A Pact Against Brecession How We Can Prevent Contagion
The British vote has shocked the financial markets, and it also threatens to cripple the German and European economies. What Europeans need now is an emergency stimulus package to fight potential contagion. The clock is ticking.
It's a matter of course that markets tend to exaggerate and go into panic mode, even when their reactions bear no resemblance to reality. The thing is: What we saw in the financial markets on Friday morning, after the news broke that the British want to leave the European Union, could be a fairly accurate reflection of the economic threat that not only the British, but also the Germans, face in the coming months.
Ring the alarm. Europeans should quickly figure out whether, as a first step, they assemble an emergency package to stop an imminent downward economic spiral, before it can pick up speed. This is best done in cooperation with the British, with their reputation of pragmatism. Otherwise, the ridiculous decision by a small majority of the Queen's voting subjects could soon mean that a lot of people will lose their jobs again in Germany and in other countries.
It is less an issue of the British possibly having to pay a little more in the future to gain access to the European single market. Or that we may need visas again to travel through the Channel Tunnel. All of this would cost money, but it's unlikely it would throw the economy off track.
The acute danger is that everyone involved now feels thrown into a period in which it will remain unclear, for months or even years, under exactly what conditions business will be conducted:
- whether or not duties will increase;
- whether there will be entirely new trade agreements with third countries;
- whether EU standards will be replaced by entirely different, British standards;
- and how many foreign (EU) workers will be allowed into the country and be available to the economy in the future.
And all of this under a likely Prime Minister Boris Johnson, who has just demonstrated that he is prepared to ignore common sense in favor of pure populism. He's the British version of Donald Trump.
The frightening thing is that there are some indications that, despite all studies and debates in the last few weeks, a large share of company executives haven't even made adjustments for the Brexit scenario -- and are now as unprepared for the outcome as players in the financial markets. If the options had even been partially anticipated, the British pound would not have slipped to its lowest level since 1985. And the DAX, Germany's benchmark share index, would not have lost 10 percent in early trading. All of this would have already have been priced in, to use the vernacular of the financial markets.
High Risk of Recession
It isn't hard to guess how UK-based companies with international operations will initially react: They will put any projects and investments that are not absolutely necessary on hold for the time being, until there is some clarity over what happens next. If this means that only a tenth of planned investments are suspended until further notice, experience has shown that this will be enough to catapult an economy into a recession, including a rise in unemployment. This isn't necessarily going to happen, but the risks are now very high following Brexit.
The real problem is that the same logic also threatens to strike in Germany and the rest of Continental Europe, although likely to a lesser extent. This comes at a time when the next populists are already touting ridiculous proposals almost everywhere, romancing about leaving the EU or the euro, a time in which the euro crisis has already created a deep sense of insecurity over the future union.
The current condition of the German economy suggests the potential economic impact of such a state of uncertainty. There are plenty of reasons that companies should be making significant investments again. Financing is more attractive than ever, interest rates are near zero, balance sheets have been cleaned up, profits are at historic highs and demand is growing. Nevertheless, the German economy is investing less in the future today than it was eight years ago, before the financial crisis began. There are few explanations for this other than that no one really knows what will happen in a few years -- and whether and how the euro zone will work in the future.
In 2012, European Central Bank (ECB) President Mario Draghi (fortunately) made it clear that he would do everything in his power to preserve the euro in its current form, which is the proper thing for a central bank to do. The problem is that the German government is demonstrating, with unbelievable negligence, that this cannot in fact be taken for granted -- especially after Finance Minister Wolfgang Schäuble broke a taboo last summer, when he said he would not rule out the amicable ejection of a member of the euro zone. Since then, every investor in Europe has been plagued by the uncertainty over whether the euro will still be in use in a country in which that person wishes to invest -- or whether that country will perhaps return to its national currency. There's probably no better way of inhibiting investment.
If this is true, the results from Britain are also moderately disastrous for Germany. The approaching Brexit will contribute to increasing investment risks, even as a self-fulfilling prophecy. The more companies hesitate, the more demand fluctuates -- and, as a result, the actual reason to spend more money on new machinery and facilities. This is a dangerous downward spiral that could soon lead to higher unemployment.
Europeans Should Up the Ante
It is now all the more urgent for everyone involved to clarify, as quickly as possible, the status the British will have in the future; to demonstrate, if possible, that there should be no further countries leaving the EU; and to ensure that the hesitation and downward spiral in investing doesn't gather momentum.
There is a tool that has an effect on investors in such times of waiting and hesitation, even if it sounds a little technical. It is the option for companies to accelerate depreciation of their investments for a certain period of time, enabling them to save money. This tool -- an accelerator -- provides benefits to companies, as long as they make the decision quickly.
After the 2001 US recession, this helped encourage hesitant companies to unblock a number of projects -- and end the recession. In Germany in 2006, Chancellor Angela Merkel used the same tool to accelerate investment and stimulate the economy after years of stagnation. Now it is all but forgotten. A similar program is currently being used in France, which is seeing a higher rate of new investment than Germany. The trick could work miracles throughout the EU, with relatively little financial commitment, and it could avert a post-Brexit crash.
If Europeans want to do a good thing for their union, they should up the ante. Here's an idea: Send every citizen of the EU (in the countries that are still members) a check that can only be used to purchase climate-friendly products, from low-CO2 refrigerators to solar panels to electric cars. That too could make a significant contribution to avoiding a sharp drop in consumption in uncertain times -- and perhaps to appease those who are currently skeptical about the EU.
Obviously there will be plenty of issues to resolve in the near future, including whether and how the EU should proceed after Brexit. We'll get back to that. Before then, after the shock of June 24, 2016, our main objective should be to avert the acute risk of an economic crash. And perhaps this will even create a new sense of unity among EU countries.
If those in charge of the EU manage to support the economy and ensure that their efforts are felt by most people (in the form of a check), this could very well be a first step in refuting the notion that Europe represents nothing but bureaucracy, the standardization of things that make little sense and the constant grousing over the fiscal policies of other nations. The clock is ticking.