Trump may end up missing Merkel more than he realizes

If ever the European and global economies needed strong and steady leadership, it has to be today. This makes Angela Merkel’s decision, following her party’s humiliating defeat in regional elections last Sunday, not to seek re-election as German chancellor in 2021 all the more regrettable.

Her pre-announced departure from the European political stage is not only bad news for Germany and Europe; it also constitutes an important setback for the global economy.

{mosads}History is likely to look favorably on Merkel’s stewardship of the European economy. Under her careful leadership, the German economic recovery from the Great Recession of 2008-2009 has matched that of the United States.

Meanwhile, during the peak of the European sovereign debt crisis in 2012, she almost single-handedly kept the eurozone together.

She did so by getting Greece, Ireland, Portugal and Spain to all agree to adopt meaningful economic reforms while also convincing a reluctant German electorate of the need to provide financial support to the European economic periphery. 

More recently, as the Trump administration has embraced an “American First” policy to international economic issues, Merkel has provided a strong and welcome voice for the maintenance of an open international economic order.

She has also got cooler heads to prevail in Europe’s ongoing difficult negotiations with the United Kingdom on its exit terms from the European Union.

The last thing that the global economy now needs is for Germany, the world’s third-largest economy, to stumble. This would seem to be especially the case at a time that global financial markets are wobbling, the world central banks are beginning to normalize their monetary policies, and China, the world’s second-largest economy, is slowing.

Sadly, it is difficult to see how, in the months ahead, Germany will avoid a prolonged period of political instability that might undermine investor confidence at home.

Indeed, it would seem that following the collapse in support for both the Christian Democratic Union and the Social Democrats at the recent regional election, the days of Germany’s Grand Coalition government are numbered.

Meanwhile, it would seem to be only a matter of time before the long knives are drawn and a bitter battle is engaged for the replacement of Merkel as chancellor.

It would also seem likely that with the rise of the far-right Alternative for Germany Party, Germany will become much more inward looking. As such, the country would be very much less likely to provide the leadership for an open international economic order that the world economy so desperately needs in the age of Trump.

Where Merkel’s strong and confident leadership is likely to be missed the most is in the handling of two existential threats that now face the European Union. The more immediate of these threats is Brexit, while the more serious of these threats is the simmering Italian budget crisis.

It’s regrettable that Merkel’s political star is waning just as the Brexit negotiations are approaching their March 2019 deadline. A weakened Merkel at this critical stage in the negotiations has to raise the chance that the United Kingdom will crash out of Europe without a deal. Should that occur, it would have serious consequences for both the United Kingdom and European economies.

More serious yet for both the European and global economies is the deepening Italian crisis. If the Greek sovereign debt crisis between 2010 and 2012 shook the European economy to its core, how much more so would a full-blown Italian debt crisis?

After all, Italy’s economy is around 10 times the size of Greece’s and, with a public debt of more than $2.5 trillion, it has the world’s third-largest sovereign debt market.

While the euro could survive if Greece were to leave, the same cannot be said of Italy, the eurozone’s third-largest economy. This has to raise the crucial question as to whether Merkel’s successor will have the political skill to defuse an Italian debt crisis.

President Trump has not hidden his dislike for Merkel and will no doubt be pleased to see her leave the international stage. However, he should be careful what he wishes for.

If the European economy were to become unstuck and suffer a banking crisis as it lost its steady hand at the helm, the U.S. economy could get hit hard. It could do so in much the same way as the European economy was shocked by the 2008 Lehman bankruptcy in the United States.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.