Germany And The Emerging Continent

 |  Includes: EWG, FGM
by: John M. Mason

How do you win over a continent of separate countries by requiring them to do something very painful given the fact that many people on the continent despise you?

Could it be that Germany is winning this battle?

Growth on the continent was reported to be 0.3 percent in the second quarter of this year, annualized to 1.2 percent. This was led by the Germans who achieved annualized real GDP growth of 2.8 percent and France, which grew at an annualized 2.0 percent. Even Portugal increased at an annualized 4.4 percent rate.

Certainly, the continent is not "out of the woods" yet, but the string of negative growth rates of the previous six quarters has been broken. And, the future still holds many uncertainties. Most analysts expect that the further growth of the continent as a whole will be modest at best, following the experience of the United States and Japan.

The continental 12.1 percent unemployment rate is expected to remain high and will drop only slowly as any economic recovery continues.

And, there remain political problems that individual countries cannot seem to shake. The Berlusconi affair in Italy lingers after the conviction of the former "leader" of the nation was held up and a jail sentence was imposed…although not yet carried out. In Spain, there continues to be questions about whether or not the "leader" of Spain's government should hang on.

Furthermore, euro-skeptics abound. Ferdinando Giugliano, in the Financial Times, quotes from the new book by David Marsh, chair of the Official Monetary and Financial Institutions Forum, who argues against the "lack of imagination and straightforward incompetence on the part of the politicians and technocrats charged with policing the single currency." Muddle will continue, Mash is quoted as writing in his book "Europe's Deadlock," but the euro will survive even though "deadlock and discord will linger on."

German persistence, however, has been the one thing to last in the battles of the last five years or so. I have written about the German "plan" before in "Where is Europe Going? Is This the German Plan?"

In this post I argued that Germany has to lead without really leading because of the feelings that "German leadership" creates. I wrote:

"The catch twenty-two to all this seems to be that a resolution of the turmoil in Europe cannot be achieved without Germany playing 'the' major role in the solution, but that Germany cannot be too aggressive in claiming this major role.

Consequently, the financial dislocation in Europe will continue until this 'catch twenty-two' is overcome … with Germany in the driver's seat!"

Well, it seems that Germany may be emerging in the "driver's seat"; that the European continent may be recovering; and that the financial dislocation in Europe may be coming to an end.

As Yogi Berra claimed, "the battle is not over…until it is over," but there are glimmers of hope that events just might be moving in the right direction.

People still believe that the final solution must include a stronger central union of government in Europe and a central banking union that consolidates the financial system. And, there is much to do to create such unification. But, the evidence seems to be that things are moving in the right direction.

Perhaps the most important sign of what is happening in Europe is the movement of the "risk averse" funds that had left the continent over the previous five years back to the European financial markets. This movement is having a major effect on financial markets in the United States.

In my opinion, we would not see such major flows of funds with such a significant impact on interest rates without a massive improvement in confidence that Europe was moving in the right direction. Of course, attitudes could change "on a dime" but for the time being we must listen to the markets and the markets are saying that confidence is growing that Europe is on the right track.

I believe that this confidence is connected with the re-election prospects of Angela Merkel, the Chancellor of Germany since 2005. Merkel is running for a third term and the election will take place later in September of this year. Odds of re-election are running heavily in her favor.

Merkel is the strong, guiding force behind what is going on in Europe. She has been an effective leader burdened with the problem of being the "leader" of Europe without seeming to be Europe's leader. She has been strongly supportive of the "austerity" measures followed by officials within the eurozone, but has had to play down her role in this effort because of the lingering distrust and hatred of the German nation and people.

Yet, Germany has come to be more and more dominant in the European picture. And, efforts to go against the German leadership and the euro-union seem to be failing. Giugliano writes in the Financial Times piece mentioned above "the great unresolved mystery of the crisis is why no euroskeptic party has gathered sustained momentum." There have been efforts, but the parties that have been created "are not serious contenders."

If the economies of Europe continue to pick up and Merkel is re-elected, then Merkel's hand will be considerably strengthened. And, the opponents of the austerity efforts will be considerably weakened.

We will also see that some economic thinking will have to be altered. The explanations of the Keynesian "Aggregate Demand" approach will find it very hard to explain what has happened, not only in the last year or two, but also in the last fifty years. The "Supply Side" arguments will be strengthened because this approach will be able to better account for these same events. This is because the aggressive implementation of massive aggregate demand policies just create greater and greater dislocations in the economy. Supply side programs work to reduce the dislocations in the economy and tend to create more sustainable results…although they do not produce these results as quickly as politicians would like.

Even with a Merkel re-election and a strengthening European economy there is much to do. Yet, success will encourage Chancellor Merkel and the European Union to proceed along the path of re-structuring. A stronger European Union is needed. A single central banking system is needed. Business must be encouraged. Efforts to create a 21st century labor force that produces a competitive workforce is vitally necessary. And, so on and so forth.

Yet, the possibility of achieving this seems to be increasing. And, the financial markets seem to be betting on it.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.