Brexit would expose Germany's vulnerable underbelly...but it's the best outcome

Paul Gambles, Co-Founder of MBMG Group and an advisory board member of IDEA Economics.

Imagine this week that the exit vote prevails, the U.K. government stands down and in a ripple effect not seen in Europe since the fall of the Berlin Wall, the immediate dissolution of the EU is announced and there is a return to national currencies.

Equities would plunge and trading in the euro currency would be suspended. European bourses would go into free-fall, continuing even after the U.K., the U.S. and others initially appear to stabilize. Each country's no longer fungible euro would be converted into national currencies and chaos would reign until many EU national governments bail out banks.

The uncertainty caused would puncture China's debt bubble, hitting emerging and developed markets. After a few years of global pain, by 2018 to 2020 peripheral Europe, the U.K., the U.S. and 'healthier" emerging economies might begin to recover. Recovery in Germany and China, however, may take far longer.

I don’t think Brexit will affect Russia: FinMin
I don’t think Brexit will affect Russia: FinMin
Brexit market risks
Brexit market risks

Until now Germany has successfully re-imposed the costs of the reckless euro borrowing spree on debtor banks, individuals, corporations and even governments. A break-up of either the euro or the EU would expose German banks' vulnerable underbellies, having effectively underwritten the euro project in exchange for German control over sovereign budgets.

Sounds scary? In my view, this would be the best long term outcome. However, it's extremely unlikely to happen. Either U.K. voters will decide to remain or, if the leave campaign wins, the U.K. government and Eurocrats will desperately cling on to power. This may delay the collapse but would leave a far more painful journey with a much more severe conclusion ahead.

If the U.K. remains, the world won't immediately change dramatically for the worse. In fact, capital markets will likely be reassured. However, markets' abilities to infer long-term movements are notoriously poor and generally discount heavily in the face of uncertainty or change (i.e. panic) but tend to underestimate gradually accumulating risks under their noses.

But in the long term...

Most of the popular rhetoric of the referendum campaign has been wrong (on both sides). There are structural dangers that aren't widely understood or reported. GDP (gross domestic product) growth in the EU has been weak for much longer than we might care to remember.

We don't know what the European growth story would have been without the EU but we do know that almost every other major region outperformed the feeble European Union. The data suggest that the EU may have in fact hindered trade and exacerbated the challenges for the old world, rather than spurring a successful single market that is one of the many prevailing EU myths. Just like U.K. Prime Minister David Cameron's four EU pillars that he outlined in January at Davos.

Cameron spoke of the EU's competitiveness, but ignored its structural inefficiencies; he called for a multi-currency trading zone, not realizing that this creates policy conflicts between the majority inside and the minority of EU members outside the euro zone. Cameron spoke of defending sovereignty while ignoring the push towards closer political union and he criticized EU immigration policy while extolling the benefits of freedom of movement of people.

If Brexit happens, this could happen...
If Brexit happens, this could happen...
Brexit's impact on US markets
Brexit's impact on US markets

Of all these the sovereignty issue is the most worrying. The EU represents "Zollverein 2.0", the original 19th century customs union led to German unification under Prussian militarism at the expense of the very existence of kingdoms like Bavaria and many other principalities.

This is what the EU has become – a central power that is now so much more powerful than the others that it can ride roughshod over them, especially since the influence of the EU's second-largest economy has been totally marginalized following its decision not to abandon sterling and join the disastrous project euro.

The EU has already facilitated the destruction of private and sovereign balance sheets with reckless levels of record debt that can never be repaid. This is why leaving now will precipitate a global economic drama. It's also why remaining in a collapsing tower of bad debt will guarantee a far worse economic outcome and catastrophic confrontations between Europe's ever narrowing core and ever widening periphery.

This may well be now or never – in a sense, we are all Bavarians now!

Paul Gambles is Co-Founder of MBMG Group and an advisory board member of IDEA Economics.