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Time for bottom fishing in the euro area?

John MacDougall | AFP | Getty Images

By taking the euro area stocks down 2.9 percent in the course of last Friday's trading, markets may be signaling that recessionary and stagnant economies have set the stage for unsettling political developments throughout the monetary union.

There is no safe harbor left in that troubled region.

Even Germany is moving toward the eye of the storm. When you see the German Chancellor Merkel's blistering attack on its coalition partners – the Social Democrats – for having formed the government in the federal state of Thuringia with the far Left Party (Die Linke) and the Greens, you know that German political stability is gone. In fact, she sounded like she was actively searching for a new partner when, in the same speech last Tuesday (December 9), she invited the Greens (polling at 11 percent) to cooperate with her center-right party CDU/CSU (polling at 41 percent).

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Germany's current governing coalition is at odds about euro area economic policies and the economic fallout from sanctions against Russia. More generally, it seems, Chancellor Merkel's hostile policies toward Russia have opened ominous differences on issues of European security. It looks like a perfect deal breaker may be in the offing.

And then there is Germany's deteriorating relationship with France. Invectives and name calling are flying across the Rhine, and things are seriously amiss at the highest political level. For example, in response to Chancellor Merkel's repeated criticisms of France's failure to meet budget deficit targets and to implement structural reforms, the French Prime Minister Valls is saying that France is doing its reforms for its own needs rather than to please foreign governments. In other words, what France is doing, or not doing, is none of Germany's business.

That is the sorry state of the French-German couple – the stalled engine of European integration.

Things will probably get worse because the highly unpopular French government is squeezed by political forces from left and right urging more assertive economic and foreign policies. They see Germany as a hegemon dictating the proceedings to the rest of Europe. The French left is in disarray, but the rightwing parties are regrouping around a distinctly nationalistic agenda largely set by the strengthening far-right Front National (FN) -- which is bristling at German hectoring.

"Dozing on a volcano"

German relations with Italy are also characterized by frictions about structural reforms and fiscal consolidation. Struggling with a recessionary economy, a record-high unemployment rate of 13.2 percent (with youth unemployment at 44 percent), and a first-ever general strike last Friday by two of the country's largest trade unions against a center-left government, Italy's labor market reforms and fiscal policies are hostages to the notoriously slow and complicated political process.

Some progress on both issues is being made, though. And, without naming names, Italy's finance minister is complaining that these efforts are not being acknowledged (presumably by Germany). But there is much less discretion about that on the part of Italy's political leaders the government has to depend on to implement these reforms. A number of them are regularly venting strident anti-German statements and demagogic calls for Italy to leave the euro area.

Spain's fast-growing radical left movement Podemos (We can) is also drawing strength from hostility to devastating socio-economic effects of austerity policies advocated by Germany. Currently polling at close to 30 percent, Podemos is becoming a serious contender in next year's general elections. This unprecedented political formation is feeding on a 24 percent unemployment rate, more than half of unemployed youth and nearly one-third of the working poor – "mileuristas" earning about €1,000.00 per month.

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Greece's apparently more virulent radical left party – Syriza – has a popular support of 25.5 percent, slightly ahead of the governing center-right New Democracy Party's 22.7 percent. The poll, conducted by Kapa Research and published today (Sunday, December 14) by To Vima newspaper, also shows that the Greek Socialist Party (PASOK), the country's third-largest, polled at 6.7 percent.

If, as seems likely, the next Greek president cannot be elected by the parliament in the three rounds of ballots, starting next Wednesday (December 17) and ending on December 29, the Prime Minister Samaras seems inclined to call an election rather than align himself with Syriza.

But regardless of how this situation plays out, Syriza has enough political clout to complicate Greece's painful economic adjustment by continuing to rail against austerity policies.

And what is Germany saying to all this?

The answer is – nothing. As its famous philosopher Jürgen Habermas says, Germany is "dozing on a volcano" as it continues to maintain its strong advocacy of austerity and reforms. Berlin is not ready to accept – and realize -- that needlessly harsh programs of fiscal consolidation in a number of euro area countries have given rise to political forces resisting rising unemployment, poverty, destruction of basic welfare services and increasing debt generated by recessions and falling tax revenues.

Taking stubbornness for statesmanship, Germany continues to insist that euro area budget deficit rules must be respected, and that structural reforms must be implemented regardless of their depressive short-term effects and an overwhelming popular rejection. Berlin even goes further by trying to obstruct the monetary policy of the European Central Bank (ECB), based on the idea that low interest rates will remove the adjustment discipline of its euro partners.

Investment thoughts

Something, obviously, has to give. And here is my guess.

German-imposed austerity policies have been dying hard of their natural and thoroughly predictable death.

Several euro area countries are clawing back some of their imprudently ceded fiscal sovereignty. They are now setting up their own politically sustainable programs of structural reforms. France, for example, is offering what might be a reasonable balance of growth, fiscal adjustment and broad market and welfare reforms. Other countries will follow.

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The ECB's supportive policies will continue, but that won't include unnecessarily massive asset purchases. There is plenty of liquidity. Bank lending to the private sector is making some progress.

The euro area equity market is oversold on fears of political instability triggered by a lackluster growth outlook. Interestingly, Germany got hit very hard: its blue-chips were top losers in last Friday's dramatic selloff.

Bottom fishing anyone?

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.