, when Britain prepared for a referendum on whether it would exit from the European Union (EU). When the U.K. shocked the world on June 23 by actually voting to leave, “Brexit” cemented its place as one of the most important words of the year.
The impact of the U.K.’s decision to leave the EU was felt immediately by the global stock market. Analysts all over the world had believed the U.K. would remain and were pushing share prices higher in the hours before the vote. When the results were announced, the reaction was a rapid—but not catastrophic—downturn across nearly every stock exchange.
As it became clear that Brexit probably wouldn’t result in the end of the EU, panic dissipated and stocks returned to normal. For Americans, the disruption seemed to have passed; Brexit would be nothing more than a temporary political problem between distant countries. After all, didn’t we start a war 240 years ago so that British decisions wouldn’t affect us anymore?
Quid Pro Quo
Brexit still has important implications for the U.S. economy because of the British pound. The pound has a long history and is considered one of the most reliable currencies in the world. Its value has helped make London the financial capital of Europe and ensures the Bank of England is a key player in global interest rates.
But Brexit means the U.K. will be disrupting its access to the EU’s massive economic power and banking needs. This could shrink the U.K.’s economy and may ruin the stability of its banks, costing the pound its place next to the U.S. dollar, Japanese yen and the euro as a top-tier currency. And that would make all the difference.
A volatile pound will drive some investors to other currencies. Since the EU and its euro are also shaken by Brexit, choices for low-risk currencies are limited and purchases of U.S. dollars and Treasury's increase.
While this further cements the United States as the economic center of the world, it does cause some problems. Although trade with the U.K. makes up less than half a percent of U.S. GDP, the appreciation of the dollar’s value makes U.S. goods more expensive all over the world, hurting our ability to export. Additionally, U.K. products that directly compete with American products (e.g. luxury cars) gain a huge price advantage in foreign markets.
Brexit’s bigger impact, however, may be on interest rates. The market disruption caused by the U.K. will make the Federal Reserve wary of raising short-term interest rates this summer as it had planned. High demand for Treasuries will push down long-term borrowing rates in major economies.
This effect was immediately evident following the Brexit vote as U.S. mortgage rates approached historic lows. If interest rates remain this low, they could inflate home prices and make it more difficult for people to buy their first home.
The full effects of Brexit are still unknown, both economically and politically. No independent county has ever left the EU and analysts are unsure when and how (or even if) it will take place. The move could fundamentally alter trade agreements, trigger recessions in emerging economies or open space for another major country to take Europe’s center stage. Regardless of what happens, it’s clear that economic changes don’t stay confined to a single country. Even with 3,000 miles of ocean between us, the consequences of the U.K.’s decision have already begun arriving on our shores.
Remember that past performance may not indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, strategy, or product referenced directly or indirectly in this newsletter will be profitable, equal any corresponding historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. You should not assume that any information contained in this newsletter serves as the receipt of personalized investment advice. If a reader has questions regarding the applicability of any specific issue discussed to their individual situation, they are encouraged to consult with a professional adviser.
This article was written by Advicent Solutions, an entity unrelated to Guidestream Financial, Inc.. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. Guidestream Financial, Inc. does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues. © 2014 Advicent Solutions. All rights reserved.