HONG KONG (ASIA NEWS NETWORK) - This week, global financial markets were relieved by the lead of French Presidential centrist candidate Emmanuel Macron in the first round over the right-wing Ms Marine Le Pen, creating a second election on May 7. So far, the populist tide after Brexit and Trump last year has not yet swept completely through Europe, as France has followed the Austrian and Dutch voters that they are not yet ready for radical change.

But there is no doubt that the populist swing is on-going, driven by high unemployment, terrorist attacks, concerns over immigration and continued depression in Southern Europe.

France is the second largest economy in the European Union (EU) after Germany, with US$2.4 trillion (S$3.3 trillion) GDP versus US$3.3 trillion for Germany, and her partnership with Germany remains the core to European stability. Ms Le Pen has emphatically argued that under her Presidency, France would exit the euro and may even leave the EU. According to the pundits, a Le Pen victory will only happen if there is low voter turnout or if Macron stumbles badly. Since French voters are deeply divided and many remain undecided or unconvinced by either choice, Frexit risks are not zero.

The EU is a project of political union through monetary union. The idea was born out of centuries of intra-European warfare, so out of the ashes of the Second World War came the dream of a united Europe with peace and stability. But as Nobel Laureate economist Joseph Stiglitz remarked, in 1992, the EU made a "fatal decision" to use a single currency (Euro) to force or induce political unity, but "without providing for the institutions that would make it work."

The Euro-zone did create the second largest reserve currency, and the early years of the Euro did witness a period of great trade and economic integration.

But by 2007, when the United States subprime crisis triggered the European debt crisis, all the Eurozone flaws and institutional inadequacies were brutally exposed. First, although there was a single central bank (European Central Bank or ECB), there was neither a fiscal union nor banking union, meaning that there was no centralised tax and banking policy to deal with failing national banks. As the Southern economies, notably Portugal, Ireland, Greece and Spain tried to bail out their banks, they incurred massive sovereign debt, which could only be sustained by lower and lower interest rates.

Secondly, since it was impossible to devalue the currency to stimulate exports, each crisis country had to deflate and take painful bank restructuring measures, resulting in massive rises in unemployment, leading to social unrest. Italian unemployment numbers are today 11.5 per cent, with youth unemployment double the national levels.

Politically, Europe is today in an existential crisis between the North and the South. The North is doing relatively well, with Germany enjoying higher exports and growth, whereas the Southern member countries are only just beginning to emerge from recession. Germany is running a current account trade surplus of more than 8 per cent of GDP.

But for her own historical reasons, Germany is willing to accept the mutualisation (co-sharing) of European debt, so that the debt burden of the Southern economies remains particularly high. In 2016, the average of non-performing loans of 8 (mostly Southern) EU members was 22.8 per cent of total loans, with Italy being in the midst of a banking crisis. Austerity without hope for quick relief has political costs.

The divisions between Germany and the Southern economies grew because from 1989 to 2002, Germany was burdened by the integration of East Germany, undergoing an extremely painful productivity adjustment, when average wages fell. Over this period, the European think tank Breugel study showed that unit labour costs in France and Italy rose, without corresponding increases in productivity. Post-2002, German industry roared ahead, whereas the Southern economies could not match in terms of labour costs or productivity.

Since the 2007 crisis cut global demand, the Southern economies survived through running higher debts, which have now come home to roost. What is not commonly known is that credit provided through ECB Target (or Trans-European Inter-central bank transfer) balances was at its height double the amount of European inter-governmental credit and IMF crisis facilities to Greece. At the end of February 2017, the German Bundesbank was running a surplus of €814 billion (S$1.2 trillion), whereas the Spanish and Italian central banks had Target debt of €362 billion and €386 billion respectively.

Fortunately, France has managed to keep her deficits at a reasonable level, but her economic position relative to Germany has weakened. After Brexit, Germany becomes even more important politically within the European Union, but militarily, France remains the sole EU member with nuclear weapons.

All in all, Frexit will be destabilising for the EU and global security, so many will hope and pray that Frexit will not happen. But the politics is not completely predictable if the economics and job security continues to deteriorate.

German economist Hans-Werner Sinn, in his 2014 book, "The Euro Trap" argues that the Eurozone cannot carry on in its current form without major reforms. These reforms are made more difficult since German elections this year will follow the French congressional elections, followed by Italian elections next year.

My Italian visit this month revealed to me that if the Italian economy does not recover, a populist government could emerge in Italy, threatening an Italian exit.

For those of us in Asia who are used to dealing with a rich and stable Europe that plays an important role in global trade and stability, a break-up of the Eurozone seems remote.

But we are not living in normal times.

To me, the future of the EU lies in clearer German thinking on her future role as the leading economic power within Europe. The head of a family must be seen to be more generous to the other members, but not so much as to hurt the family finances. Getting that balance right will be key to whether the EU fragments or not.

Andrew Sheng is Distinguished Fellow, Asia Global Institute, University of Hong Kong and Asia News Network's guest economic columnist.