The Pound Is A Long-Term Opportunity

| About: CurrencyShares British (FXB)

Summary

The market is assuming the British economy will not be able to survive the uncertainty and process of Brexit.

The pound has fallen a great deal. Should the British economy not fail, it should recover.

Brexit does not necessarily mean doom and gloom for the British economy.

Consider a long-term position in FXB and GBB once the Tory leadership contest ends and negotiations begin.

Now that we have all had the time to assimilate that the United Kingdom has indeed voted to leave the European Union, we should take time to recognize what the future possibilities are. For starters, the U.K. is still a part of the European Union. It has yet to invoke Article 50 of the Lisbon treaty, and the countdown to official exit does not begin until the UK officially does so. When the referendum ended up on the "Leave" side markets plummeted worldwide, and have since enjoyed a relief rally and an increase in volatility. While we will no doubt have to live with increased volatility for some time, since no one knows what the end result of a smaller European Union and a standalone Britain looks like, it will both be impossible for markets (at least in the UK and Europe) to crash endlessly or shake off the result of the referendum. British voters have essentially created a superstate (like Schrodinger's cat, not a supranational state). There is a chance that Britain remains a part of the European Economic Area, and a chance that it reverts to total isolationism, and everything in between. While the decision to work for either goal is currently up to the British people, a great deal of external influences may affect their decision and their ability to carry it out. The result will have long-lasting implications on economic growth in the region and on the British pound (FXB, GBB).

The "Remain" campaign tried to capitalize on the importance of staying in the European Union in order to minimize economic uncertainty, and maintaining accessing to the single market. Voting "Leave," according to the "Bremainers," would lead to economic and political disaster. David Cameron, in his last speech before the referendum, said this:

Britain is better off inside the EU than out on our own. At the heart of that is the Single Market - 500 million customers on our doorstep... a source of so many jobs, so much trade, and such a wealth of opportunity for our young people. Leaving the EU would put all of that at risk.

Additionally, the remain campaign tried to portray staying in the EU as the way to keep Britain open to the outside world, to immigration and trade. All things that are crucial for growth. Now that the UK will leave, it seems Britain will become isolated, closed off from the single market, and less dynamic.

On the other hand, Boris Johnson, a lead Brexit campaigner, described a future where Britain would become more open to the world post-Brexit. He would like more skilled immigration, closer trade ties with the rest of the world (and not have to wait for the rest of Europe to close a deal), and the development of a British economy that is considerably more productive and dynamic than the rest of the old continent or their former selves. His post-Brexit speech, I think, exemplified what he was fighting for by campaigning for "Leave." He had a few quotes that I think people (and markets) have overlooked when considering where the UK is going. The first had to do with what the UK's relationship with Europe should be going forward:

We cannot turn our backs on Europe. We are part of Europe, our children and our grandchildren will continue to have a wonderful future as Europeans, traveling to the continent, understanding the languages and the cultures that make up our common European civilization, continuing to interact with the peoples of other countries in a way that is open and friendly and outward-looking. And I want to reassure everyone Britain will continue to be a great European power, leading discussions on defence and foreign policy and the work that goes on to make our world safer.

Another very important quote I would like to highlight would be Boris Johnson's view on immigration:

We have a glorious opportunity, to pass our laws and set our taxes entirely according to the needs of the U.K., we can control our borders in a way that is not discriminatory but fair and balanced and take the wind out of the sails of the extremists and those who would play politics with immigration.

There is a possibility that the UK is forced into a bit of isolationism because of the geopolitical necessities of the other European Union members. While I don't think this is likely, it has been hinted at by some heads of state, such as Francoise Hollande's famous comment about the "consequences" for the UK should they vote to leave.

The more interesting, and I believe a likely scenario would be for the United Kingdom to pursue a very open trade policy, both with Europe and the rest of the world, and succeed. It will attempt to stay as close to Europe as possible, and above all else, attempt to preserve access to the single market. But it will also attempt to sign or join free trade agreements with the rest of the world rather quickly. Several critics of Brexit, among them The Economist, have pointed out that the UK is not ready for trade negotiations. While it has relied on the EU to do this for the last forty or so years, the United Kingdom should be able to put a team together (or several) considering the prevalence of English common law around the world and the large commercial interest at stake. More importantly, the United Kingdom would not need to necessarily negotiate all of its new trading relationships. It could join "open platforms" such as the TPP (under Article 30). The TPP alone would give it more open access to 40% of the world's economy. It is not unheard of that Europe would allow this. Broadly speaking, Europe has this arrangement with Switzerland. It basically has access to the Common Market, but does not have to pay into the EU budget and can negotiate FTAs with other countries (it does have to accept freedom of movement, however).

As for how other countries would react to a more open UK, it is hard to see countries of the TPP saying no to the United Kingdom. Additionally, events in Europe - from the rise of euro-skepticism, to a weakened financial system, to a renewed euro crisis - could all strengthen the UK's hand and force Europe into concessions. There are geopolitical reasons for trying to punish the UK, but there are plenty of commercial reasons to attempt to have as much free trade as possible. As for countries in the TPP, it would be hard to see countries in the commonwealth (Australia, New Zealand, Canada, and Singapore) or the USA raising any objections to the UK's membership. Additionally, most, if not all, of the other members should be excited to have the UK join, given Britain's trade deficit will be an opportunity. Furthermore, most local industries will not be threatened by UK competition, at least not any more than by American, Canadian, or Japanese firms.

Should the UK be able to pursue a more open trade policy and reach deals while preserving some access to Europe, the devaluation of the pound in recent weeks will reverse. The development of a more dynamic economy subject to more foreign competition will lead to higher growth over the long term, not to mention allow the UK to shake off the disinflationary pressures of the recent shock. Given how the market is anticipating the worst possible outcome, it only makes sense to keep in mind that it is not the only outcome, and that this means there is considerable upside for the pound overall, particularly as the current shock subsides after a few months, as well as British indices.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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