The financial markets aren't afraid of Brexit – they are afraid of the incompetence of global leadership

The markets worry when European political leaders make dire warnings about Brexit, not because they believe these warnings, but because they feel this shows the leaders are frightened by change

The financial markets have been reacting to the possibility of Brexit (Getty Images)

Whatever happens in the Brexit vote next week, there has been a discomforting message from the financial markets. They have been more alarmed than reason says they should be. The particular red light that flashed most violently was the 10-year German bund yield dipping below zero. You pay money to lend to the German government for 10 years.

Yet Germany is the eurozone’s largest and most successful economy. It has even lower unemployment that the UK. The government is in fiscal surplus. And it has a huge current account surplus with the rest of the world. There must be better opportunities there for savings to earn some money. Germany may be a safe haven in a sea of troubles, but my word people must think those troubles are bad to lead to this.

The possibility of the UK leaving the European Union ought not to be a big enough issue to do real damage to the world economy. I know the Chancellor of the Exchequer and the Governor of the Bank of England have issued grave warnings, and of course those warning should be taken seriously. But the reality is that UK would continue to trade with Europe. There would be some new arrangement ensuring that. We are not in the eurozone so the euro should not be affected. We are not in Schengen so that is not affected either.

In any case, even on the worst assumptions, the loss to global GDP would be tiny. The UK is 3 per cent of global output. Let’s assume that we lose 5 per cent of GDP as a result of Brexit (an assumption that I think is far too high, given the continued decent growth notwithstanding Brexit fears). That is 0.15 per cent of the global total – barely worth thinking about.

So what is it?

The best explanation I can see is that people are frightened that there will be another global recession and that if it happens there will be nothing the authorities can do about it.

The second part of that thought must be right. The world’s treasuries and central banks are out of ammunition. The classic way to combat recession is to boost demand by fiscal and monetary policy. But increasing budget deficits isn’t practicable given public debt levels, or at least not by much. And if having near-zero interest rates for seven years has not engineered a self-sustaining recovery, what makes anyone think that negative rates might do so? Actually, many people believe that negative rates probably make things worse, though this is not the conventional central bankers’ opinion.

But what makes people think there will be a global recession? It is certainly true that the present expansion is mature. We all know that there is a business cycle and we don’t seem to be able to do much about it. So sooner or later there will be a downturn. We are seven years into the present upswing, so it would be reasonable to expect that downturn in the next two to three years. But there are several reasons to think that it won’t be particularly serious. There is little or no inflation, at least in the developed world. There is spare capacity in almost all major economies. Technology continues to advance, and we may be under-measuring the positive impact that has on living standards.

For what it is worth, each year the International Monetary Fund does a tally of the risk of recession in the next year for the major global regions. Its most recent assessment, back in April, put the probability for the US at around 22 per cent, the eurozone 34 per cent, Japan 41 per cent, and Latin America at more than 50 per cent. But for emerging Asia – China, India, Indonesia and so on – it puts the chance of recession at near zero.

Maybe investors think the outlook has deteriorated since then. But the oil price has recovered quite a bit and that would not have happened were there not decent demand for energy. Besides, even if there were to be a general downturn in the next year or so, it is hard to see it being anything like as serious as the most recent one. If history is any guide, those big recessions only come along every 50 years or so. So it is hard to see quite why the markets are in such a tizzy. Unless…

Unless it is something very simple. Investors do not trust the policy-makers. They worry that if there are more signs of a slowdown they will do the wrong thing. They worry that the present ultra-loose monetary policy is perverse. They worry when European political leaders make dire warnings about Brexit, not because they believe these warnings, but because they feel this shows the leaders are frightened by change.

This fear that the grown-ups are not behaving like grown-ups is corrosive. Whatever happens in the vote next week they will have a chance to show they can respond in a measured and competent way. This isn’t just about Brexit. It is about competence of leadership on the one hand, and confidence in that leadership on the other.