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Last call to lighten up on euro area assets

Economic, institutional and geopolitical reasons are all lined up to raise a big caution flag about investment in the European monetary union and in the rest of the EU trading bloc.

With a feeble and uncertain exit from a two-year old recession, a crippling unemployment rate of 12 percent and accelerating price deflation, the euro area – or any part of it – is no longer offering investors the promise of a sustained upturn and of cyclically-induced gains in corporate profits.

(Read more: Euro zone inflation tops forecasts, unemployment stuck at 12%)

After years of a German-imposed debilitating fiscal retrenchment – under conditions of declining demand, output and employment – the euro area is still struggling with budget deficits in excess of 3 percent of gross domestic product (GDP) and a public debt of 93 percent of GDP.

That highly damaging fiscal policy was left in abeyance only after the German Chancellor Merkel safely won her re-election last September, and after unrelenting social unrests, rising poverty and destitution forced the austerity taskmasters to finally heed an ominously deafening "basta!" (enough) from the long suffering European south.

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"Pact of Stupidity"

Yesterday's (Saturday, March 22) huge "March for Dignity" in Spain's capital Madrid was an example of such anguished calls. More than 100 people appear to have been injured as desperate Spaniards were protesting rising poverty and hopelessness. Spain's General Council of the Judiciary is reporting that last year they recorded every day some 140 forced home evictions, and the National Institute of Statistics says that each day desperation drives at least 8 people to take their own lives.

In a pointed dig at Germany, Italy's maverick Prime Minister Matteo Renzi vented the same anger when he recently said that the German enforced "Pact of Stability" (enshrining the rules of euro area's fiscal management) was in fact a "Pact of Stupidity," despite a timid rider about economic growth added to it by the French President Hollande to make France look less subservient to Berlin's diktat.

(Read more: German court says euro zone's crisis fund is legal)

Having got what it wanted, Germany, apparently, seems eager to soften its image. Ignoring and preempting the EU Commission's entirely reserved professional judgment on Italy's budget proposals, Chancellor Merkel rushed in to say last week that she was "totally impressed" by Renzi's fiscal program. Never mind that Italy's numbers and assumptions have yet to be checked and approved by fiscal experts in Brussels.

This is the economic, social and political context in which the European Central Bank (ECB) is trying to support whatever is left of the euro area's apparently shriveling "green shoots" of recovery. Sadly, its valiant efforts -- against constant and public German hectoring about imaginary inflation dangers -- are not working. The long and continuing run of austerity policies has damaged the euro area's banking system – a crucial web of financial intermediaries serving as a transmission mechanism between the monetary policy and the real economy.

That is what one can see in the latest batch of the euro area monetary statistics. Last January, for example, bank lending to the private sector saw the third consecutive month of 2.2-2.3 percent annual declines. Even the rate of growth of housing loans, hitherto the strongest part of bank lending to households, was dropping, and the lending to the corporate sector – down 2.9 percent in the year to January -- remains a seemingly unfixable disaster area.

In view of all this, it is difficult to see how a widely advocated quarter point decline in ECB's interest rates can solve what is essentially a structural problem that needs time and patient support to heal.

To make things worse, the ECB's task is not helped by an administratively monstrous compromise on the key issue of the European banking union. According to the new rules, the winding down of financial institutions the ECB might deem unviable will require literally hundreds of voting decisions at national and European levels.

Unraveling euro area

Sounds complicated? Regrettably, even bigger complications are on the way. How about Spain in three separate pieces, a resurging "Serenissima" and parts of the former Austro-Hungarian Empire changing hands?

(Read more: Germany willsend bond-buying program to European court)

This is not a Matteo Renzi or a Beppe Grillo joke. Venice (aka "La Serenissima") and the whole region of Veneto over six days of voting (ending last Friday) said "yes" with an overwhelming 89 percent majority to the question "Do you want Veneto to become and independent and sovereign republic?"

And get this: The region of Veneto consists of seven provinces, it is home to 3.8 million people, contributes more than 9 percent to Italy's GDP, public finances of its 581 provincial communities are perfectly balanced, none of its elected leaders are under any judicial investigation and 70 percent of its inhabitants speak the Venetian dialect.

The road to independence will be long and hard, but the people of Veneto are unlikely to give up. They have been working on this for many years, and the latest financial crisis has apparently convinced them that they would be better off going back to what they had been for more than 1,000 years, until the French Emperor Napoleon abolished the Republic of Venice in 1797.

The financial crisis also exacerbated Catalonia's long-standing quest for independence from Spain. The Autonomous Community of Catalonia has 7.6 million people and produces a quarter of the Spanish GDP. This is a strong and homogeneous region, with its own historical, cultural and linguistic identity.

During the elections in November 2012, Catalonian parties advocating independence came out victorious. They have now scheduled a referendum to separate from Spain on November 9, 2014. Madrid considers that public consultation unconstitutional and vows not to allow it.

Spain's Basque region, which recently renounced its long armed struggle for independence, is certain to follow.

Italy's Alto Adige (South Tyrol) is also a restless part of the country. The vanishing Austro-Hungarian Empire lost it to Italy at the end of WWI in 1919. This is Italy's richest province. The German is spoken by nearly two-thirds of the population, and there are long-running tensions because some of the province's leaders want it to become part of Austria.

(Read more: EU stocks could top highs, despite week's decline)

Belgium has been in a slow-motion disintegration for quite some time, with the richer Flanders region battling to separate from Wallonia. The Flemish nationalists won the last elections in 2012, and a question of referendum about the future of the country is likely to flare-up again after the next elections on May 25, 2014.

Outside the euro area, the referendum for the independence of Scotland is scheduled for September 18, 2014. According to the latest opinion polls, the "yes" vote is gaining ground.

Investment implications

While one can easily dismiss the talk of independence for Corsica, Provence, Savoy, Brittany and Alsace – all parts of France –new independent and sovereign states on the current territories of Spain, Belgium, Great Britain and maybe Italy are real possibilities.

These processes are currently under way. They will all be very destabilizing and will pose serious political, economic, security and institutional problems for the euro area and for the EU as a whole.

And then there are extremely dangerous sanctions games going on between the EU and Russia. Solutions to issues opposing these two large economic systems are nowhere in sight. As things now stand, the situation will probably get much worse.

The upshot is that, barring an unlikely bilateral climb down, Russia's large EU trading partners, such as Germany, will be particularly hard hit.

(Read more: ECB ready to fight deflation, keeps eye on euro: Draghi)

All this means that investors would be well advised to think about huge risks inherent in any European assets. The future of the euro area and of the EU as a whole looks bleak and uncertain as a result of unforgivable economic mismanagement and political myopia born of nationalistic infighting and a lack of vision of a common European destiny. Perhaps fittingly, in the year marking the centenary of WWI – Europe's greatest slaughter the humanity has ever known – this continent is showing again that bile and enduring hatreds are no substitute for wise statecraft and empathy.

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.

Follow the author on Twitter @msiglobal9

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