The European Union (EU) is a political and economic union comprised of 28 countries from the tiny island of Malta with a population of 429,000 situated on 122 square miles to the obvious world powers like Germany, France and Britain.
When combined, the EU represents seven percent of the worlds population and 24 percent of global gross domestic product (GDP, measured in purchasing power parity). The idea behind the union, which dates back the end of World War II, is to have a single mark through standardized laws and allow for the free movement of people, goods, services and capital.
Great Britain joined the EU in 1973, but is now considering leaving the EU and will have a referendum on June 23rd that will determine whether they leave or remain.
This potential change is known as the ‘Brexit,’ which is a play on words following the near departure of Greece from the euro currency recently that was dubbed the ‘Grexit.’ (Only 19 of the EU members use the common currency and Britain is not one of them).
There are a variety of reasons behind the potential decision to leave including trade, EU budget issues (like bailing out Greece), high regulation, immigration concerns and greater independence over their own destiny.
Right now, polls show that Brits are split between leaving and staying with 45 percent of voters wanting to stay, 40 percent wanting to leave and the remaining 15 percent undecided. Betting markets, for whatever they are worth, suggest a 70 percent chance that Britain will stay in the EU.
So far though, markets have shown concern about a potential Brexit, most notably in the foreign exchange markets. On Thursday, the pound fell to a two-year low against a trade-weighted basket of currencies.
If the Brits did leave the EU, the heightened uncertainty about their future would initially cause the pound to weaken further and interest rates to fall further (the yield on the 10-year gilt is currently 1.45 percent). British stocks, which make up about approximately 18 percent of our developed international allocation, would also likely drop on the news.
Longer term, though, it’s harder to say what the impact would be for Britain. Moody’s, the ratings agency, said that a Brexit could lead to a negative outlook for their AA1 sovereign debt rating, but also said that the impact of a departure would be ‘manageable.’
Ultimately, we won’t know what the effects will be because it depends so heavily on what kind of trade deal Britain is able to get with the EU. If the ‘leave’ camp is right and the trade deal with the EU remains substantially in place, it could be a boon to Britain. If the ‘remain’ camp is right, trade wars and tariffs could slow economic growth and increase unemployment.
First, though, we’ll have to see what the referendum brings in June. Once we hear from the British people, we can start to look at what changes may happen.