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The Oktoberfest Hangover Comes Early

On Monday, Germany awoke with a massive hangover - not, as it were, caused by the beginning of Oktoberfest last weekend, but rather the result of its national election which, for the first time since World War II failed to immediately produce a clear, stable ruling majority. Instead, the country was thrown into political chaos as both Chancellor Schroeder and Ms. Merkel, head of the opposition Christian Democratic party, claimed victory and now scramble to form a coalition government.

When Chancellor Schroeder called for early elections back in May, public opinion in favor of Ms. Merkel was a resounding 20 points ahead of that for the beleaguered Mr. Schroeder. Prior to Sunday's election, the chancellor had gained ground but all major opinion polls still showed Ms. Merkel's CDU party - combined with its sister party the CSU - leading Chancellor Schroeder's SPD party comfortably by 42% to 34%.

As results began to trickle in, however, it was clear that support for Ms. Merkel was not as strong as the polls had suggested. Instead of receiving a clear mandate from the German electorate, the CDU barely managed to squeak past the resurgent Chancellor Schroeder and his Social Democrats by a mere 0.9%, capturing 35.2% of the vote compared to 34.3%.

Voters fear winds of change

Last minute heroics are nothing new for Chancellor Schroeder, who earned the moniker "Comeback Kid" during the 2002 election when he rallied from behind to defeat Edmund Stoiber following a strong campaign against the war in Iraq and helped by public approval of his handling of the devastating floods that ravaged the country.

Although Germany experienced contracting economic growth during the 2002 campaign, as the chart below illustrates, much of the rest of the world was also slowing down. More importantly for the chancellor, however, was the fact that the unemployment rate was below 10% as Mr. Schroeder had pledged to reduce Germany's historically high rate of unemployment, which had become a chronic problem.

But what makes Chancellor Schroeder's latest resurgence in this year's election all the more remarkable is his ability to come within a hair's breadth of obtaining the majority of the votes despite stagnant economic growth and post-war record high unemployment, which hit 5 million earlier this year, well above his 1998 election pledge to cut it below 3.5 million. This very fact says less about Chancellor Schroeder's charisma and more about the German voter's resistance to change.

Despite the numerous gaffes made by Ms. Merkel on the campaign trail, which include confusing gross wages with net wages, and the fuss about the tax ideology of Paul Kirchhof, her shadow finance minister, the real reason the CDU failed to capture enough support has more to do with its campaign of aggressive reforms, including a 2% increase in the VAT and making it easier for firms to hire and fire employees.

As Chancellor Schroeder is well aware himself, when pushing through his Agenda 2010 package of labor and social reforms, Germans do not take kindly to reform. Just as Mr. Schroeder's measures were needed to help reduce the burden on the German economy by its generous welfare system, so too are Ms. Merkel's ideas vital for the future economic success of Germany. If Ms. Merkel is guilty of anything during this campaign it is that she may have been too honest and forthcoming with the voters about the tough measures needed to put Germany back on track.

Let the games begin

So where do we go from here? Under German law, the political parties have 30 days following the election in which to form a government and offer up a candidate for President Koehler to nominate as chancellor, who is then voted on by the lower house of parliament, or Bundestag.

Setting aside any political repercussions of the delayed October 2 vote in Dresden, the current situation is such that no natural coalition has sufficient votes to secure a ruling majority, with the CDU- FDP alliance holding 45% and the current governing coalition between the SPD and Green party mustering only 42.4%. Instead, a host of unnatural coalitions have been discussed, with the four main options - and their respective level of support - represented in the chart below.

The coalition that is the most discussed - and feared within the business community - is a "grand coalition" between the CDU and the SPD. This also happens to be the only coalition of the four that has actually been tried, with Kurt Georg Kiesinger heading up a rather unremarkable CDU-SPD government during the late 1960's.

Although the formation of a grand coalition seemed the most obvious choice before the election, the fact that the CDU/CSU ticket failed to post a resounding victory over the SPD has opened the door for Mr. Schroeder to claim the throne for himself, arguing that only he could lead a stable government. Indeed, Mr. Müntefering, the SPD party chief, added further fuel to the fire by arguing that a grand coalition lead by Ms. Merkel would be "unthinkable."

With Ms. Merkel's image tarnished after the poor election results, there was speculation that division within her own party concerning her right to rule could lead the way for a grand coalition headed up by Mr. Schroeder. However, this notion was quickly squashed when she was re-elected yesterday as the head of the CDU/CSU with 98.6% of the vote, thus strengthening her grip on the party.

Looking ahead to the October 2 election in Dresden reveals the possibility that negotiations between the two sides could become even more protracted. Currently, the CDU/CSU has 225 seats in the Bundestag compared to 222 seats for the SPD. However, a total of three seats are up for grabs in Dresden and if the SPD were to win all three (although at the moment this looks to be highly unlikely), both parties would have an equal number of seats and, therefore, an equal claim to select the next chancellor.

Because of this impasse, both Chancellor Schroeder and Ms. Merkel have been forced to seek out an alternative to the grand coalition - the most promising of which would be a " Jamaica" coalition (named for the colors of its flag) between the CDU, FDP and Green party.

Although on the surface this might seem to be an odd match between left-wing environmentalists and right-wing conservatives, there is a surprising amount of common ground when it comes to economic policy issues with both sides favoring free, open markets. The main sticking points between the two extremes consist of shutting down the country's nuclear power plants, the protection of workers' rights against dismissal and Turkey's place within the EU.

Despite these differences, there is some hope that a deal might be struck. Even though many Green party officials remain skeptical of the alliance, citing concerns about the CDU's "cold" social policies, they still remain open to the idea and will at least listen to possible proposals from CDU officials. Of course, if the Green party does join forces with the CDU- FDP coalition, they would do so without Joschka Fischer, the party's most visible and popular member, who said he would not join the coalition, opting instead to remove himself from politics all together.

While the possibility of a Jamaica coalition seems like a long-shot at best, the notion that the current governing coalition between the SPD and Green party could lure the FDP into a "traffic light" coalition seems to have been shot down before it even got started.

FDP party leader, Guido Westerwelle, has already categorically ruled out the possibility of joining forces with Chancellor Schroeder, citing the fact that the Free Democrats core ambition to completely overhaul Germany's tax system and allow companies to more easily hire and fire stands in stark contrast with those policies of the SPD. Despite repeated attempts by SPD party officials to change Mr. Westerwelle's mind and entice him to join together the interests of both employees and employers, it appears that the lights may already be out at this intersection.

The last possible coalition - one that unites the SPD and Green party with the newly formed Left party - is perhaps the most improbable, especially given the fact that Oskar Lafontaine, the Left party's star candidate, is considered persona non grata within SPD circles following his brief stint as Finance Minister during Chancellor Schroeder's first term. In fact, all major parties, including the SPD and Greens have publicly ruled out the possibility of governing with the Left party.

Thus, with no clear coalition available, the likelihood of any nominee put forth by President Koehler obtaining a majority seems rather remote. The president could install a minority government, but this makes little sense given the fact that neither the CDU nor the SPD would have enough votes to push legislation through parliament, rendering the government virtually useless. Therefore, the president may be forced to dissolve parliament and call for fresh elections.

Take two (elections), and call me in the morning

Although another election may seem like a drastic step, it may be the only viable solution available to restore stability to German politics and, when you consider the alternatives proffered up, it may be the only way to move the country forward - assuming, of course, that a new election produces a clear ruling majority.

They say that the best way to cure a hangover is to drink the hair of the dog that bit you. Of course, in my experience, all this does is prolong the suffering and, in the end, makes matters worse. So it would be for Germany if it chooses to move forward under the stewardship of an unstable coalition like those mentioned previously.

The market was already leery of a grand coalition between the CDU and SPD, pushing the euro lower as punishment for the fear that the much needed reforms offered up by the CDU would be watered down and ineffective. That scenario was under the assumption that one party would at least have a solid majority. Now, however, with both parties claiming victory, the possibility that they will cooperate, especially on such divisive topics as tax cuts and labor reforms, seems highly unlikely.

Same goes for the trio of tripartite coalitions. To secure the support of either the Green party or the FDP, either the CDU or the SPD would be forced to give up far more of their agenda than they had initially expected, rendering the initial reason for voting for either the CDU or SPD pointless. Four years of political gridlock and acrimony is not what Europe's largest economy needs.

Instead, it may be best for Germany to take its medicine and head back to the polls with the hope that either Ms. Merkel or Chancellor Schroeder can muster up enough support for a ruling majority. Although the euro may initially balk at the concept and break below $1.20 and test support at $1.1960, the possibility of a stable government with the ability to push through much needed reforms is far more preferable to several years of indecision and rancor within the walls of the Reichstag.

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