The Brexit effect is Just Beginning
After A decade of no growth in purchasing power for most people in Europe and North America—except for those at the top, who’ve garnered most of the income gains—voters are rejecting mainstream politicians who support what’s seen as an untenable status quo.
This was made quite clear by the stunning rise of Donald Trump as Republican presidential nominee, the surprisingly strong showing of socialist Bernie Sanders—and the unexpected decision by U.K. voters to leave the European Union. Slow global growth, as the excess debt built up in the 1980s and 1990s is worked off, is compressing incomes. Also, globalization—the most important economic phenomenon of the past three decades—transferred manufacturing and highpaid jobs from the West to Asia. With little unitvolume growth and virtually no pricing power in this business expansion, corporations have had minimal revenue growth. The route to profits growth was marginboosting costcutting, with negative effects on labor compensation.
Regardless of the facts, fringe politicians have convinced many that the income squeeze is due to immigrants who steal jobs and compress wages by accepting low pay. Unfair trade practices by China and other emerging economies is another contention, as is terrorism by immigrant Muslims. Europe politically, economically and financially. Will Brexit be contagious? It’s a very real risk.
Beyond Europe, slower worldwide economic growth and falling international trade will further depress growth in exportdependent China and other developing countries that send most of their exports directly and indirectly to subdued Europe and North America.
Slower global growth and abundant commodity supplies mean exporters will be forced to devalue their currencies to earn more dollars. That will make the $1.15 trillion in dollardenominated nonbank emergingmarket corporate bonds more expensive to service. For investors the safehaven greenback is an obvious buy.
Slowing global growth also increases the likelihood that my $10 to $20 per barrel target for crude oil prices will be reached. Saudiled OPEC is no longer willing to cut production to maintain oil prices while others gain market share. So OPEC is engaged in a highstakes game of chicken, and in this price war marginal costs mark the bottom—$10 to $20 per barrel in the Permian Basin and less in the Persian Gulf.
Falling oil prices contribute to deflation, which is already evident in goods prices worldwide and will spread to services. If chronic general deflation results, buyers will hold off in anticipation of still lower prices as the Japanese have for two decades, a further depressant to economic growth.
I expect more easing from central bankers, led by the Bank of England. Safehaven currencies will benefit, and highgrade corporate bonds will continue to appeal to yieldhungry investors.
Negative interest rates will become more common with inflation fading into deflation. This is bad news globally, especially for banks. In fact, I think the fallout from Brexit and a nosedive in crude oil prices could well precipitate a financial crisis and global recession. “Mad as hell” voters will push lawmakers into implementing major fiscal stimuli, deficits be damned. Will massive stimuli save the day and restore economic growth? I certainly hope so.