On June 23 of this year, the United Kingdom will hold a referendum to decide whether to exit the European Union. The vote has all of the hallmarks of a decisive, or potentially divisive, event. As students of history may know, on June 23, 1532 (which incidentally was also a leap year) Henry VIII, the King of England, entered into a secret agreement with the King of France, Francis I to the detriment of Charles V, the ruler of the Spanish and Holy Roman Empires. The underlying reason for the secret pact was apparently concern that Charles V was attempting to create a universal monarchy and thus a European hegemony. One can’t help but wonder, almost 500 years later, if the same undercurrents are still present today.
So what do we think about all of this in Chicago? And what is the potential effect on our futures and derivatives markets? Regarding whether an exit should occur, interestingly, we fall in to two distinct camps with points of view that align very closely with those in the U.K. We have the group that I’ll call “The Establishment” which not surprisingly includes those who favor globalization, free trade and generally open borders and markets, and who are typically secure economically, and the group that I’ll call “The Localists” who tend to support conservative immigration policies, restrictions on cross-border trade and as a group have not fared as well economically from free trade and globalization. In the U.S. we have a saying – “all politics is local” which means that any political decision made at the national level has to have a benefit locally and receive buy-in at the local level. Thus, the views of all should properly be taken into account, and one that does not take local views into account does so at their peril. The Establishment group in the U.K. would do well to remember that.
In Chicago, we think that the Establishment group has, to some degree, forgotten that “all politics is local”. On the continent, the EU leadership apparatus appears to have become an exercise in isolation, far removed from the person trying to make a living in Stoke-on-Kent. One can imagine two completely separate worlds. If that is what has happened, and the EU leaders have lost touch, then no one should be surprised if the U.K. exits the union. Why? Because “all politics is local” and the perception by the man in the street, rightly or wrongly, is that the EU hasn’t done much for them. The Localists are tired of edicts from Brussels. If you have been watching the U.S. presidential elections you would probably conclude that we have the same problem here.
So what happens to futures and derivatives markets if an exit were to occur? I believe that the Establishment group is right in that an exit from the EU would have significant adverse effects on the U.K. economy and consequently futures and derivatives markets around the world. Like a number of other observers, I suspect that global markets will become volatile as uncertainty and the decibel level of the conversation about whether the European Union can continue to exist will inevitably increase. In the short-term that would mean a flight to quality, a lower sterling against other major currencies, and stock markets in flux. We could expect a loss of confidence by foreign investors as they try to figure out where the country is headed. The Bank of England would probably take steps to maintain monetary and financial stability which would lead to some kind of monetary easing at least in the short-term In the long run. There is also a school of thought that suggests that an exit might be good for futures and derivatives markets (at least in the short-term) since uncertainty leads to more risk transfer and potentially more volume and activity. Unfortunately, history demonstrates that volatility ultimately leads to lower overall participation in our markets and only when things settle down do certain users of futures and derivatives markets return. We’ll have to wait and see.
The Localists claim that these fears are overblown, but I’m not so sure. In the age of electronic trading and banking, capital, liquidity and economic activity can move across borders easily. In the 21st century moving liquidity from one country to another can be as easy as unplugging a wire in a data center and plugging it in to a different server located ten feet away. Capital, liquidity and trading activity will always seeks the most efficient path and to the extent that better returns and better liquidity can be found elsewhere, that is where capital and the economic activity that follows it will go. Futures and derivatives markets are not immune from these realities and it is possible that a consequence of the U.K. exiting the union would adversely affect futures markets worldwide.
We also think that no matter what happens the U.K. has a problem. The population seems quite divided and we can expect a close vote rather than a mandate either way. As the London rock group “The Clash” crooned “If I go there will be trouble, if I stay it will be double”, and that sums up the issue.
But the most compelling question is whether this is a pivotal moment for the U.K, the European Union and the man in the street. Or is this just one more chapter in the debate about European hegemony that has been going on for nearly a millennia? What would Henry VIII have to say about this ruckus? I think we know.
Carl Gilmore is the President of Integritas Financial Consulting in Chicago, Illinois. Carl writes, lectures and participates on panels about futures industry and financial markets topics in the U.S. and abroad. More information can be found at www.integritas-financial.com.