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Merkel III: Will the euro area be third time lucky?

Alexander Hassenstein | Getty Images

During the election campaign last summer, German Social Democrats (SPD) – Chancellor Merkel's opponents and now coalition partners – were never tired of pointing out that structural reforms benefiting German economy were theirs, not hers, because they implemented them in the early part of the last decade in their so-called 'Agenda 2010.'

Some of Chancellor Merkel's euro partners also bitterly complained that she aggravated the area's financial crisis by dragging her feet on urgent issues while playing up to the German electorate.

(Read more: German SPD votes to enter 'grand coalition' with Merkel)

Well, she won. But, without any attempt to rain on her parade, both of these issues show serious tensions she will have to deal with during her next mandate.

With six (out of fourteen) important ministerial posts in the new government, the SPD apparently wants to forge a closer union of Germany's three center-left parties (SPD, Greens and the Party of the Left) – which won the majority of the votes last September – in preparation for the 2017 elections. That surely won't make it easy to steer a coalition of bitter rivals.

Chancellor Merkel's allegedly insensitive and task-masterly approach to rising poverty in the euro area – whose unemployment has increased by nearly half a million people so far this year – will also create difficulties for her in the management of the monetary union, especially if, as seems likely, a prominent SPD member were to become the president of the EU Commission in 2014.

There are already signs of such tensions. The EU Commission, for example, got enough political support from its member countries to launch an examination of Germany's excessive reliance on exports by apparently restraining its domestic demand. Germany, in fact, is being told to stop living off its euro area partners at a time when the Commission expects the country's trade surplus to remain this year close to 7 percent of the gross domestic product (GDP). That will be the eighth consecutive year of trade surpluses between 6 and 7 percent of GDP, contributing nearly one-third of German economic growth over that period.

The U.S. is also chiming in on the same topic. Last Thursday, the U.S. Treasury Secretary Jacob Lew told the House Financial Services Committee that Europe (and China) had to help rebalance global trade and capital flows. That was clearly a message to Germany, which currently accounts for 99 percent of the euro area trade surplus.

(Read more: Germany has a new government, what next?)

Get competitive and sell, stop printing money

Chancellor Merkel will probably react to that by repeating to her euro partners to improve competitiveness and sell something instead of continuing to count on printing more money. Germany, its finance ministry says, is a successful exporter because it can compete in world markets with products and services people want to buy.

But the EU Commission has a different idea. It told Germans that their 2014 budget proposal did not follow the Commission's fiscal policy recommendations, and it asked for a new budget draft to be submitted to Brussels "as soon as a new federal government takes office."

Speaking about the review of German economic policies, the EU Commissioner Olli Rehn said that by failing to stimulate its domestic demand Germany was slowing down the euro area growth and continuing to accumulate trade surpluses.

Some stimulus to domestic demand may come from the introduction of the minimum wage of 8.5 euros per hour. That will raise incomes for 15 percent of the German labor force. But there still will be a large pool of what Germans called the "working poor" during the election campaign – three-quarters of workers in a number of service sector industries, and an estimated one quarter of the labor force in part-time jobs on temporary contracts.

None of that will change. Businesses and Christian Democrats (CDU/CSU) are loudly complaining that the new minimum wage will erode German competitiveness, and that the possibility to retire at 63 (instead of 67) will drastically raise the cost of new social policies.

At the moment, however, these concerns are overshadowed by rising exports, high business confidence, 62 percent of Christian Democrats who are satisfied with the new government, and more than half of Germans who are happy with the grand coalition that will control almost 80 percent of the seats in the parliament.

All this means that there are no domestic pressures to change Germany's current economic policies – beyond the already agreed minimum wage and relatively minor adjustments in some social transfer policies. Public spending will remain tightly controlled by Wolfgang Schäuble, the finance minister, who wants to keep chipping away at Germany's large public debt of 89 percent of GDP.

(Read more: Merkel gets a mandate, but market reaction muted)

A dinner date in Paris

And, yes, Chancellor Merkel and her new Foreign Minister Frank-Walter Steinmeier will have a date in Paris next Wednesday after the new cabinet takes the oath of office, and after she makes a statement to the parliament on Tuesday about her European policy.

The trip to Paris for Germany's new leader, and a trip to Berlin for the French new leader, is a traditional ritual to show that the French-German friendship is alive and well, and that the two countries continue to work together on the European integration.

This trip is also part of the two countries' long standing practice of holding meetings to agree on the issues on EU or euro area summit agendas. Such an EU summit is scheduled for December 19-20, with two questions prominently tabled for debate – the euro area banking union and the EU defense policies.

The euro area banking union is a done deal. The European Central Bank (ECB) is even getting a new building ready to house its hugely expanding staff that will supervise and regulate some 6000 banks.

The only big question that still remains to be agreed on is the procedure of winding down insolvent financial institutions. The principles on how to do that have been accepted, but the issue still being debated is who will pay, and how, for the liabilities of these liquidations.

(Read more: Germany's coalition deal)

Germany wants every country to take care of its own, with a possible recourse to a special fund. Germany's position is apparently to keep maximum pressure on the ECB and national authorities to closely supervise the banking system in order to prevent the replay of Irish, Spanish and Cypriot financial disasters. And that is how it will be until Chancellor Merkel's trademark "step-by-step" approach leads to a different solution.

Euro area investors can feel reassured that Chancellor Merkel is back in action. Her tough love message to the rest of the euro area will remain unchanged. But I do believe that, under certain conditions, she may be willing to agree to some relief for euro area countries laboring under the rigors of ongoing fiscal adjustment.

Follow the author on Twitter @msiglobal9

Michael Ivanovitch is president of MSI Global, a New York-based economic research company. He also served as a senior economist at the OECD in Paris, international economist at the Federal Reserve Bank of New York and taught economics at Columbia.

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