Brexit: the monetarists weigh in

We are full-on tin hats mode here on Alphaville, as we pass along interesting commentary as fast as we spot it.

Two of the most prominent monetarist economists have just weighed in on Brexit, concluding that it represents a monetary shock more than, well, all the other kinds of shock.

An excerpt from Scott Sumner first:

At this point (midnight) the global economy has been hit by a negative monetary shock, one of the biggest in years. Here’s what to watch tomorrow:

1. Does the crisis show signs of spreading to the PIIGS?

2. What do the world’s central banks do, especially the ECB and the BOJ?

… If I read the fed funds futures correctly, they are now forecasting low rates for essentially forever. T-bond prices must be soaring. David Beckworth says we are a monetary superpower—well we are now a lot more super than even 3 hours ago.

I’d emphasize that this is an almost purely a monetary shock—in real terms it makes little difference whether the UK is in or out of the EU (especially in places like the US and Japan). It’s monetary. That means the ultimate effect depends ENTIRELY on how the central banks react.

And here’s David Beckworth:

Why does a strengthening dollar matter? … [The] rapid growth of what the BIS calls the ‘parallel dollar system’. This is a system of dollar loans and dollar debt securities that has emerged outside the United States.

This dollar credit to and from non-U.S. residents has tripled since 2000, while non-resident Euro and Yen financing has remained relatively stable. In fact, the dollar’s share of this non-resident credit growth has increased from 62% to 75% according to BIS data.

This means there is a lot of dollar-denominated debt outside the United States that is very vulnerable to dollar shocks. Brexit just increased the real debt burden of these borrowers.

So between tightening monetary conditions for the dollar bloc countries and increasing real debt burdens for all the non-resident issuers of dollar debt, the global economy has been hit with a large dollar shock. Put more crudely, the strong dollar noose that has been choking emerging economies since mid-2014 has now been complemented by the opening of trap door on the gallows via Brexit. This makes the strangulation of global economy complete.

We’d say the monetary shock certainly plays a role but isn’t mutually exclusive to the economic problems caused by the myriad other complexities involved.

Feel free to debate in the comments.

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