Europe is in deep trouble whichever way the UK’s Brexit vote turns out

The survival of European unity, the single market and the euro is on the line, giving investors good cause to be alarmed

PUBLISHED : Monday, 20 June, 2016, 11:46am
UPDATED : Monday, 20 June, 2016, 3:34pm

Europe is in deep trouble whichever way the UK’s Brexit vote turns out

This Thursday’s British EU referendum is the big risk event global markets are dreading. It could be a nightmare scenario, threatening to trigger a chain reaction that could plunge markets back into a new global catastrophe. The real worry is that the world is already slipping back into a black hole of uncertainty whichever way the vote goes. This time there may be no easy way back.

No wonder world policymakers are panicked. While European Council President Donald Tusk over-exaggerated by warning Brexit could mean the end of Western civilisation, both the IMF and OECD are deeply concerned about the consequences for the world economy and financial markets.

The major central banks are already drawing up contingency plans and getting ready to intervene if the UK votes to leave the EU and markets descend into chaos. It is hard to see what they can do. Global currency, credit and equity markets are already highly agitated.

Europe should be especially worried. Whatever happens in this week’s Brexit vote Europe will feel deep shockwaves. It is a “no win situation”, with Europe standing to lose whichever way the vote goes. Europe is not long out of the 2009-2013 euro zone crisis and it has taken huge stabilisation efforts from EU governments and the European Central Bank to stop European monetary union and the euro from falling apart. It would not take much to open up old wounds and set Europe lurching off into a new economic and financial crisis.

A “leave” vote would have an immediate impact. Capital flight out of the UK, a sterling currency crisis and the threat of economic ruination would hit British markets especially hard. Europe would not be spared and market speculators would quickly home in on contagion risks spilling over into the euro zone. Economic and financial stability would be knocked off its perch. The bears would scent blood and begin the hunt for “who goes next”.

Even if the UK votes to “remain”, the barn door has been opened far too wide on European disintegration risks. Despite all the healing balm thrown into the ring from the ECB’s monetary super-stimulus in the last seven years, the same old problems persist.

Europe remains deeply divided, split between the economic haves and have nots. Extremely rich and powerful Germany on the one side and struggling euro zone nations like Greece, Portugal and Spain on the other.

Immersed in deep debt, stifled by austerity and dogged by rampantly high unemployment, there is little chance of long-lasting economic recovery for these nations, especially considering the extremely challenging global backdrop right now.

The threat of hard landing in China, instability in emerging economies and now the threat of Brexit contagion all pose serious dangers ahead for struggling euro zone nations. But there are bigger elephants in the room, not the least growing anti-austerity protests in France and the risk that Italy falls victim to the deepening investor gloom.

Despite the drive to negative interest rates, the glut of QE money and the high defensive walls surrounding the euro zone’s vulnerable financial markets, the ECB’s monetary defences are hardly impregnable. With market jitters becoming more acute, peripheral yield spreads are already widening relative to German government bonds on safe haven flows.

If markets decide to take on the ECB, it could trigger a dangerous re-run of the 1992-1995 and 2011-2012 deconvergence bloodbaths. European markets are highly vulnerable.

The real worry is that EU policymakers continue to kick the can down the road without solving the real economic and social inequalities dogging Europe. As long as Germany gets stronger, at the expense of the weaker European nations, political divisions will widen and the cohesive forces holding Europe together will continue to fragment. Anti-austerity protests and political extremism are on the rise and leading to deepening antipathy towards Brussels and the EU.

These trends are crystal clear in the usual suspects like Greece, where up to three quarters of voters are dissatisfied with the EU. More alarmingly similar trends are showing up in core countries like Austria, Netherlands and France which are witnessing the emergence of more inward-looking, nationalistic and anti-EU tendencies. It bodes badly for the future.

There is much more at stake in Britain’s Brexit vote this week. The survival of European unity, the single market and the euro is on the line. Investors have good cause to be alarmed.