The pieces have been moving into place for months now.  German Chancellor Angela Merkel has seen her power within German political circles wane for more than a year.  Italy’s opposition to the European Union’s budget rules is stiffening.

Bond yields are beginning to not just rise, but blow out uncontrollably.

The Fed keeps raising rates to arrest inflation not supported by increased wages.

Brexit talks are at a standstill.

Last week Merkel suffered what could easily be her most important political defeat over the past two years.  She lost a parliamentary vote for her candidate in an internal vote of her Christian Democratic Union (CDU) party.

As pointed out by Alex Mercouris at The Duran, this is the first time in more than forty years a German Chancellor lost an internal party vote of this magnitude.  And it speaks to the growing frustration among not only party members but the German electorate in general.

I saw a recent poll from Die Welt which has Alternative for Germany (AfD) creep past Merkel’s Grand Coalition partner, the Social Democrats (SPD), and challenge the CDU itself.

Because when you back out the Christian Social Union’s (CSU) total which runs between 8% and 9% AfD is now in a position to become the party with the highest backing in Germany.  And this is happening on the eve of Bavarian State elections this month.

Poll EN

So, CDU party members are in an absolute panic over these numbers.  They are reaching levels which can see a major party become a minor one very quickly.  Don’t believe me?

Ask the Democrats in Italy.

What Alternatives for Germany?

I’ve talked about AfD’s chances to achieve this result in the past in terms of them crossing the 16% Chasm.  And it appears, that slowly, they are doing so.

German politics, from what I understand, is not used to this kind of upheaval and certainly not these kinds of leadership challenges.  Earlier this year Merkel barely survived a challenge by former CSU Leader Horst Seehofer over immigration.

So, where to things go from here?

As Mercouris points out, Merkel has very skillfully gutted the landscape of the CDU to keep potential leaders from emerging within the party.  The SPD is falling off a cliff having lost more than half of its support since the 2014 elections. And the CSU is primarily a Bavarian party so they don’t have the support of the entirety of Germany.

This landscape is why we’ve seen the Greens rise to 15% as well as AfD’s rise.  And that cannot be ignored.  The hard left of German politics is now split and ineffectual.  But, no party has emerged in this chaos to take the reins of power.

This is reminding me of Italy’s situation at the end of 2017 with no less than five parties polling in double digits.  It’s a messy situation and it makes more sense in Germany that big shifts in voter preference would occur at a slower rate given the stability of German coalition governments since the modern state was founded after World War II.

In other words Germans are loathe to make these kinds of changes.  So, you know the situation must be bad if these numbers are changing this quickly.

So, it shouldn’t be much of a surprise really to see this type of breakdown and the slow rise of AfD past the 16% chasm.  It may be the riots in Chemnitz that finally begin pushing their poll numbers into the 20’s nationally.

My worry is that AfD is a pure protest vote against Merkel and once she is gone support will fade like it did for UKIP after the Brexit vote.  UKIP built its support on Brexit, but once the vote happened many disgruntled Tories went home to have the more experienced party lead the talks.

Fat lot of good it did them, but I can see the logic.  Nigel Farage stepping down didn’t help matters either.

So, the same thing could be occurring here in Germany.  Frustration with Merkel over immigration could end the CDU’s slide if she is deposed and someone else takes over.

Because here’s the rub.

Politics as Unusual

Political volatility in Germany now is about the worst possible scenario for the European Union.  Merkel is the de facto head of the EU. And it is dealing with revolts both internal and external, all of which revolve around fundamental questions of sovereignty of member states.

Internally, it is dealing with an obstinate and confrontational group of Italians over budgets and austerity as well as the challenges from Hungary and Poland over sovereignty, both of whom now face Article 7 censuring.

Brexit talks are breaking down as British Prime Minister Theresa “The Gypsum Lady” May has botched both delivering a Brexit no one except the EU wants and selling it as a Brexit of substance at home.

And then we add in Donald Trump’s attacks on the post-WWII institutional security order, i.e. NATO, and the parameters of international trade things get even dicier.

In my opinion, the only thing propping up Merkel right now is her standing up to Trump on energy and defense issues.

But, that is forcing her to make deals with Russia which run counter to The Davos Crowd’s plans to destroy Russia… and we all know who Merkel takes her marching orders from.

What’s a would-be continent-spanning Empress to do, right?

And this begs the big question that if Merkel were deposed as Chancellor during all of this what effect would that have on investor confidence and the structure of financial markets?

As I said at the open, all the pieces are in place.

It’s the Debt, Stupid

The only thing keeping the European Union together in its current form is Germany’s strong-arming everyone into line along with the IMF and the ECB.  But, any replacement for Merkel will be far more nationalistic, even if it is a member of the CDU, than Merkel.

And that means being far more willing to let Italy walk out of the Union if it doesn’t do what’s in Germany’s best interest.  And to German nationalists, right or wrong, bailing out lazy Italians is not on the agenda.  Part of what fueled AfD’s initial success was the endless bailouts of Southern European countries like Greece and Italy previously.

This just sounds like a complete nightmare from an investing standpoint. No matter how cocked-up things look here in the U.S. we’re not in danger (yet) of the kind of political breakdown which would threaten our financial markets in the same way a messy and disorderly break up of the EU would be over Italy defaulting on its debt.

George Soros can try to monkey with the Supreme Court and mid-term elections, but  the U.S. is still a far stabler political union than the EU is.  Its markets are deeper and more liquid, for now.

I know the actual situation of dealing with Italian bonds is more complicated than them simply walking away.  But, during a banking crisis that threatens everyone’s savings and the solvency of the German banking system, complicated becomes simple really quickly.

Italy issues a new currency and offers to pay its debt back in it or nothing at all.  Germany screeches.  Lawyers go into action.  Arms are twisted.  Governments fall.

Most importantly, capital flees the scene of the chaos.

At the end of the day it’s all paper and that paper isn’t worth the legal fees to untangle who owes what to whom anymore.  So, if Italy holds its ground a Germany Without a Merkel has no chance of avoiding a complete melt-up in bond yields, which will finally begin the chain of events that leads to a new monetary system and global institutional order.

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