Discussing these issues in a recent Vanguard webinar were Peter Westaway, Ph.D., former official at the Bank of England, Vanguard’s chief economist for Europe, and head of our European Investment Strategy Group; and Jonathan Lemco, Ph.D., former professor of political science at Johns Hopkins University and senior investment strategist with Vanguard Investment Strategy Group. This is an edited transcript of their conversation.

What can the British expect from Brexit, and can Prime Minister Theresa May deliver it?

Peter Westaway
Peter Westaway

Peter Westaway: Most economists, myself included, think that in the long run, Brexit will cause living standards in the U.K. to fall in terms of GDP. It could be a decline of 5%, it could be 10%; we don’t know. As the government appears to be going towards a hard Brexit, it may be towards the more pessimistic end of the spectrum.

That doesn’t necessarily mean voters are going to be disappointed. The referendum wasn’t fought around GDP. It was much more around issues like sovereignty and immigration. In that respect, it may be that some degree of power will indeed be handed back to the U.K.

But as for the consequences of lower immigration, it’s difficult to say. I think about 150,000 people were coming into the U.K. before, not including E.U. migrants. The U.K. government are trying to get that down to 100,000 or less, and that’s not going to be an easy target to hit—nor will it necessarily be desirable when you think about some of the contributions those migrants make, whether they are students, high-skilled workers in the financial services industry, or low-skilled workers in the agricultural sector or the services sector. The government will be aware of these things and will be looking at ways to reduce immigration in such a way that the economy isn’t derailed.

What are your expectations for trade between the U.K. and other countries?

Peter Westaway: Brexit supporters said that withdrawing from the E.U. will allow us to be more flexible and strike up better deals with emerging markets, the U.S., Australia, and so on.

It remains to be seen whether these deals really are going to be easy to strike. It’s not going to be quick. Indeed, it’s going to take a long time before the U.K.’s relationship with the E.U. is settled, and until then, it’s going to be quite difficult for any hard deals to be struck. We might end up with the U.K. falling back on its World Trade Organization trading relationships, which are very unfavorable in the first instance.

Most economists that have looked at this say the most important determinant of successful trade is geographical opportunity, and that’s why we in the U.K. currently trade so much with the E.U.

Regarding anti-E.U. sentiment, what are your expectations for the upcoming elections in France and other European countries?

Peter Westaway: There’s no question that there’s a lot of anti-E.U. sentiment, but the big question is whether that sentiment, and those votes, will translate into actual economic power.

In France, Marine Le Pen [leader of the right-wing Front National] looks likely to get through to the final round of voting on May 7. But we’ve seen Emmanuel Macron [of the Socialists] edge into the lead; opinion polls [at the time of this event recording] suggest he could win something like 60% in the final round. Even if François Fillon [of the center-right Republicans] gets through to the final round against Le Pen, he could win by a large margin.

Of course, polls were similarly confident last year about election results in the U.S. and the U.K., and a lot of people ended up with egg on their faces. Even so, I think there’s a decent chance that Macron could become president, and far from the E.U. and the euro unraveling, we would have a very pro-E.U., reform-minded government in France, which might, in alliance with Germany, start bringing the E.U. together more closely.

Could you elaborate a bit on Marine Le Pen?

Peter Westaway: She’s far right, and hence she’s tapping to the anti-immigration sentiment we’ve been talking about. But the main reason markets are worried about Le Pen is she wants France to leave the euro and the E.U., and if that were to happen, I think the game would be up for both of those institutions.

That’s why we’re seeing spreads between French and German bonds blowing out to 70 or 80 basis points in recent weeks. It’s similar to the risk we saw at the time of the Greek debt crisis—that countries would leave the euro or the E.U. and the whole edifice would start to unravel. Most people in the market don’t think that’s going to happen, but it’s a risk people pay attention to.

In Germany, which also has a national election this year, the sentiment isn’t as evident. Is that the case?

Peter Westaway: Indeed. There is an anti-E.U. party, Alternative für Deutschland, but its support is on a much smaller scale. The interesting development in Germany has been the emergence of the center-left candidate Martin Schulz [of the Social Democratic Party], and it’s increasingly possible that he could unseat Angela Merkel [of the center-right Christian Democratic Union] as chancellor.

On the face of it, given that Mrs. Merkel has been the de facto leader of the E.U. over the last few years, this would be concerning for pro-Europeans. But at the end of the day, I think Schulz is as tied to the European project as Merkel is. I don’t think we need to place as great a significance on a change of government in Germany.

Looking more broadly, could you give an outline of the international picture? Are other countries picking up Donald Trump’s agenda?

Jonathan Lemco
Jonathan Lemco

Jonathan Lemco: Some are, in both the developed and developing worlds. I would stress that it’s not about emulating Donald Trump, per se. Some call what we’re seeing around the world a populist movement. I prefer to think of it as more a nationalist movement, whether of the right or the left.

In Europe, Italy, Poland, and Hungary are good examples. In Southeast Asia, the Philippines fits this model very nicely. In Latin America, Venezuela has a very strong nationalist movement.

From a market perspective, we should pay close attention to Mexico. It’s part of NAFTA [North American Free Trade Agreement], which is central to the trade debate. According to the early polls, the leading candidate in next year’s election is Andrés Manuel López Obrador, or AMLO, a leftist former mayor of Mexico City. He’s talking about dismantling existing NAFTA provisions, among other anti-free-market proposals. As with Mr. Trump, it’s all about a call for change.

When the existing elite lose credibility, when inequality is growing, when people have aspirations to improve their lives, yet don’t see a way to do it, when people are feeling very insecure, they seek alternatives. That’s what we’re seeing now in important parts of the world.

Let’s turn to China, where President Xi Jinping seems to be consolidating power.

Jonathan Lemco: Mr. Xi is consolidating power in a way we have not seen in many years.

But this is at a time when GDP growth in China is adequate. Quality of life for the Chinese people continues to improve. They do have serious problems starting with massive fiscal challenges, particularly private sector and bank debt issues, but broadly speaking, the economy continues to do reasonably well.

That means that they’re buying goods from all over the emerging market world as well as from developed economies like Australia and Canada. That’s good for the world economy.

Key, though, will be an upcoming meeting of China’s leaders in the next few months and the new policy proposals they bring forward. Even more important at that meeting will be the question of which rising leaders will take on the most important roles. That to us seems most unclear, and we’re watching very carefully.

What is the best response to global uncertainty for a long-term investor?

Peter Westaway: There are a couple of things that have come through very clearly over the last six to nine months in the light of these political uncertainties. First is that it is very difficult to predict how political events are going to play out. The second thing is even if you can foresee political events, it’s not always easy to predict how markets will respond. The huge rallies in the equity markets after the Brexit vote and the Trump election surprised many people.

Jonathan Lemco: One lesson international investors learn almost from day one is that there’s always going to be a civil war somewhere, an economic reversal somewhere else, or a natural disaster—an earthquake, for example, which may be a drag on a nation’s budget. There’s always something on the negative side—and indeed, on the positive side too. The markets respond to all kinds of inputs.

It’s very hard for us to predict events, and as a consequence, I do believe that it’s in the investor’s interest to stay broadly diversified, to have a long-term perspective, to keep your investing costs low. You’ve heard this from Vanguard in the past, of course, but it remains true.


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