Stuck In The Middle With Merkel? German Politics Get More Interesting

German politics will become more interesting starting this weekend. On Sunday, the largest state in the former East Germany, Saxony will hold its local election. The key issue is how does the anti-euro Alternative for Germany (AfD) do.

In May, much to the chagrin of Chancellor Merkel, the AfD garnered enough vote to secure representation in the EU Parliament. In Saxony, it actually polled better than in the country as a whole (10% vs.7%). We argued at the time that the votes for anti-EMU parties (like the AfD, but also the UKIP) cannot be taken at face value, as polls show that not all supporters were as anti-EMU as the candidates campaigning. Those parties were siphoning or channeling protest votes in general.

Saxony is a case in point. The AfD recognizes that its anti-EMU position is not playing as well in Saxony and have toned that rhetoric down. Instead, they have been emphasizing their conservative social platform instead. These issues include promoting discipline in schools, opposing using the government to empower women, resisting pressure to use gender neutral language, and rejecting forcing schools to including handicap children. It wants to strengthen protection for families and opposes efforts to ease citizenship for foreigners.

In some ways, the AfD is similar to the US Tea Party. Many of the AfD supporters appear to have been more comfortable in the major center-right parties, like the Christian Democrat Union (CDU) or the Free Democrat Party (FDP). However, the CDU did not secure a majority and hence has to govern in a coalition with Social Democrat Party (SPD). Merkel has made some concessions to the SPD on social issues, which the AfD supports do not agree with. At the same time, the FDP have imploded and did not secure enough votes to be represented in the Bundestag, the lower chamber of parliament.

The AfD then is a challenge to Merkel's right, in a similar fashion as the US Tea Party is challenge to the traditional conservative leadership of the Republican Party. A chief difference is that the Tea Party, at least up until now, has sought to capture control of the Republican Party, rather than splinter and form a new party.

The AfD needs to garner 5% of the vote in Saxony to be represented in the local government, and the recent polls suggest it will be close. Polls indicate it may get 5-7% of the popular vote. However, even if it gets the 5%, this is still a let down from how it did in the state in the EU parliament election. This should be a warning to other protest parties that the cathartic experience may not be repeated. This may also impact their negotiating position within the EU parliament.

While the election in Saxony sees a challenge to Merkel from the right, on September 14 the elections in Thuringia and Brandenburg elections will pose a challenge from the left. This is particularly true of Thuringia, the birthplace of Martin Luther, Bach and Goethe. The incumbent government is the same coalition as on the national level--CDU-SPD. However, the weaker economic performance of the state is seeing support for the former Communist party, now the Left, increase. There is an outside chance that it captures a plurality of the vote, especially if disgruntled SPD voters support it rather than casting their lot with the CDU.

Such an outcome could help influence the national politics. The Left advocates controversial programs like bank nationalization and caps on income. This is not to say such policies would be enacted by Merkel on the federal level, but they could help shape the debate.

The other state election on September 14 is in Bradenburg, which is also the home of the federal capital Berlin. It is currently governed by an SPD-Left coalition. In the 2009 election, the coalition drew 60% of the vote. Polls suggest it will not do quite as well this time, but will still garner sufficient support to remain the governing coalition.

A strong showing by SPD, Left and Greens in state elections can influence the future of German politics. The demise of the FDP is what forced Merkel and the CDU to form a coalition with the SPD after last year's election. The SPD had little choice, as well. The national leaders rejected a coalition with the Left, but it may have been more pragmatic than ideological. The combined SPD, Green, Left vote was shy of the majority needed to govern.

The next national election is in 2017. One of Merkel's critiques of her predecessor and benefactor Kohl, was that he overstayed his welcome. She had intimated, according to press reports, that she might not complete her current term, seemingly interested in a larger European role or a global role (as in UN). However, such speculation has quieted, and it is now expected that she will not only complete her current term, but stand for another. A pincer movement by her opposition, the AfD on the right and the SPD, Greens and Left on the other side, may get her to reconsider the lesson from Kohl's experience.

Lastly, while staying in the realm of politics, and looking down field a bit, recall that Lithuania will join the monetary union at the start of 2015, and this will trigger a change in the voting at the ECB. The changes will mean that the national central bank governors will not all vote at each meeting, and this includes Germany. As a German candidate, Weber, was to have been Trichet's successor before he unexpectedly resigned, a German will likely succeed Draghi. Weidmann is the obvious choice. There is some speculation that Draghi may not complete his term, perhaps becoming the next Italian president. Our European contacts do not give much credence to such speculation, but it is important for investors to know of such scenarios.