The UK's surprise vote to leave the European Union dramatically raises doubt about the sustainability of the global economic expansion, undermines confidence in European political stability, and challenges 70 years or more of established economic policy orthodoxy. The ensuing global equity markets swoon reflects these uncertainties and suggests a more defensive posture by investors, business managers, and consumers in the months ahead.
The European economy, burdened by excessive regulation and structural rigidity, has expanded at a tepid pace since the recession with the support of an extraordinarily accommodative monetary policy from the European Central Bank. The uncertain effect of the UK's removal from the EU's trade and labor agreements poses risk of an economic contraction in Europe, the UK, and beyond.
The UK vote to leave provides fresh oxygen to secession movements in Scotland, Catalonia, and other regions within current national borders. Furthermore, nationalistic sentiment in France and Germany as well as other countries may spark anew. After more than 70 years of stability in Western Europe and a quarter century since the collapse of the Soviet Bloc, the European map may be redrawn again with new risk to global security and economic welfare.
European recovery from the cataclysmic destruction of WWII was built upon the notion of a unified economic community in which goods, services, labor, and capital would flow freely across borders. These policies in Europe, and the proliferation of free trade and market-based economies around the world, have resulted in unprecedented improvement in living standards. The implicit rejection of time-proven policies by UK voters could jeopardize these gains.
Since my last commentary the economic outlook has shifted dramatically. A short month ago I anticipated that, in recognition of a resilient US economic expansion with GDP growth likely to exceed 2%, the Federal Reserve would raise short term interest rates two times this year. Now that looks highly improbable. With the UK's vote to leave, I expect the Federal Reserve, investors, business managers, and consumers will proceed cautiously.
Let's hope UK and European leaders hear the cries of voters for a more productive and just economic order and return to market-based economic policies unfettered by excessive regulation and bureaucratic interference from Brussels. Officials in Washington would be wise to heed those cries as well.