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Germany's political crisis is an economic sideshow

  • Forming a stable new government in Berlin is a tough venture, Michael Ivanovitch writes.
  • Four very different parties must converge on an acceptable program
  • Thanks to the European Central Bank, the euro area will do well and will offer great asset values
German Chancellor Angela Merkel, top candidate of the Christian Democratic Union Party (CDU) for the upcoming general elections, holds a vegetable during a campaign rally in Freiburg, Germany, September 18, 2017.
Kai Pfaffenbach | RT
German Chancellor Angela Merkel, top candidate of the Christian Democratic Union Party (CDU) for the upcoming general elections, holds a vegetable during a campaign rally in Freiburg, Germany, September 18, 2017.

It would be unwise to take popular talkfests and loud one-liners for negotiations to promptly form Germany's new government. Europe's largest economy is now at the beginning of one of the most difficult political processes in its post-war history.

Fortunately, barring more dramatic complications, the short-term impact of this Italian-looking imbroglio won't matter much for euro-denominated asset values. The currency is firmly in the hands of the European Central Bank, a supranational institution that is, by design, the only truly and totally independent central bank in the world.

Longer-term implications of German political instability for Europe and the monetary union are a different story. As things now stand, institutional reforms to create a euro area fiscal union, and to strengthen the coordination of structural policies, are effectively postponed sine die — a Latin phrase to say a back, very back, burner that may never light up.

That, too, doesn't matter. The EU and the euro area can function with the current degree of integration, overseen and arguably mismanaged by a sprawling European administrative infrastructure. They should probably copy the Trump administration's appointees in charge of rolling back excessive bureaucracy and throwing away their thick regulatory rule books.

Germany needs a repair job

But it would take more than Washington's newly-minted deregulation cops to straighten Europe out. The recent German elections have shown that Chancellor Angela Merkel and Finance Minister Wolfgang Schaeuble have created serious problems for Germany. They have also gravely damaged the rest of Europe by causing needless suffering and waste of the continent's human and capital resources with their austerity policies.

German analysts credit those two politicians for creating — from Christian Democratic Union defectors — Alternative for Germany (AFD), a right-wing party that went from zero votes in 2013 to 13.26 percent of seats in the lower house of the German Parliament after September elections.

As for the rest of Europe, I wonder whether Merkel and Schaeuble occasionally see pictures of hungry Greeks marching on the Syntagma Square with posters saying "We still love you Mrs. Merkel." Or the long lines of hungry Spaniards waiting for a meal at Caritas soup kitchens.

The Spanish turmoil I see on television while writing those lines is a sequel to a -0.95 percent average annual GDP growth for seven years between 2008 and 2014, an unemployment rate culminating at a shocking 26.1 percent in 2013, half of Spanish youth without jobs and a new class of working poor ("mileuristas" — people with monthly salaries of 1,000 euros or less).

Those callous policy errors, and a new constellation of political forces they created in Germany and in the rest of Europe, will make it very difficult for Berlin to form a stable government, and to reassert German influence within the EU and the monetary union.

Indeed, before looking for possible coalition partners, the center-right CDU and CSU (a Bavarian Christian Social Union) have to agree how, and on what political platform, they can maintain their partnership and a mandate to form a new government.

Traditionally tense relations between what they call the CDU-CSU "sister parties" (or, simply, "the union") have been brought to the breaking point by Merkel's CDU open door policy toward migrants and refugees, and her alleged mismanagement of east and central European security problems that have damaged Bavaria's business interests in its backyard captive markets.

What now?

Bavaria's governing CSU party got less than 39 percent of the home state vote on September 24 — about ten points less than in 2013 elections. Its leadership is now under enormous pressure to step down or move further to the right to fight the rapidly growing right-wing AfD party in next year's Bavarian state elections.

That would make it very difficult for Merkel's CDU to forge a common political program with the CSU and the left-leaning Green party. The CSU's revered late leader and former Bavarian Minister-President Franz Josef Strauss used to say that "there must be no democratically legitimate party to the right of CSU," and that "the Greens are like tomatoes; first they are green and then they turn red."

At the moment, some of Merkel's closest advisors see the coalition talks dragging well into the early months of next year.

The leaders of the German Socialist Party (SPD) have much darker forecasts. They expect that Merkel will not be able to form the next government with CSU, Greens and the Free Democratic Party (FDP). In that case, and if Merkel were to step down, SPD would be ready to create again a stable government in a grand coalition with CDU and CSU.

Meanwhile, Germany's prolonged interregnum will leave France in a state of limbo. French President Emmanuel Macron has staked his political future on painful labor market reforms, demanded by Germany, hoping that he would get Berlin's support for far-reaching EU and euro area institutional changes to placate his powerful left- and right-wing Eurosceptic opponents at home.

All Macron has to show for that so far are falling approval ratings, social unrest, massive street demonstrations, rolling strikes and unemployment rising to 5.6 million people at the end of August. And, yes, he got a vague and useless encouragement by Merkel, along with a bazooka from her putative coalition partner FDP that new layers of EU bureaucracy were not needed, and that the money of German taxpayers would not be used to bail out fiscal miscreants in southern Europe.

What now? Miffed by German hectoring, some French politicians think that France, Italy and Spain should move ahead and begin implementing Macron's proposals for "Europe's renewal."

How feasible and credible would that be?

Laboring under an unstable minority government, Madrid is struggling to keep Catalonia, one-fifth of the Spanish economy, within the Kingdom of Spain.

An estimated 41 percent of the Catalan population wants independence. Those people are unlikely to settle for more autonomy, but, under current circumstances, they cannot legally split from a unitary state. Still, the Catalan secessionist drive is a difficult sociopolitical, constitutional and moral issue, and it remains to be seen how Spain and the EU democracy lecturers to the Visegrad Group (Poland, Hungary, Czech Republic and Slovakia) will deal with that.

Italy is also an unlikely partner to support the French EU reforms. The next general elections will probably take place in May of next year. The Democratic Party is the only pro-European political formation, but it is currently polling only at about 27 percent. The real kingmakers are likely to be the three center-right Eurosceptic parties Forza Italia, Lega Nord and Fratelli d'Italia. They are getting 36 percent of the popular vote.

Investment thoughts

It will take some time to constitute Germany's new government because four very different political parties (CDU, CSU, FDP and the Greens) have to come up with a mutually acceptable and coherent policy program. "It's all up in the air," says the FDP's young leader, Christian Lindner.

But that is unlikely to derail an ECB-engineered euro area economic recovery that is now getting support from less restrictive fiscal policies, improving trade accounts and structural reforms.

Indicators of the euro zone's key economic fundamentals look good. Aggregate demand has accelerated to an annualized growth rate of 2.4 percent in the second quarter of this year. Price inflation remains well below the ECB's 2 percent medium-term target. The current account surplus in the year to July came in at a whopping $370 billion, with Germany, Italy and Spain showing large net exports of goods and services.

The ECB will probably begin to phase out some of its nonconventional stimulus measures in the next few months, but, with the core price inflation and unit labor costs growing at an annual rate of 1.2 percent, it is too early to initiate credit tightening conditions.

The euro area economy will do well, and the euro assets will remain among the most attractive investment outlets.

The EU's future? Don't bother. It will have to wait for leaders like Macron, Lindner and maybe even a nine-lives-possessing Silvio Berlusconi.

Commentary by Michael Ivanovitch, an independent analyst focusing on world economy, geopolitics and investment strategy. He 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 Business School.

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Correction: This story has been updated to reflect that the German CSU party stands for the Bavarian Christian Social Union.