Two months after Britain’s shock referendum result, and what has happened? Not a lot. Though you wouldn’t think it from reading the running commentary. So was Project Fear the hoax that the Leave campaigners always said? Probably not.
The few days after the result seemed to fulfil Project Fear more quickly than even Remain campaigners suggested. The pound fell sharply and many stock indices tumbled too. There was much talk of this or that investment being stopped, or this or that institution or business being under threat. Remain supporters have kept up the pace of alarmist talk ever since, to judge by my Facebook feed.
But Brexit campaigners have a point when they poke fun at this. When it comes to cold, hard economic statistics it is very hard to see much, or any, adverse impact. The stock markets have fully recovered. Retail sales, employment and prices all looked pretty healthy in July. The government still finds it laughably easy to raise money on the bond markets; the Bank of England’s currency reserves went up. Only that fall in the currency has persisted. And no doubt that reflects weaknesses in the economy before the vote – given the scale of the ongoing current account deficit. The various indicators that have taken a plunge represent sentiment rather than hard fact, and may have been contaminated by the sheer shock of it all, as might the gloomy reports from the Bank of England and the Institute for Fiscal Studies.
On only one thing can Brexiteers be disappointed. The remaining EU has sailed on just as smoothly as the UK, with the Euro strengthening significantly against the pound. This defies predictions of imminent panic and collapse gleefully made by (some) Brexit campaigners. No other country seems at all inclined to follow Britain’s lead to the exit. Even as the emerging kerfuffle on Italian banks is as good evidence as you might ask for about problems with EU rules and democratic mandates.
There is, of course, one possible explanation for this insouciance: denial. Maybe people think that exit is so hard, and will have such obviously dire consequences, that it will never happen. Speculation about the invocation of Clause 50 for formal exit pushes it further and further into the future. If so it shows remarkably little insight amongst the market makers. Any process by which the referendum result is reversed will be very messy, and entail a lot of collateral damage.
Personally I think people are putting too much faith in the markets’ ability to see trouble ahead. The signs that the 2008 crash was in the works were obvious more than a year beforehand, when the interbank markets froze. Strong enough, as I don’t tire to point out, for me to move my pension portfolio from shares into index-linked gilts and cash. The more perceptive would have seen the trouble coming a year before even that, when US property prices started to slide, threatening the foundations of the whole financial edifice. And yet the markets did not reflect the mounting danger at all.
And at the other end of the scale, when it comes to the multitude of small decisions taken by consumers and businesses that drive the short term statistics, there is also a sort of built-in inertia. Short term decisions quickly overwhelm intangible longer term worries. People don’t know what to do, so they carry on as normal.
There are two ways in which the Project Fear may yet turn out to be on the money. One is a slow decline that accumulates: slower growth turns to a shallow recession that persists. That would be perfectly consistent with current statistics. The other way would be like the 2008 crash: a delayed reaction leading to a sudden crash. Both of these follow my metaphor of the economy being holed below the waterline in my post in the week after the result. The ship is in mortal danger despite no damage visible above water.
Why might trouble happen? It comes back to the basic weakness of the British economy (which, it must be said, EU membership was doing little to help) – a substantial trade and current account deficit. Britons as a whole are spending more than they are earning, and have been for many years. That has been OK because plenty of foreigners have been prepared to lend us money, or to invest in British businesses or property. Also British multinationals may be selling off foreign assets and bringing the proceeds home. Brexit is putting that investment flow at risk.
What happens if the country can’t get enough currency to pay for imports? Demand for Sterling falls, and the currency sinks. That might attract investors (British assets look a bargain) or scare them (with the risk of further depreciation). Currency reserves, private and national, start to be drawn down. That will affect living standards. Then either the trade balance corrects (buy fewer imports and sell more exports), or things start getting nasty with a financial crisis as the stability of banks and the entire payments system comes into question – which is what happened in 2008, for different reasons. These changes tend not to happen smoothly.
The problem is that the financial system is very complex, with all sorts of buffers and hidden dependencies, which makes it non-linear. Responses are not proportionate to the changes to the system. Past performance is a poor guide to future dangers. There might be a lot of short-term factors stabilising things, but that could be undermining resilience. The country could be building up vulnerability to the next financial crisis, just as the Labour government of the naughties created vulnerability to the banking crisis of 2008.
Or perhaps the Brexiteers are right. The financial system will adapt to the new realities calmly and the British economy is fundamentally stronger than the pessimists say. The economy will sail serenely on and gather strength to boot.
The thing is that it is just too early to tell. It could be many months, or even years, before any crisis caused by Brexit emerges. I will be watching for signs of trouble. But, to be honest, I haven’t seen them yet. It’s all a phoney war.