Europe relocates its spine

It’s a rare thing indeed to see Europe dominating the political debate in China, but last month’s EU-China summit and the visit by French President Nicolas Sarkozy grabbed the headlines. As the dollar continued to slide to record lows against the renminbi, everyone in Beijing seemed more interested in the overvalued euro.

For their part, the Europeans finally seemed ready to be the bad cop. EU Trade Commissioner Peter Mandelson’s blunt denunciation of the “tidal wave” of counterfeits, the “theft” of European intellectual property and currency manipulation surprised Vice Premier Wu Yi, who is used to milder language from her European counterpart.

But among sections of the European diplomatic community, there was relief that Mr Mandelson has finally learned to play tough. Many Eurocrats – who are led in Beijing by an egocentric math professor who simply doesn’t have the wherewithal to slug it out with Beijing – believe that China has been taking the EU for a ride.

For the past few years, Bo Xilai, who until November was China’s commerce minister, has consistently gotten the better of his “friends” from Brussels, who failed to understand that flying in for a day or two and dangling carrots in front of tough Chinese negotiators doesn’t work.

And as any mainlander will tell you, never trust anyone who calls you “friend” – a tactic commonly used in China to put people at ease and extract from them what you will.

Whether swapping the carrot for the stick will work is doubtful, but the EU had little choice but to act. Europe’s trade deficit with China is expected to hit US$253 billion this year, and there have been many calls for a US-style muscular approach.

Until now, the Americans have done a much better job of expressing their discontent at China’s trade tactics and currency regime. Continual rumblings from Congress, the establishment of the twice-yearly Strategic Economic Dialogue (SED) and an aggressive use of the WTO complaints system mean that China at least takes US concerns seriously (although whether it decides to do anything about them is another matter).

In contrast, Europe’s lack of genuine political leverage, its softly-softly approach and its internal divisions have failed to garner Beijing’s respect.

So did the EU’s new approach work?

Chinese Premier Wen Jiabao promised to increase the flexibility of the yuan against the euro, which has risen 8% against the Chinese currency since it was “depegged” from the dollar in July 2005. But this vague resolution didn’t included a commitment to stimulate an appreciation of the yuan against the euro. The currency basket is still dominated by the dollar, which continues to fall against the euro, dragging the yuan down with it.

European diplomats welcomed the establishment of a bilateral working group to discuss exchange rate issues, while the planned forum for “high-level economic and trade dialogue” could evolve into a European version of the SED. At the same time, though, Europeans recognize that these bodies are unlikely to be more than talking shops.

As an export powerhouse itself, the EU used to be insulated from a massive imbalance of payments. But the trade deficit with China, which has tripled over the past six years, is now a political as well as an economic problem.

Unless Beijing makes a firm move to revalue the yuan, the EU is likely to join hands with the US and vent its frustration in the WTO. Europe’s toughening stance might be about to get tougher.