US-China economic rivalry leaves EU squeezed, ECB worried

Meanwhile, top EU officials at the European Parliament plenary in Strasbourg on Tuesday (18 April) called for reducing Europe's reliance on China, while maintaining the bloc's partnership with Beijing.

"We are witnessing a fragmentation of the global economy into competing blocs, with each bloc trying to pull as much of the rest of the world closer to its respective strategic interests and shared values," the ECB president said.

Lagarde told the Council on Foreign Relations in New York that geopolitical rifts caused by rivalry between the US and China could push up inflation by five percent. It could also threaten the leading currency positions of the US dollar and the euro.

She said that a "period of relative stability may now be giving way to one of lasting instability resulting in lower growth, higher costs and more uncertain trade partnerships".

Costs tend to increase as countries stop or reduce trading with rivals and seek supplies at home or from allied countries, Lagarde said, adding that disruption to global supply chains would hit "critical sectors" such as the car industry.

Lagarde pointed out how crucial stable global trade conditions are: the US is "completely dependent" on imports for 14 critical materials and Europe relies on China for 98 percent of its rare earths supplies.

Lagarde, a former International Monetary Fund (IMF) managing director, warned that a splintered and less efficient world economy would make it harder for central banks to contain inflation, and that banks will need help from with governments to find ways to control costs.

"Central banks must provide for stability in an age that is anything but stable," Lagarde said, warning: "The time to think about how to respond to changing geopolitics is not when fragmentation is upon us, but before."

While China has been building allies in defiance of US dominance, rich, democratic nations in the west have called for more resilience in supply chains, to ensure a buffer from war, pandemics and attempts at coercion by authoritarian regimes — including China.

EU's role

Lagarde touched on raw nerves on key political European strategic questions — where will the EU find itself? Part of, or stuck between, these big blocs.

EU foreign policy chief Josep Borrell meanwhile told European lawmakers in Strasbourg on Tuesday that there is a need to avoid a new cold war between the "west" and the "far east".

Borrell said that the EU needs to work together with China, as it is the biggest creditor for emerging countries, and has enormous impact on the fight against climate change.

"We are in rival mode, but we have to keep talking to China," Borrell told MEPs, adding: "We can't stop negotiating with China when it comes to trying to sort out the biggest problems because China is not a democracy."

"Decoupling is clearly not viable, desirable, or practical for Europe, but there clearly is a need for Europe to work on de-risking some important and sensitive parts of our relationships," EU Commission president Ursula von der Leyen told MEPs.

She nevertheless warned China against using force in the Taiwan Strait, reiterating a message she delivered to Chinese president Xi Jinping during a high-stakes visit to Beijing earlier this month.

Her comments came after French president Emmanuel Macron suggested in interviews that Europe should be wary of getting drawn into a US-China confrontation over Taiwan.

"I believe we can, and we must, carve out our own distinct European approach that also leaves space for us to cooperate with other partners, too," von der Leyen told MEPs.

Currency wars

Lagarde also said the US could not take for granted the dollar's continued role as the go-to currency, even if, for now, its central role remains unchallenged.

"So far, the data do not show substantial changes in the use of international currencies," Lagarde said. "But they do suggest that international currency status should no longer be taken for granted."

Around 60 percent of the world's foreign exchange reserves and international debt is denominated in dollars, with the euro a distant second at 20 percent, according to ECB data.

China, Russia and other countries are seeking to wean themselves off dependence on the US. Some countries seeking alternative currencies such as the Chinese renminbi or the Indian rupee, accumulating gold or setting up their own payment systems, weakening the dollar's role.