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After the Brexit Vote: Take a Deep Breath

The results of the referendum in the United Kingdom to leave the European Union have come as a shock to many, especially investors. While we have no greater insight into what the future holds, there are some things that are known.

First, the process of exiting the European Union is likely to take years. According to a briefing prepared for the European Parliament on Article 50 of the Treaty on European Union, negotiations on an exit from the EU have a two-year window which can be extended by agreement of both parties.

Announcements by several European leaders have suggested that little will change in the interim period, and they have made calls for calm and measured actions. Central banks around the world have announced support for liquidity in the banking system. Political leaders in the U.K. are planning for a smooth transition of power.

The harshest reactions are mostly in financial markets, where equity markets are initially selling off, some currencies are moving sharply, and safe havens like gold and U.S. Treasuries are rising. Yes, uncertainty has increased, but economic activity in the short term is unlikely to change dramatically.

In the U.S., economic risks associated with Brexit are relatively minor. U.S. exports to the U.K. account for about 3.8 percent of total exports, while imports from the U.K. are just 2.6 percent of U.S. total imports. Again, increased uncertainty can have an impact on business decisions such as hiring and capital investment, and declines in equity markets can have a negative impact on consumer confidence that could begin to restrain spending.  But the U.S. economy has proven quite resilient to external shocks in the past.

Longer-term, Brexit is raising doubt about the durability of the entire European Union. Some argue that it will be in the best interest of EU officials to take a harsh and punitive stance towards the U.K. during the exit negotiations, in order to discourage other countries from leaving.  That’s certainly possible but sentiment could quickly turn against such tactics if the EU is seen as a political bully intimidating countries that are pursuing the will of its people. Also, other countries around the world may see advantages to quickly creating positive relations with the newly disentangled U.K.

Overall, it is a historic event but not one that suggests the end of the world is imminent.

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