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Europe Oscillates Between the U.S. and China

Jun 30, 2022

When it comes to the U.S.-China relationship, Europe maintains a neutral position, even if that creates uncertainty. Depending on the issue at hand, the EU will favor either Washington or Beijing. This is despite growing efforts by the transatlantic allies to align their positions through various mechanisms, including the EU-US Trade and Technology Council (TTC). For instance, the European Union supports Washington on a host of China-related matters and is increasingly aligning its Indo-Pacific strategy with that of the U.S. At the same time, Europe backs China’s monetary ambitions, including a wider use of the renminbi – a dynamic that has potential to weaken the U.S. dollar and undermine the effectiveness of western sanctions. 

U.S.-EU Alignment on China

The Biden administration has reached out to its European allies to create a common front to counter China, while Sino-European relations are at a low point, particularly after Beijing imposed sanctions on European individuals and organizations in March 2021. Since the creation of the Trade and Technology Council (TTC) in June 2021, a new level of transatlantic cooperation has been ushered in, particularly in the following areas: (i) standard-setting for new technologies including telecommunications infrastructure, artificial intelligence and next-generation vehicles; (ii) supply chain resilience and sustainability in sectors such as semiconductors, batteries, medical equipment and supplies, pharmaceuticals and critical minerals; (iii) industrial subsidies with focus on state-owned enterprises, forced technology transfers and intellectual property. Recent TTC discussions also included coordination on export controls and investment screening practices, as well as outbound investment restrictions; (iv) economic coercion, after China’s imposition of broad import restrictions on Lithuania, as well as products in its supply chains.

Russia’s invasion of Ukraine has led to further transatlantic cooperation in the Indo-Pacific, including Taiwan. In December 2021, the U.S. and the EU set up a high-level dialogue on the Indo-Pacific, complementing the TTC. Washington wants to establish an Indo-Pacific version of NATO and is actively pressuring Europe to join the Quadrilateral Security Dialogue – known as the Quad, a strategic security dialogue between Australia, India, Japan, and the U.S. – as well as cooperate more closely in the framework of the AUKUS pact - a trilateral security pact announced on 15 September 2021 between Australia, the United Kingdom, and the U.S. for the Indo-Pacific region. The U.S. and the EU have also stepped up their consultations on Taiwan and sent delegations to the island in recent months.

After the U.S. and its European allies kicked Russian banks out of SWIFT (Society for Worldwide Interbank Financial Telecommunication) - the western-dominated network banks and other financial institutions use to transfer money - attention has focused on China’s potential role in helping Moscow circumvent those sanctions through the use of Beijing’s Cross-Border Interbank Payment System (CIPS) which utilizes the Chinese currency, the renminbi (RMB, or yuan). Seen as an alternative to SWIFT, CIPS’ stated goal is to advance the internationalization of the renminbi and put limits to the dominance of the U.S. dollar. European banks and governments have so far supported an increased role of the renminbi in the world economy. Ironically, such a dynamic could potentially help Beijing undermine the effectiveness of sanctions that the U.S. and the EU may impose. 

Europe’s Support for the Renminbi

Outside mainland China and Hong Kong, Europe has the largest number of CIPS participants – 169 out of a total of 1304, as of April 2022 - including some big banks such as HSBC and Standard Chartered (United Kingdom), BNP Paribas (France), Deutsche Bank (Germany), and Banca Intesa (Italy). The European banks connected to CIPS tend to clear renminbi funds used to finance projects under Beijing’s Belt and Road Initiative. Yet, the scope of their RMB-denominated services is set to increase also due to the perception by asset managers of the renminbi as a safe haven. The prospect of a bigger use of the Chinese currency is thus pushing major European banks to position themselves in the emerging market of RMB trading and services.

According to the latest editions of the RMB Tracker,a monthly report from SWIFT Business Intelligence, Europe is second only to Hong Kong with regard to global cross-border RMB transactions. Overall, the old continent clears around 10% of the world’s RMB-denominated payments, and there is every reason to think Europe’s market share will continue to rise. China is Europe’s first trading partner in terms of goods. As Chinese companies have limited access to foreign currency to pay their European counterparts, the use of CIPS and of the digital yuan is expected to grow. Moreover, it is becoming increasingly easier for European businesses to invest RMB-earnings in RMB-denominated financial instruments managed by European banks, including their branches in China. During the negotiations on the Comprehensive Agreement on Investment (CAI),an accord that if ratified would boost trade and investment relations between the EU and China, the European Commission obtained binding commitments by Chinese authorities to expand market access for European banks and financial institutions in the Asian giant. 

Furthermore, all of Europe’s central banks as well as the European Central Bank have accepted China’s currency as a viable reserve and signed swap agreements with the People’s Bank of China - a trend that has intensified after the renminbi became part of the International Monetary Fund’s official reserves. The European Union unanimously backed the decision by the IMF in December 2015 to include the renminbi in the Special Drawing Rights (SDR), which is an international reserve asset that includes the U.S. dollar, the euro, the British pound, and the Japanese yen. Washington voted against it, criticizing the EU for supporting the Chinese currency which, according to U.S. policy makers, does not meet the criteria for reserve status.

A repeat of this transatlantic divide over the renminbi occurred in May 2022, when all the European representatives in the Executive Board of the IMF voted in favor of increasing the share of the Chinese currency in the SDR, while Washington voted against. The IMF raised the weight of the renminbi by 1.36% to 12.28%, making the Chinese yuan the third largest in the IMF’s official reserves, behind the U.S. dollar and the euro.

While Washington is pressuring its European allies to create a common front to deal with Beijing, Europe lends its support to China’s monetary ambitions which could, over time, undermine the very foundation on which U.S. power rests, namely the dollar as the world’s reserve currency. Europe’s oscillating behavior may thus be seen as a boon or as a threat, depending on the issue and whether you are in Washington, or in Beijing.

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