When a global reserve currency loses 5 per cent of its value over the space of two weeks, the markets are clearly spooked, but in the case of sterling, you wonder if the really scary movie may be playing in a different theatre.
Over the past two weeks, currency traders have been dumping British pounds as dissent erupted in Prime Minister David Cameron's cabinet over the terms he agreed for the U.K.'s continuing membership of the EU. Even old friends and political allies, London Mayor Boris Johnson and Justice Minister Michael Gove are publicly sharpening knives, and the prospect of a so-called Brexit is being seen by some hedge funds as a British black swan event.
Up until now most pundits, pollsters, bookmakers and forecasters had assumed the British would heed the establishment advice of big business and grudgingly vote to stay. Brexit is a leap into the dark or the deep blue Atlantic Ocean; to quit a free-trade zone that accounts for 45 per cent of U.K. exports is a huge risk that could have job and investment consequences, say the "innies." The "outies" argue that Britain could always do a free-trade deal like Norway or Switzerland. A divorce settlement between Europe and its second largest economy would be difficult if not downright acrimonious; we know even without deep analysis that every one of the 27 remaining member states would indulge in its little moment of spite or large act of revenge. Could London expect to retain its near monopoly on trading in euros, European financial futures or sovereign bonds post-Brexit?
For a hedge fund, it's an easy call to short the pound on political uncertainty over the risk of a detached and isolated Britain. However, it ignores the much bigger and more frightening prospect of a European Union shorn of its most dynamic and fastest growing economy and of its financial centre. As France remains stuck in its centralized, socialist quagmire, the U.K. has become Europe's second largest economy and at current rates of growth could surpass Germany by 2030. The U.K. plays a huge role in attracting inward investment into Europe, through the City, its legal and financial institutions based on the English language, and the English Common Law judicial system.
Britain's EU bill, a major bugbear for the Brexit lobby, is often exaggerated but is not insignificant, about €12-billion ($22.7-billion), of which it gets half back in the form of farm subsidies and regional grants. Britain's net share of the cost of running the EU would have to be shared out among the stronger economies, including Germany, the Netherlands and the Nordic states, worsening voter resentment in those countries of the begging bowl held out by the Mediterranean and Balkan states.
But the real risk for Europe in a Brexit is that the union dissolves from the exposure of its internal contradictions. The loss of a powerful voice from a prosperous and politically stable society will expose the dysfunctional and ideologically tendentious politics of the EU. Over the past few years, two fundamental pillars of the EU have been shown to be built on quicksand: the euro, which has only survived thanks to an open-ended financial guarantee from Germany, and the Schengen agreement on borderless travel that is already defunct as core EU states, including Austria, Denmark and Sweden establish "temporary" border controls to halt the flow of migrants. It is a coincidence that has not gone unnoticed that the U.K. opted out of both the single currency and Schengen.
Loss of the U.K.'s influence could be "truly devastating" for the EU, says the chief economist of Deutsche Bank, David Folkers-Landau, who points to the critical relationship between the EU's founder nations, France and Germany, into which the British brought checks and balances. Without the U.K.'s cosmopolitan influence, the Franco-German relationship, a 20th-century psychodrama of passive aggression and political blackmail, will once again dominate the EU political discourse, making it ever more insular, inward-looking and resistant to change.
Perhaps the best reason for a short-seller to take a good look at the euro is to consider who else in Europe longs for Brexit. Step forward, Marine Le Pen, the leader of France's National Front party who would like to hold a referendum in France on EU membership. Nationalist, euroskeptic politicians in the Netherlands, Finland, Italy, Austria, the Czech Republic and Germany are watching events in Britain with great interest.
Carl Mortished is a Canadian financial journalist based in London.