The United Kingdom is already feeling the impact of its highly contentious decision to leave the European Union. According to the National Institute of Economic and Social Research, a London-based think tank, the U.K. economy has a 50 percent chance of entering a recession before the end of 2017. Since June 23, the value of the pound sterling has experienced the largest recorded drop of any major world currency in recent history.
Yet the ongoing fallout from the Brexit is not limited to the U.K. The governments of China, the United States and a host of other nations almost unanimously advised the U.K. against leaving the EU. Some are better placed than others to see out the period of heightened economic uncertainty that has followed the British referendum.
Before the Brexit, London was the world's largest foreign-exchange hub; the most recent figures from the Bank of England show average daily trading volumes in April 2016 of around $2.2 trillion. According to SWIFT, London also became the largest clearing center for the renminbi (RMB) outside Hong Kong and mainland China in March this year. Data from the global transaction services organization reveal that 40 percent of all payments made between the United Kingdom and greater China were made in the Chinese currency that month.
Yet the Brexit has left a cloud of uncertainty hanging over London's financial industry. The British capital, which currently has the largest pool of RMB deposits in Europe, has already hosted several RMB bond floats. Yet these bonds may soon face strict European banking, fund transfer and talent recruitment restrictions.
When they were part of the EU, the U.K.’s financial institutions had "passporting" rights, which gave them restriction-free access to the EU single market. After the Brexit, the loss of those rights is now a distinct possibility, so many asset managers are already relocating staff out of London and establishing funds in neighbouring EU countries.
The referendum results mean many Chinese companies will now think twice before opting to use Britain as a launchpad for further investment in Europe. Many believe London's potential loss of status as the financial gateway to the EU will make Beijing re-evaluate its entire strategy for internationalizing the RMB.
"London's euro-trading and the euro-clearing business will most likely have to move to another EU country," says Francesca Panelli, an international economy analyst with international consulting firm Oxford Analytica, which is based in the United Kingdom. "If this happens, China may well ramp up its own currency operations in other European cities."
Beijing is unlikely to find a shortage of takers for its RMB business. Of the leading contenders, Luxembourg - already home to the European headquarters of three of the largest Chinese banks - is well placed to cash in.
"Luxembourg is the Eurozone's pre-eminent hub for cross-border RMB business," says Zennon Kapron, founder and manager of financial research firm Kapronasia, which has offices in Shanghai, Singapore, Hong Kong and New Delhi. "The country has worked tirelessly to strengthen relations with China. Its importance for RMB trading will undoubtedly increase as a result of Brexit."
Others believe that the loss of euro trading may see London pitch aggressively for even more Chinese and Asian business, and build on its strengths in private banking and fintech. Once unshackled from EU regulations, the city could assume a Singapore-style banking environment, wooing new investors with light-touch regulations and attractive tax breaks.
"There are a lot of variables at play," says Desmond Lachman, a visiting scholar at the Washington-based American Enterprise Institute, a think tank focused on the global macroeconomy and global currency issues. "It sounds contrary, but Brexit could actually see London strengthen its position vis-a-vis the RMB. The British referendum may also see China focusing closer to home as it looks to boost global RMB usage.
"The Chinese financial industry is underdeveloped and illiquid compared to [its] counterparts in developed economies," says Min Chun, a senior project leader with Daxue Consulting, which conducts market research and management consulting from its offices in Beijing, Shanghai and Hong Kong. "In the wake of Brexit, Beijing is likely to concentrate more on deepening its own financial markets."
Brexit has opened Pandora’s Box in the world's currency markets. Since the referendum, the pound sterling has plummeted to a 31-year low against the dollar, and expectations are that it will keep falling for some time.
The changing sterling-dollar dynamic has led many U.S.-based manufacturers to consider hiking the prices of products sold in the U.K. Both Dell and HP have already raised their U.K. prices by 10 percent, with more companies expected to follow suit.
The unprecedented nature of Brexit and the subsequent fall in sterling mean there is considerable uncertainty over how currency markets will play out during the next six to 12 months. Investors have responded to this state of unpredictability by piling money into "safe haven" currencies such as the dollar and the Japanese yen, driving up their relative value.
It may be good for U.S. consumers and travelers, but a strong dollar is bad news for many American companies, as it continues to hamper exports and drive a burgeoning trade deficit, which hit a 10-month high in June.
The U.S. Federal Reserve, encouraged by falling domestic unemployment, raised interest rates at the end of last year, but a stronger dollar, coupled with uncertainty over economic growth, has so far halted any further increases. In the wake of Brexit, some analysts have even raised the possibility of a rate cut.
"Safe haven flows mean the dollar is likely to strengthen further this year," says Oxford Analytica's Panelli. "This is despite the likelihood of a Fed pause in hiking rates."
The strong dollar is contributing to bullish U.S. domestic consumption. The driving force of the American economy - personal consumption expenditures - increased by 4.2 percent in the second quarter of 2016, according to the U.S. Department of Commerce. Yet in Japan, where domestic demand is too weak to underpin economic growth, a rising post-Brexit yen is about as welcome as a fox in a chicken coop. Even before the referendum, deflation had become the Japanese norm, with consumer spending on a downward slide.
"Brexit was the last thing Japan needed," says the AEI's Lachman. "A fall in sterling and the RMB is clobbering the Japanese economy."
"Brexit is a setback for ‘Abenomics,’ which has made no real progress towards its goal of ending deflation," says Benjamin Charlton, Oxford Analytica's senior analyst for the Asia Pacific region. "The Bank of Japan may now need to loosen monetary policy even further."
A strong dollar is also an ongoing challenge for China. Although a weaker RMB is good for a sluggish Chinese economy, Beijing and the People's Bank of China need to manage the pace of change in order to minimize capital outflow. When the RMB slipped below the 6.7/dollar level in July, the PBoC duly intervened to steady the ship.
Most analysts agree that keeping the RMB in a controlled, post-Brexit descent will require a delicate balancing act. According to figures from China's customs department, the country's exports dropped 4.4 percent year-on-year in July in dollar terms, raising the likelihood of further RMB devaluation.
"In the aftermath of the referendum, the PBoC let the RMB devalue away from the global spotlight," says Oxford Analytica's Panelli. "It may allow it to fall a little more, but excessive devaluation risks a currency war."
Dominic Ng, East West Bank’s CEO and chairman, believes talk of RMB volatility is overblown.
"Compared to fluctuation in other currencies, such as the euro and yen, over the past few years, the RMB is far more benign," says Ng. "Beijing has handled currency pressures pretty well over the last 18 months. The Chinese government certainly has the balance sheet and reserves to continue to manage things tightly."
Beijing's policy makers are attempting to counter capital outflow by trying to boost the usage of RMB by American companies. China is set to give a 250 billion RMB ($38 billion) investment quota to the U.S. and has recently selected an American bank for RMB trading and clearing. Although data from SWIFT show the RMB fell to sixth place in global transactions in April, China will be hoping sterling's post-Brexit volatility will push it back up the table.
In the aftermath of Brexit, many people asked whether this was simply the first step in the breakup of the entire European Union. Although the shockwaves from June 23 are still being felt in Paris, Berlin and farther afield, a domino-style meltdown of Europe's greatest institution currently looks unlikely.
Yet Brexit is symptomatic of an underlying and burgeoning dissatisfaction across much of the world with the current economic order and its impact on wealth distribution, wages, jobs and the flow of people. Governments in many Western nations are now likely to face growing pressure to rein in open trade and immigration policies that have characterized world growth in recent years.
"Brexit is just one example of a growing backlash against globalization," says the AEI's Lachman. "We are now seeing the same trend manifest itself in the run-up to the U.S. presidential election. This sentiment has serious trade implications."
In the United States, the anti-globalization tide underpins public opposition to sweeping trade deals. The North American Free Trade Agreement and the proposed Trans-Pacific Partnership are both opposed by Hillary Clinton and Donald Trump.
To avoid long-term economic damage from Brexit, the U.K. will have to forge a raft of new trade deals in double-quick time. The challenge for the British government, besides keeping the electorate on board, is to convince other countries that they are better off dealing with a U.K. outside the EU.
One immediate victim of the Brexit fallout may be the Transatlantic Trade and Investment Partnership, a proposed U.S.-EU free-trade agreement that has now been sitting on the negotiating table for three years.
"Even before Brexit, TTIP negotiations had been slow and difficult," says Larissa Brunner, Oxford Analytica's Western Europe analyst. "Although the EU as a whole appears to remain committed to it, public opposition has been increasing."
"TTIP will almost certainly go onto the back burner now," says the AEI's Lachman.
Whether the U.K. will be able to benefit from the EU's failure to embrace TTIP remains to be seen. There is strong support in the Senate for a bilateral U.S.-U.K. trade deal, where a proposed “United Kingdom Trade Continuity Act” was introduced less than a week after the Brexit referendum.
While Brexit has raised serious questions about the future of free trade, the U.K., China and the rest of the world are now waiting on the outcome of the U.S. presidential election in November.
"Any changes that the U.S. makes in its trade stance will have a far larger global impact than Brexit will, so governments will likely wait before making any hasty decisions," says Kapronasia's Kapron.
The next six months – a period of time encompassing the U.S. presidential election and the probable triggering of Article 50 (which starts the legal process for the U.K.'s withdrawal from the EU) – are likely to have a significant impact on global trade, currency dynamics and policy making.
By early 2017, it should become apparent whether Brexit is simply a storm in a teacup, or the first step in a seismic economic rebalancing act. For now, in this period of post-Brexit limbo, the knock-on effects of the referendum will continue to affect different businesses in different ways.
"This is the problem," says Oxford Analytica's Charlton. "The inherent unpredictability of the situation is making some companies wary."
On the political side, events on both sides of the Atlantic show that many Europeans and Americans are becoming increasingly critical of globalization. If this dissatisfaction cannot be contained, it may lead to a proliferation of barriers to free trade, migration and other globalizing forces.
Despite this uncertainty over the future, the sheer size of the Chinese economic engine is likely to insulate it against the worst effects of any possible post-Brexit downturn. This, after all, is a country that continued to thrive during the global financial crisis.
"In terms of trade with China, companies shouldn't hold back," says East West Bank's Ng. "People who have a great strategic idea about how to collaborate with a Chinese company, to help Chinese business go abroad, or to enter the Chinese market, should just do it. These things are still going to work, with or without Brexit."
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