Are the markets really terrified of Brexit?

One of the mistakes that pro-market people sometimes make is to talk about the financial markets as though they are a magical, mystical force. The markets are spooked; the markets shuddered; the markets are unhappy; the markets are angry; the markets can’t be bucked. I wonder if this tendency among capitalists – to view the markets as though they are a vengeful God of the Ancients – has anything to do with the decline of religion among elites and the need to replace it with other beliefs. It may also be because Adam Smith’s “invisible hand” description of the market process is so alluring and has overtones of conjuring. Whatever the explanation, the tendency is an enemy of clear thinking about what is really happening.

It is far better to think of financial markets and what happens in them as the accumulated result of millions of decisions taken by individuals sometimes working in concert, sometimes in competition, and quite often running around in circles bumping into each other while trying to find out what everyone else is doing. It is not perfect, but not only has no better system been discovered for allocating capital, it has produced amid the chaos enormous gains for humanity.

I mention this because of the recent turbulence in the City of London and beyond that was blamed on the possibility of Brexit. Since the killing of Jo Cox MP last week – and it sounds callous even to mention it, but it was clearly a factor – investors and market participants have calmed down about the possibility of Brexit. They are back to pricing in a Remain victory on Thursday, so one hears less now about the markets in the mainstream media.

I certainly had quite a few phone calls and texts early last week from people who work in the City telling me that a panic was underway when it looked for a while as though Leave would win. Banks and investors were on alert, which in itself is quite worrying. Those institutions spend hundreds of millions of pounds on analysis each year (and bill their clients) yet they seem not to have woken up to the serious possibility of a Brexit until rather late in the process. Only when a few polls (which were badly discredited in the 2015 general election) moved did they wake up, and start the process of running around bumping into each other. All you needed to work out several months ago that this could really happen was access to a television or radio, or a conversation with a British voter or two.

But were those in the financial markets spooked about Brexit specifically? What is really going on?

The great Hamish McRae offered a proper explanation a few days ago. If you missed his column on the Independent website on Saturday then it is well worth catching up with.

The possibility of the UK leaving the European Union ought not to be enough of an issue to do real damage to the world economy, he said.

“I know the Chancellor of the Exchequer and the Governor of the Bank of England have issued grave warnings, and of course those warnings should be taken seriously. But the reality is that UK would continue to trade with Europe. There would be some new arrangement ensuring that. We are not in the eurozone so the euro should not be affected. We are not in Schengen so that is not affected either. In any case, even on the worst assumptions, the loss to global GDP would be tiny. The UK is 3 per cent of global output. Let’s assume that we lose 5 per cent of GDP as a result of Brexit (an assumption that I think is far too high, given the continued decent growth notwithstanding Brexit fears). That is 0.15 per cent of the global total – barely worth thinking about.”

So what is driving the concerns? It is more likely, according to McRae, that investors do not trust policymakers and know that they lack the wherewithal to respond if there is a more serious economic emergency, meaning an emergency much more serious than little old Britain winding down its membership of the EU over the next few years. After years of QE and very cheap money (all of which has blown asset-price bubbles) there are few options available in terms of firepower if there is a recession.

That means that when George Osborne warns of the implications of Brexit do not fall for the idea that he is doing so from a position of great strength. He, and the Governor of the Bank of England, are international players who know that we are – due to the business cycle – due a downturn of some form in the next couple of years. That does not mean that a 2008-style implosion, a once in a 50 year event, is definitely on its way. It could easily be a smaller readjustment. Anyway, crashes are rarely forecasted successfully, and you tend not to know you are in such a scenario until it happens.

Such global vulnerabilities may or may not justify concerns about Brexit. The warnings look over-cooked, in my view. But the weaknesses, stresses and challenges we have been told about in the last few weeks by those who work in the markets are not really at root about Brexit. The story is much bigger. The post-crisis response has run out of road.