The warnings get ever more blood-chilling. According to the Organization for Economic Cooperation and Development, a U.K. vote to leave the European Union in a referendum on June 23 would spread shockwaves through the global economy. The International Monetary Fund talks of "severe regional and global damage." At the recent G7 summit in Japan, world leaders warned of a "serious risk" to global growth.
At first sight the furor seems absurdly out of proportion. After all, Britain accounts for just over 2% of the global economy. Even if the U.K. Treasury's worst-case scenario of an unprecedented 6% decline in gross domestic product came to pass, that would constitute a mere 0.13% hit to world output. To put that in perspective, China's growth over the last six years has added the equivalent of three entire Britains to the global economy.
So could Brexit be a global non-event, rather like the Y2K software bug in 2000, the avian flu epidemic around the turn of the century and other media-fuelled panics? In terms of direct impact on trade flows and the real economy, perhaps yes. But when the risks to the world's financial architecture are taken into account, it is a very different story. Indeed economists may be underestimating the chaos that would ensue if contagion spread to the eurozone.
Britain is not part of the EU's eurozone single currency area, so the process of contagion would be political, not financial. Still, that will come as small comfort to the technocrats who run the eurozone. Mario Draghi, president of the European Central Bank, has saved the euro once already by forcing down bond yields in distressed countries of the European periphery through a series of unorthodox monetary maneuvers. But there is no similarly clever "fix" for strikes, riots and political fracture. If populist politicians in some of the 19 EU countries in the eurozone were to demand their own versions of Britain's In or Out referendum, embattled governments would find it hard to refuse. The result would be what Axa CEO Henri de Castries calls "the unravelling of Europe."
Conditions are ripe for a Eurosceptic groundswell, especially in France, where the unpopular socialist President Francois Hollande has been struggling to push through modest reforms to working conditions in the face of violent demonstrations. A recent Pew Research survey revealed that French support for the EU is collapsing, with 61% of the public taking an unfavorable view of the organization, up from 31% in 2004.
This is far higher than the comparable figure of 48% for the U.K. Unfavorable views predominate in Spain and Greece as well, and support is at an all-time low in Germany. Meanwhile the economic imbalances remain eye-popping. Youth unemployment in Spain stands at 45%. Germany, benefitting from euro weakness, clocks up a current account surplus equivalent to a staggering 8.5% of GDP. Greece remains in a twilight zone, bankrupt by any normal reckoning.
The idea that the euro is unsustainable in its current form is no longer restricted to the wilder fringes of economic opinion. In his 2016 book "The End of Alchemy," former governor of the Bank of England Lord King writes, "If the alternative is crushing austerity, continuing mass unemployment, and no end in sight to the burden of debt, then leaving the euro area may be the only way to plot a route back to economic growth and full employment. The long-term benefits outweigh the short-term costs."
The sundering of the euro
The original sin of the eurozone was to bring together greatly dissimilar national economies into a monetary union that lacked the political, societal and cultural coherence to make it work. Quite deliberately the planners made the system as rigid as possible, in the hope that that periodic crises would force the necessary political and cultural changes and justify leaps to greater integration. But Pew Research shows that the number of people wanting less political integration exceeds those wanting more in all 10 of the EU countries surveyed.
According to Lord King, "Monetary union has created a conflict between a centralized elite on the one hand, and the forces of democracy at the national level on the other. This is extraordinarily dangerous." He goes on, "It has sowed the seeds of divisions in Europe and created support for what were previously seen as extreme political parties and candidates. It will lead to not only an economic but a political crisis."
The euro is not just any old currency. A quarter of central bank reserves are held in euros and it is second only to the dollar in its volume of trade finance and foreign exchange deals. In our vastly complex global financial system, with its ever-expanding galaxy of products and transactions, almost every significant player will be exposed to the euro one way or another. The sundering of a major currency would be an event to put the demise of Lehman Brothers in the shade.
Yet according to Lord King and others who think like him, such a denouement is simply a question of time. Anything that speeds up that process is a very big deal indeed, and the U.K. vote has the potential to accelerate it through the potential knock-on effect on increasingly Eurosceptic countries such as France, Spain, Greece, and even Italy. Brexit on its own means little. The problem is the specters of Frexit, Spexit, Grexit and Itexit that it may raise.
Peter Tasker is an analyst with Tokyo-based Arcus Research.