ETF Trends
ETF Trends

Note: This article is courtesy of Iris.xyz

By Dr. Sonu Varghese

The referendum on Thursday in the United Kingdom (UK) – on whether or not the country should leave the European Union (EU) – loomed as the biggest potential ‘known-unknown’ risk to global capital markets in the immediate future.

The decision to leave the EU was a tremendous one for the British people. The UK accounts for 13% of the EU’s population and about 15% of its economic output.

Related: 10 ETFs Hit the Hardest in ‘Brexit’ Fallout

To put this into perspective, Brexit is akin to the entire Northeast region of the United States, including the financial hub of New York, choosing to secede from the union because they pay a lot more in taxes to the center than the benefits they receive in return.

The key issue is that while the British people are aware of the pros and cons of being in the EU (at least on the face of it), there is considerable uncertainty about the counterfactual, i.e. what British life would look like outside the union.

Related: Safety ETF Plays Rally on Brexit Concerns

While it is impossible to fully discern all the ramifications of Brexit, some of which may become clear only over a decade or so, we believe it is worthwhile to try and unwrap some of the issues the UK will have to deal with.

How the UK got here

After a couple of attempts at membership in the European Economic Council (EEC) during the 1960s, both of which were vetoed down by France’s Charles DeGaulle, the UK eventually entered the club of European nations in 1973.

Membership in the EEC was in fact put to a referendum (the current Brexit vote is not the UK’s first official poll on EU membership) in 1975, and was overwhelmingly supported by 67% of the British public. However, it is important to understand that voters in 1975 were hoping that membership in the EEC would mitigate some of problems faced by the UK during that decade, such as industrial decline, union strikes, power outages and high inflation amidst the oil crisis. A different, more economically powerful Britain exists today in the minds of the public, a point we will come back to.

Related: 10 ETFs Hit the Hardest in ‘Brexit’ Fallout

Since the 1970s the UK has had an uneasy relationship with the EU. Prime Minister Margaret Thatcher negotiated a rebate on Britain’s EU contributions in 1984, making the argument that it received much less in agricultural subsidies than other members (France being the largest recipient). Yet, on February 7th 1992, UK Prime Minister John Major (also from Thatcher’s Conservative party), signed the Maastricht Treaty along with leaders of eleven other members of the European Council, essentially creating the European Union and the Euro currency (which Britain opted out of).

Related: Safety ETF Plays Rally on Brexit Concerns

Crucially, the Maastricht treaty was never put to referendum in the UK, unlike in France, where it barely passed with 51% of the vote, and in Denmark, where it took two tries. In fact, uncertainty over its ratification led to considerable turmoil in currency markets in late 1992. The UK ended up withdrawing from Europe’s common exchange rate mechanism (ERM), which sought to reduce exchange rate variability and promote monetary stability, after failing in its fight against currency speculators.

The Maastricht treaty was eventually ratified by the British parliament in 1993, but just barely so, as members of the Prime Minister’s own party rebelled and put his government in serious danger of falling. At the time, former Prime Minister Thatcher was quoted as saying that John Major had ‘put his head in the fire’ by signing the treaty.