Brexit Primer: Background, Possibilities, and Implications

Most of the following is a condensed, informal, mental note-taking, but for those who don't even want to read that, here are the ultra condensed bullet points:

• Brexit (and Trump, Sanders, etc..) exist because people are discontent and not sure how to change their lot in life
• EU is complex and makes up rules as it goes, so even the smart folks aren't sure what the Brexit fallout will be, let alone the average British voter 
• The UK is a small part of the EU goods/services trade.  The EU will survive the immediate economic impacts no question
• The bigger concern for the EU is the long-term implication, i.e. does Brexit pave the way for mass exodus?
• Many traders are borderline anglophiles, and perceive this as a bigger deal than it is, but they have money and are trading accordingly.  
• Bottom line: not a huge deal for immediate, practical purposes, but due to deeply embedded feelings about the UK's global economic importance (and possibly, longer-term EU disintigration fears), traders are making a big deal of it.  This means a likely SHARP snap back if UK voters choose to remain in the EU (for stocks and bonds).  On the other side of the coin, there's no telling how fully Brexit is priced in to current trading levels if UK voters vote to leave the EU (i.e. the rally might not be over yet).

Background

People are unhappy everywhere, not super-duper unhappy, but there's a global economic malaise of sorts in place for a variety of reasons.  At minimum, the malaise amounts to lingering pain from the wounds inflicted by the financial crisis.  At most, this malaise feeling is the logical next step in the broader socioeconomic reality where power and wealth continue to concentrate as population growth and per-capita productivity inevitably decline.  Entire essays could be written on each of the past 2 sentences, but we'll take them 'as read' for now so we can move on with quicker treatment of Brexit.  The bottom line is that the last 8 years have been the winter of our discontent for much of the world.

Rise of Brexit (and Trump, and Sanders, and Tsipras in Greece, and <insert your "disruptor" here>)

When people are unhappy, they want things to change.  In an increasingly complex world, it can feel all but impossible to effect the sort of change people seek.  Without a doubt, it's absolutely impossible for voters anywhere to grasp the long-term implications of their votes and it's logically impossible to experience the other version of reality that would have happened if a vote went the other way.  Take QE, for example.  Lots of people have railed against it, but we can't really know what things would have been like without it.  Maybe they would have been great, or maybe they would have been worse.  It's not possible to be smart enough to know for sure. 

All that to say, sometimes people only know that they're unhappy and they want things to change.  In America, the rise of Trump and Sanders is how that played out.  In Greece, it was the way Tsipras came to power.  In Britain, they have Brexit.  It's a vote against the status quo because the status quo is less pleasant than people want it to be, and a vote for big, basic things (like leadership or broad-scale political affiliation) is a very easy way to say you want things to change.

Unfortunately, both the political and economic ramifications of such votes (for leaders or Brexits, or Grexits, etc.) are vastly too complex for voters to grasp.  This notion of complexity is especially important when it comes to the European Union, which is the tiniest of infants when it comes to systems of government.  The EU, in many REAL ways, makes things up as they go along.  I don't say that in an ignorant, critical sort of way, but it's disconcertingly true.  For instance, there wasn't even a mechanism put in place for a country to exit the EU until 2009.  (And don't forget the great debate about EU QE where the ECB mapped out it's QE plans in early 2014 and fought with Germany for nearly a year before being able to actually buy bonds).

Bottom line: people vote for "something different" and can't necessarily comprehend the fallout.  Even the savviest people can't grasp a future reality in a system that is being defined and redefined in real time. 

No one knows for sure.

All of the above to say: no one knows exactly what the fallout will be, but we have a few pretty good ideas of the practical immediate impacts.  Namely, there will be very few practical immediate impacts.  The U.K. is not a Euro-currency area, and they're not exiting because they can't pay their EU-related bills.  Right there, the two biggest issues with the Greek drama are out the window.  Furthermore, it will take years before this divorce-if it happens-is finalized. 

The European Union is primarily about the flow of trade and people (goods, services, employees, money).  In terms of numbers, completely erasing the UK from the EU's equation isn't a big deal in and of itself.  It's the IMPLICATIONS that folks are worried about.

Like what?  The most obvious, most simple fear is that Brexit paves the way for other countries to exit-ESPECIALLY if things go OK for the UK in the process.  The endgame fear is disintegration of the EU in a matter of years.

EU disintegration (and even the fears thereof) is the market mover here.  It has major long term global growth implications, and it's hitting at a time where the phrase "global growth concerns" is already in common parlance in financial markets.

One final complicating factor is the historical role of "London" in the hearts and minds of the American trader.  London has strong ties to Wall Street, and for decades has been "our man on the street" covering all things relating to European markets.  London is on a huge mental pedestal for a lot of market participants in the US, and the perception of drama for London simply has connotations of drama for everyone, because it's London, for goodness' sake!  In other words, the sun never set on the British empire in the minds of many of the world's market participants. 

Thus, the trading community is really not helping contain the volatility surrounding Brexit.  They're trading like it could be a much MUCH bigger deal than it probably will be.  (Caveat: it could be a very big deal indeed, but not for quite a long time, and in a very slow and uneventful way).

If you're wondering if this makes a "remain" vote a very dangerous thing next week, I think that's a fair assumption!