Not that the German economy has fared poorly in the past four months, but the political stalemate that has endured over that period is finally moving forward - with Chancellor Angela Merkel’s conservatives (CDU/CSU) yesterday agreeing terms for a renewed ‘grand coalition’ with Martin Schulz and the SPD. But many on both sides still oppose the pairing which in some ways seems about as unmelodious as the UK’s Clegg-Cameron-Coalition of yesteryear. So in the typical drawn-out fashion a final vote on the deal, by half a million registered SPD members, is still required and expected by the 4th of March. A rejection of the terms would likely result in at least a few more months of political uncertainty at the political and economic centre of Europe and the possibility of a snap election; not to mention the potential deposing of both Merkel and Schulz from a despondent party base.
If the 4th of March 2018 sounds like a familiar political date that is because it’s also the due date for the Italian general election - similarly expected to result in a hung parliament. There the two stand-outs are Luigi Di Maio (the new frontman for Beppe Grillo’s anti-establishment Five Star Movement) and the familiar face (but not hair!) of Silvio Berlusconi who has managed to assemble a right-wing rabble to lead both the Five Star Movement and Renzi’s centre-left alliance by 10 points. But with around 40% of votes still undecided and in our view no foreseeable leadership strong enough to tackle the over €2.2tn government debt problem which equates to 135% of GDP or €37k for every man, woman and child. So even if there isn’t a hung parliament it is likely that neither party will be capable of achieving any of the needed structural reforms.
We still see Europe’s barriers for achieving political consensus nationally, let alone across the EU, as a major downside risk to European financial markets. Typically stable economies like Germany, although continue to perform economically with record low unemployment levels and booming growth, perpetually fail to exhibit the necessary political strength or will to lead the single market, while the more minor EU member states continue to see their respective anti-establishment movements grow.
And political strength is indeed necessary if any of the imbalances that have burgeoned over the past two decades are ever to be addressed. For although the EU in aggregate may have a net creditor position there are huge imbalances that are impaired and have been exacerbated by the common currency. Of the 36 European economies we monitor 75% are net foreign debtors with fully 50% having net foreign debts greater than 50% of GDP - which we assess are at risk of being unsustainable with even minor shifts in sentiment/yields or modest periods of weak growth. It’s already taken a lot of political strength and cost a lot of popularity to tame the market effects of these imbalances and inject short term bailout funds and stabilising mechanisms. If this strength fades then so does much of the ability to sufficiently extend and maintain many of these artificial stabilisers.