A Battle Over Who Will Rule with Merkel

David Marsh, frequent AGI participant and Director and Co-chairman of the Official Monetary and Financial Institutions Forum (OMFIF), writes that the remaining week of Bundestag election campaigning will decide between a Grand or Black-Yellow Coalition. This essay appeared first as an OMFIF commentary. 

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The likelihood of a Grand Coalition between Germany’s two main parties, the Christian Democratic Party (CDU) and the Social Democratic Party (SPD), after next Sunday’s general election has increased slightly in the last few weeks. Financial markets would probably interpret this as a vote of confidence in euro rescue measures.

The election has been reduced to a battle between the SPD and the liberal Free Democrats (FDP), the current coalition partner of CDU Chancellor Angela Merkel, over who will enter a coalition with her after next Sunday. We are likely to see weeks if not months of uncertainty and volatility in German politics – and no clear-cut end to the doubts overhanging economic and monetary union (EMU).

Unpredictability is heightened by Merkel’s reputation for being a “poor finisher” in election contests. Likely confusion in Berlin will be viewed with particular concern by the Paris government, which has been hoping for a strong lead from Berlin to push EMU into a positive direction.

With her party well ahead in opinion polls, Merkel is likely to be asked by President Joachim Gauck to form a new government. Yet, whatever coalition she heads will probably be beset by disagreement and infighting. We may see Italian-style bickering over forming a new German government.

The fragmentation of German politics is likely to be confirmed. The FDP’s failure to be elected to the Bavarian parliament yesterday may increase the FDP sympathy vote in next Sunday’s poll. Under the German election system, some CDU voters could give their second vote to the FDP to ensure that the Liberals get past the Bundestag 5 percent hurdle, depriving the CDU of the votes it needs to rule in Berlin with the present coalition.

The FDP’s eclipse in Bavaria, when the Christian Social Union (CSU), Merkel’s Bavarian allies, won an absolute majority in yesterday’s regional elections, hardly strengthens pro-euro forces. The CSU’s general secretary, Alexander Dobrindt, in August 2012 accused European Central Bank president Mario Draghi of becoming a “counterfeiter” over his plan to bring down euro area interest rates through the Outright Monetary Transactions bond-buying program.

The most likely outcome of a CDU-SPD link-up in Berlin would be a rise in European stock markets and possibly, too, the euro, depending on how quickly the U.S. Federal Reserve, now deprived of the destabilizing possibility of Lawrence Summers taking over as chairman, scales back its liquidity injections.

The Social Democrats are widely seen as more accommodative on assistance for debt-laden peripheral euro members. However, the benign effect of any SPD return to a Berlin coalition should not be overestimated.

Berlin’s maneuvering room will limited by the electorate’s generally rising euro skepticism and constitutional difficulties about Germany’s financial help. So, relief for financial markets will probably be short-lived as operators realize Germany’s lack of ready solutions for Europe’s long-running deadlock.

Commentators should bear in mind one important statistic. The opinion poll gap between the combined forces of the CDU and its Bavarian CSU allies, and the SPD, has declined to around 12-13 percentage points from 15 points a few weeks ago. But the voting difference between the two main parties is still the largest since the 1957 election when Christian Democrat Chancellor Konrad Adenauer (for the first and only time in the Federal Republic’s history) won an absolute majority. If there is a Grand Coalition, it will be anything but a smooth-running alliance.

A month ago, I was predicting that Merkel was 90 percent likely to be returned as government leader after the elections on September 22. I am sticking to this forecast. Whereas I thought earlier that there was a 60 percent likelihood of a continuation of the present coalition between the Christian Democrats and the liberal FDP and only a 30 percent chance of a Grand Coalition, I now believe that the possibility of a CDU-SPD combination has risen to between 40 and 50 percent.

Chancellor Merkel, in power since 2005, is Europe’s pivotal leader. But, her power is constrained by the following factors:

• If the present CDU-FDP line-up remains in power, the Free Democrats, bolstered by their success in holding on to government office, will exploit their chances of articulating their relative skepticism about euro rescue measures. On the other hand, FDP virulence over the euro would almost certainly increase further if the party returned to the back benches in the Bundestag.

• If the SPD regains a seat in government, differences between the CDU and the SPD will be acute. Peer Steinbrück, the SPD chancellor candidate, boosted by his unexpectedly positive showing in the TV debate with Merkel two weeks ago, has said he doesn’t want a Grand Coalition – and would subject Merkel to great pressure in negotiating and implementing any coalition agreement.

• The anti-euro Alternative für Deutschland (AfD) party is still not expected to cross the 5 percent threshold needed for Bundestag representation, but it is creeping up in the opinion polls. A better-than-expected performance and an entry into the Bundestag would make a Grand Coalition more likely, but would also increase the fractiousness of the German debate on the euro.

• If the SPD and its Green ecological allies unexpectedly gained a workable majority on 22 September to form a so-called Red-Green Coalition, then Merkel would go into opposition. If this happened − only a 10 percent likelihood, I believe − both the euro and European equity markets would fall steeply. The resulting left-wing government would be unstable. A Red-Green Coalition would face much more resistance over euro assistance measures from the CDU in opposition than Merkel has had to deal with from the SPD in the past four years.

• Separate regional elections in the state of Hesse next Sunday, at the same time as the country-wide vote, will be closely watched. Opinion polls predict a knife-edge result. A defeat for the existing CDU-FDP coalition government would increase further the majority of the Social Democrats and Greens in the upper house of parliament, the Bundesrat, representing federal states – increasing legislative hurdles for a Merkel-led government in Berlin and making a Grand Coalition still more likely.

• Whatever the outcome of Sunday’s poll, controversy over euro bail-outs will be stoked up further ahead of next May’s European Parliament elections by the increasingly evident requirement of Greece, Portugal, and Ireland for more official credits next year. In addition, Greece will almost certainly need debt relief measures including a write off by official creditors and central banks to reduce its overall debt burden from present unsustainable levels.

The views expressed are those of the author(s) alone. They do not necessarily reflect the views of the American-German Institute.