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Why Brexit Matters to US Savers and Investors

July 28, 2016

Headlines are replete with alarm about the United Kingdom’s unexpected decision to leave the European Union. Brexit, as it has been called in the press, has roiled the political landscape around the world and its reverberations will likely be felt well into the future.

Will Brexit impact financial markets? What impact, if any, will it have on savers and investors?

The answer to the first question is clear. Brexit created new uncertainty about the future state of the EU, an economic bloc with a larger currency-adjusted GDP than the U.S., according to the World Bank. Will other nations follow the U.K.’s lead? What will remain if others head for the door? Will disruption in the U.K. and EU cascade to other economies? Uncertainty is always with us in varying amounts, and financial market volatility tracks higher during periods like this.

The answer to the second question requires more analysis. In recent years, some economists have lamented their expectations for a prolonged period of economic softness dubbed the “new normal.” They are concerned that aging populations and technological change in developed nations are setting the stage for generally stagnate economic conditions.

The Brexit vote called into question the viability of two widely acknowledged remedies to the new normal: global free trade and immigration.

Global Free Trade: Since the 1700s when political economist David Ricardo first put ink to paper, textbooks have theorized that free trade between nations lifts aggregate economic output. Accordingly, global free trade has been viewed as a powerful remedy for the new normal.

Economic populism presents an alternative point of view. When Country A trades with Country B, the total economic value created might indeed be higher than if they hadn’t traded at all. But that might only be true because additional economic value for Country A is so large that it more than offsets economic losses for Country B. Said another way, free trade creates winners and losers.

This alternative theory has taken hold in political circles around the world, including here in the U.S. It was also a compelling theme in the Brexit vote.

Immigration: Many developed nations have aging populations. As consumers age they spend less. When they collectively spend less the economy slows. If the age distribution of a nation is shifted lower via importation of younger consumers, the outlook for its economy improves. Therefore large immigration of mostly younger people partially reverses a key driver of the new normal.

Let there be no mistake: Brexit was as much about resistance to mass immigration as any other factor.

If global free trade and large-scale immigration are resisted around the world, what are the other remedies to the new normal? Economists have no shortage of ideas, but these two look far less doable now versus prior to the Brexit vote.

In the long run, investment returns track an economy’s growth or lack thereof. Brexit reinforces the new normal thesis because it makes two policy remedies to slow growth less likely to be implemented. As such, expectations for lower investment returns are reasonable, absent the emergence of a growth catalyst that is currently not visible. Likewise, interest earned by financial institutions and credited to savings will likely remain low. Savings rates should be increased so goals can be met in a generally low-return environment.

This is not to say the global economy is destined to struggle indefinitely. Economists are notorious for being wrong more often than they are right. Indeed, the new normal thesis could be relegated to a footnote in future economics textbooks. Even so, Brexit reinforces the reasonableness of modest expectations.