World Leaders Are Taking Investors Down A Dangerous Economic Path

Conditions for investors around the world are getting worse.

Let’s start with Europe, the world’s second-largest economy. The European Union is a collection of states that are vastly different from one another. They are separated by culture, language (which impedes labor mobility, resulting in semipermanent labor productivity disparity between countries — think Greece and Germany), economic growth rates, indebtedness and history.

European political (EU) and monetary (EMU) unions were great experiments that made a lot of sense on paper. Europe, at roughly the same-size population and economy as the U.S., was at a competitive disadvantage as dozens of currencies embedded extra transaction costs in cross-border trade, and each currency on its own had little chance of competing with the U.S. dollar for reserve currency status.

There were also important noneconomic considerations. Germans were haunted by their past; they had started two world wars in the 20th century, and a united Europe was their way of lowering the risk of future European wars.

Economic and monetary union sounded like a logical marriage of all the significant powers of post–World War II Europe, but the arrangement was never really a marriage. It was more like a civil union. EMU members combined their currencies into one, the euro. They agreed to use the same central bank and thus implicitly guaranteed one another’s debts.

Read: The world is becoming desperate about deflation

 Though treaties put limits on budget deficits (limits that, ironically, Germany was the first to exceed), each country went on spending its money as it wished. Some were relatively frugal (like Germany); others (Portugal, Ireland, Italy, Greece and Spain) went on spending binges, like newly hitched college students who had just gotten their first credit card, with an irresistibly low introductory rate and a free T-shirt.

Now let’s turn to Brexit, the U.K. referendum on exiting the EU. Ironically, the U.K. doesn’t have half the problems that most EU nations are going through. Because it is not part of the EMU, it has retained its currency and its central bank.

The U.K.’s main dissatisfaction with EU membership stems from the immigration issue. Because treaties have turned the EU into a borderless union, when Germany accepted refugees from the Middle East and Northern Africa, it basically made a unilateral decision on behalf of all EU members to accept those refugees to all EU countries. High unemployment, wage stagnation and terrorism are now endemic in the EU, and you can see how the U.K.’s citizenry might have a problem with this.

After the Brexit vote, the financial media lit up with opinions on its consequences for the EU and the global economy. They’ve varied from “Brexit is a nonevent” to “This is a Lehman moment for the global economy,” referring to the Lehman Brothers bankruptcy that almost brought the financial system to a halt in 2008. The arguments on both sides are quite convincing.

The argument for Brexit’s being a nonevent is simple and straightforward. The U.K. maintained its currency, and the pound’s  decline in the aftermath of the referendum will help cushion any negative fallout on the British economy. The U.K. and the EU will forge new trade treaties. There is a fear that the EU may impose trade sanctions on U.K., not so much to punish the U.K. but to threaten other EU members that exit will come at a stiff economic cost (effectively turning this voluntary club into a prison). However, the U.K. is a net importer of goods from the EU; thus any sanctions will hurt remaining EU members more than the U.K.

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Vitaliy Katsenelson

I am the CEO at IMA, which is anything but your average investment firm. (Why? Get our company brochure here, or simply visit our website).

In a brief moment of senility, Forbes magazine called me “the new Benjamin Graham.”

I’ve written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. (I’m working on a third - you can read a chapter from it, titled “The 6 Commandments of Value Investing” here).

And if you prefer listening, audio versions of my articles are published weekly at investor.fm.

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