Why Brexit means trouble ahead, except for Trump
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Global markets are gripped by fear for a second time this year. The first shock came in early January, when the world woke up to the implications of a hard landing of the Chinese economy. A measure of that shock came in the form of a rise in gold prices of $100 an ounce over the next month.


The second shock came out of the United Kingdom last night, with news that voters had approved a referendum to take Britain out of the European Union (popularly known as "Brexit"). Gold rose, again, as fear swept through markets around the world. But this time prices rose $100 an ounce in six hours instead of 30 days. (By the time U.S. markets opened this morning, gold had given back about 25 percent of this gain.)

Other markets in Asia and Europe suffered dramatic losses on their openings, with London's FTSE 250 initially falling 12.3 percent and Tokyo's Nikkei down 7.9 percent. The Chinese currency, the renminbi, fell to its lowest level in five years, reviving fears that a weakening Chinese economy, the world's second largest, will reinforce deteriorating conditions around the globe. In the U.S., within minutes of their opening bells, the Standard & Poor's 500 lost 2.6 percent of its value and the Dow Jones industrial average fell almost 3 percent. All told, global stocks looked to be headed for their worst one-day loss ever.

This will not be the last of the tremors to shake financial markets this year. The reverberations of Britain's decision to exit the EU will echo through trading floors and political institutions for many months and probably years. Compounding the immediate economic fallout from the vote, the Bank of England may be forced to raise interest rates to save the pound, which suffered it greatest one-day loss in the modern era. Scotland and Northern Ireland, both strongly pro-EU, may look to sever ties with Britain and remain in the EU, bringing an end to the United Kingdom.

Elections loom next year in France and Germany. Anti-EU sentiments will surge in Europe now and could spell trouble for governments across the continent. Negotiations surrounding the British-EU divorce will be complex and likely contentious. The terms of their divorce could intensify hardships in the U.K. and Europe, or they might mitigate the damage and thereby lower the perceived costs for other member nations considering severing their ties to the EU.

The U.S. presidential race is likely to be affected as well. In the final days of the Brexit campaign, the conventional wisdom of Western political and business observers shifted from uncertainty to confidence that the referendum would be defeated. Polls taken in the final days reinforced this consensus. But when the votes were counted last night, the "Leave" forces had won by 4 percentage points, far more decisively than surveys had indicated was possible.

This failure of polls to accurately gauge pro-Brexit sentiment will raise questions about how much confidence can be placed in polling of the race between presumptive nominees Hillary ClintonHillary Diane Rodham ClintonWhy does Bernie Sanders want to quash Elon Musk's dreams? Republican legislators target private sector election grants How Democrats can defy the odds in 2022 MORE (D) and Donald TrumpDonald TrumpBiden to move ahead with billion UAE weapons sale approved by Trump Fox News hires high-profile defense team in Dominion defamation lawsuit Associate indicted in Gaetz scandal cooperating with DOJ: report MORE (R). Trump's appeals have been similar to those made by Brexit advocates, and his success through the GOP primary campaign repeatedly defied the conventional wisdom of American political and business elites.

Most of the U.K., European and U.S. elites lined up against Brexit. Despite that fact, or perhaps because of it, the British voted to leave the EU. Likewise, in the U.S., much of the political and business establishment has opposed Trump. In the wake of last night's decision in the U.K., that opposition is likely to intensify. But Trump has thrived in the face of such opposition, and the message sent by British voters is likely to boost Trump's prospects — if he can navigate what could be a very messy convention and exercise greater discipline on the campaign trail.

In response to the deepening economic and political uncertainty ignited by the Brexit vote, governments around the world will begin a long-term easing of monetary policy. This will be difficult to accomplish since interest rates are already at or below zero. Nevertheless, additional interest rate reductions and doses of quantitative easing are likely.

The Federal Reserve has been cutting back its plans for raising interest rates since this year's first economic shock in January. The news from the U.K. last night is probably a death knell for those plans. Since 2008, the Fed has repeatedly overestimated the strength of the U.S. economy and underestimated the political and economic headwinds buffeting the global economy. While the Fed has raised interest rates only once during this period, in December, the relentless talk about its intent to raise rates has had the indirect effect of doing just that.

For seven years the U.S. and Europe have battled the fallout from the 2008 financial crisis with one arm tied behind their backs. The austerity politics that have, to one degree or another, dominated economic policymaking in Europe and the U.S. have denied governments the use of fiscal policy (tax cuts and spending increases) to boost their economies. This has left them with no option but to use monetary policy alone for this purpose. They are close to exhausting the effectiveness of monetary measures and face the choice of abandoning austerity or doing nothing.

The limited effectiveness of monetary policy without complimentary fiscal policies has contributed greatly to political turmoil in the West. Brexit is a self-inflicted wound. As long as only the Portuguese, the Italians, the Irish, the Greeks and the Spanish (the "PIIGS") suffered the consequences of austerity, Western political and financial leaders could tighten the screws with impunity. The PIIGS had it coming because they had been irresponsible, they believed. Suffering would build national character.

But now Brits and Americans are rebelling under economic policies that ignore their plight while serving the interests of economic elites. These policies have proven themselves bankrupt, politically and economically, and unless they are abandoned for others that respond to the fear, suffering, and anger of our fellow citizens, we will face much greater turmoil for years to come.

Diehl is a former chief of staff of the U.S. Treasury Department, director of the U.S. Mint and staff director of the Senate Finance Committee.