Germany’s election was good for Angela Merkel, but leaves Europe and the euro in extreme state of uncertainty.
Merkel’s landslide victory comes with a twist as much of her party’s strength was due to voters abandoning ship from the coalition partner FDP. Thus, the election result leaves Merkel in need of forming an awkward coalition with either the SPD or the Greens.
The storyline goes that one of these coalitions will be more “EU-friendly” as the parties to the left tend to lean toward more generosity toward the EU project than Merkel. But even a “grand coalition” with the SPD if likely to be anything but grand and the greater risk from here is that Germany’s leadership in Europe risks being as weak as Merkel’s victory in the elections was strong. That’s at least in part because every EU-related decision in Germany will be a nervous exercise in calculating the effects of domestic politics within an uncomfortable coalition.
From here, Merkel is likely to try to continue the approach that has brought her relative success so far, making small concessions here and there, such as a small third bailout in Greece, to stem the risk that any individual crisis triggers a wider contagion. What we won’t see is a new overall vision for Europe.
The ongoing “Big Question for Europe” is the fundamental tension that will tear Europe apart if it is not eventually addressed: the single currency and single central bank within a multiple-sovereign union.
The EU is a house without a foundation, and such a house can’t stand forever. And a new Merkel-led coalition will not put Germany on a path toward building that foundation, it will merely see Germany continuing to send out the repairmen to plaster over the cracks that are appearing in the walls as the house continues to destabilise.
The euro last week rallied to the highest level since early this year against the dollar, as the Federal reserve shocked the world with its announcement that it would not begin to slow the rate of its asset purchases. But let’s realise that even if the Fed had slowed asset purchases, the central bank’s balance sheet would still soon mark a $1 trillion (Dh3.67 trillion) of expansion in 2013 alone.
Meanwhile, the ECB’s balance sheet has actually been shrinking around 25 per cent over the same time frame. From here, the euro only weakens if Merkel somehow commits more fully to the EU and allows a more active role for the ECB, or if we see a return of the EU break-up risk story.
Europe already risks rising tensions with this new German government, a rising euro will quickly accelerate those tensions within the EU and without and bring us quickly to the next chapter of the history of this awkward union.
The last thing Europe needs is a strong currency.
— The writer is head of foreign exchange strategy at Saxo Bank.
