Some thoughts about Brexit.
My bottom line on Brexit is the following: I hold a cautious expectation that the people of the United Kingdom will vote for Remain. If this will indeed happen, the temptation will likely win in the EU to muddle through and not to enact a needed better organization along a multiple speed approach. If Brexit will win, the pressure to reinforce the core of the EU, i.e. the euro-area, will be proportional to the severity of the ensuing crisis. Only confronted with the abyss, there is the hope that political leaders and their constituencies will do what needs to be done. Initially the leaders will only proffer bland words and action will be left to central banks. The latter´s tools, however, will be of limited effectiveness. This will put the onus of action back on political leaders, but their “only on the brink” approach will mean an extended period of uncertainty and half solutions.
Let me take a fundamental approach on Brexit: ignore polls, forget bookies, put under the category of sorrow rather than under that of forecasts the horrific killing of Jo Cox. What do we know about the British people that could help understand whether they will decide to stay in the European Union or not? I think many, including me, would find it natural to associate three characteristics to the Brits: pragmatism, an international approach and economic sense. Sentimentalism and nationalism have historically characterized other peoples more than the British one. But it is only nationalism and sentimentalism, against any sense of pragmatism, economic sense and an international approach, that can push to a Brexit vote. So, my sense is that Remain will prevail. I advance this forecast with the needed caution and humility that comes from the awareness, instilled by innumerable warnings by my wife, that I have too rational view of the world, incapable of capturing the immense variety of human behaviour.
Still, I stand by my expectation. If there is a vote for Remain and risky assets and sterling get a reprieve, I will congratulate myself. If, on the contrary, there is Brexit, I will reflect again about the limitations of my Weltanschauung, heeding the suggestions of my wife.
A cautious expectation of Remain does not dispense from thinking about what could happen after the vote, whatever the outcome.
In case of a Remain vote, the temptation to muddle through will prevail. This is, however, as likely as myopic.
Even with Remain the UK will continue to be a semi-detached member of the Union. Some other members of the EU share its unwillingness to participate in one or the other part of the overall construction, but the UK is quite unique in its aloofness from many EU initiatives. Given this fact, the EU will have to continue showing its ability to be different from any existing political organization and not just an infant United States of Europe. It will have to encompass countries with different interests and desires for integration, including a core that could indeed move, indeed is already moving, in fits and starts, towards a federation. It will also need to accommodate countries preferring a looser form of co-operation. Thus a two, or multi speed, Europe will be even more necessary, also if the UK remains in the EU. What is needed is to put this approach on clearer and more solid bases. For instance, the core of the EU, which corresponds to the euro area, needs to move from the intergovernmental to a more federal approach. It needs its own institutions, starting with its own Parliament and Commission. A bold implementation of the 5 Presidents report would be just the first step. The countries in the other circles will need clear rules defining rights and obligations. The current halfway house does not fit the needs of either the core or the different circles around it.
The need to better organize the European Union as a multiple speed system, with a more integrated euro area and different circles around it will be even stronger in case of Brexit.
Of course, I see the deep contrast between the need for the €-area to move towards a more complete union, including the necessary institutional innovations, and the political difficulty to do so in the face of populist, anti EU parties in countries like France, the Netherlands, but also Italy, Germany and Spain. I.e. some of the countries, it should be said, that displayed in the past more destructive forms of nationalism than the UK. The balance between these two opposing forces will depend, in my view, on how serious the shock of the British vote will be. If Brexit happens and a financial, economic and political crisis will follow, the pressure to move towards unity in the core, also at the cost of meeting strong opposition from anti-EU parties, will be strong. After all, the force of pro EU majorities is still there. At the recent European Parliament elections anti EU parties did not reach 30 per cent and I hope that, confronted with catastrophe, political leaders, and their constituencies, will find again the force to react and oppose the populists. Moves to complete banking union and to establish a euro area minister of finance are the obvious first moves.
Once again, however, the “on the brink approach”, theorized by Kirkegaard and Bergsten and first prophesized by Monnet, will come into play: only when they are in front of the abyss do the Europeans find the courage and force to do what is needed to avoid falling into the abyss.
In case of Brexit I expect initially only soothing, but generic words from political representatives: “the EU has to be preserved”, “we work on the solidity we have built in 60 years of our common endeavor”, “we will do whatever is needed to preserve it”. In addition I expect they will say they want to engage into negotiations about exit, but will clarify that the Brits should not expect either a quick or a generous approach. I also expect some kind of a soft reference to a multispeed EU.
Against political inaction, initially actions will have to come, once again, from central banks. But the two tools that central banks have, interest rates and liquidity provisions, will not be particularly effective to deal with the consequences of Brexit. There is little room for the ECB to further lower rates and it is not clear that a cut of rates by the Bank of England will be well advised at a time when the pound will likely be under downward pressure. Liquidity provision by the ECB, in its turn, is unlikely to help, given that the epicenter of the crisis will be in the UK. Liquidity provision by the Bank of England could be more effective and the tool that is most likely to be effective is a reactivation of the foreign currency swaps, in particular with the ECB and the FED, so that the Bank of England could offer liquidity in euros and dollars to its financial system. Even this would, however, have only limited and temporary effects.
Whatever action central banks will be able to take, cannot deal with the deeper problems caused by Brexit. This, joined with the “on the brink approach” by political leaders, will mean an extended period of turbulence until a, barely sufficient, solution will be given on the political front.