The U.S. fiscal cliff has been avoided -- at least for now -- and international attention is soon likely to shift back to the Eurozone crisis, which dominated the global agenda for most of 2012. In particular, all eyes will be on Germany and its leader Chancellor Angela Merkel, who was recently ranked by Forbes magazine as the world's #2 most powerful politician (behind President Obama) for being "the backbone of the 27-member European Union" and the one individual who "carries the fate of the Euro on her shoulders."
Merkel's strategy to preserve the current Eurozone -- in essence by offering German bail-out funds to the likes of Greece and Italy in return for tight fiscal discipline and structural reforms to boost competitiveness -- might soon be sorely tested. Greece, for example, could easily blow up as the popular backlash against new austerity measures reaches a tipping point and causes Athens to renege on its reform commitments. And after the Italian general elections scheduled for late February, Merkel's new counterpart in Rome may well be Silvio Berlusconi, a man who is strongly opposed to the Chancellor's handling of the Eurozone crisis and has publicly denounced Germany as a "hegemonic" dictator.
If things turn really ugly along the Eurozone's southern flank, Merkel will have to decide whether to draw a red line and withhold future German financial support (thus making, for example, a Greek default and Euro exit inevitable) or whether she wants to cave in and throw more good money after bad in another last-ditch effort to keep the Eurozone intact and limit global financial contagion.
If Merkel pursues option 1 ("Eurozone break-up"), Germany's export-dependent economy and stellar employment figures would be hard hit as the world's biggest economic bloc risks dragging the rest of the globe back into recession. With option 2 ("handing out blank checks"), the Chancellor is bound to provoke a tough backlash from her countrymen. Despite enjoying the somewhat questionable reputation of being the most patient taxpayers in the world, Germans may finally realize that they are vulnerable to massive losses of wealth resulting from Berlin-backed Euro rescue packages that are never going to be repaid and, ultimately, a sharp spike in German inflation triggered by the eventual demise of the Euro and rebirth of some type of Deutschmark currency.
For Merkel, matters are made more complicated by the fact that Germany will hold a string of crucial elections this year, beginning with regional elections first in Lower Saxony on January 20th and then, in September, in Bavaria as well as general Bundestag elections to be held that same month. For sure, the Chancellor's personal approval ratings remain well above 50 percent and opinion polls indicate that her conservative CDU/CSU parties have now surged past the 40-percent mark. The problem, however, lies in the weakness of Merkel's FDP coalition partner. The pro-business FDP, while still part of the governing center-right coalitions in Berlin, Lower Saxony, and Bavaria, is now polling at around four percent - below the five-percent minimum threshold required to even re-enter parliament, let alone form a future government.
There is a distinct possibility that the opposition SPD and Green parties will return to power in Lower Saxony in two weeks' time, marking what they hope will be the beginning of the end of the CDU/CSU-FDP coalition that has ruled Germany since the Fall of 2009. If the FDP loses in Lower Saxony, the days of Philipp Roessler, who now serves as Party Chairman as well as German Vice Chancellor and Economics Minister, are likely to be numbered. But even under a stronger, charismatic, and more disciplined leader, the FDP would still be at risk of being marginalized in German politics for years to come.
That being said, it would be a huge mistake to bet against Merkel, who remains the odds-on favorite to retain her post after the next Bundestag elections, albeit as head of a different coalition government. The Chancellor is way more popular than her key opposition challenger, outspoken yet gaffe-prone former SPD finance minister Peer Steinbrueck, whose party is now only polling at 29 percent nation-wide -- not enough to form a coalition with the Greens (12 percent).
That leaves essentially two other options: First, a re-launch of the CDU/CSU-SPD "Grand Coalition" that ruled Germany during 2005-2009. Such a coalition is not only deemed by political analysts to be the most likely outcome of the Bundestag elections in September; it is also the kind of government that a majority (52 percent) of German voters would prefer to see in office. The second, though less probable, option is a CDU/CSU alliance with the Greens. For the conservatives, joining forces with the Greens would open up precious new political space as their coalition options would no longer be limited to a disappearing FDP (or a weakened SPD for that matter). Even CSU Chairman Horst Seehofer, who used to be categorically opposed to any coalition with the Greens, just last week alluded to that very possibility in case the FDP is no longer in a position to be part of the next government.
In the meantime, Chancellor Merkel's strategy is to muddle through in the hopes that the Eurozone crisis does not blow up in her face before the elections. In last week's televised New Year's address, Merkel already called on her fellow citizens to show "courage" since "the economic environment next year will not be easier, but more difficult" and because the European sovereign debt crisis "is far from over."