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After less than 100 days in office, President Trump has radically shifted his view on two foreign policy issues that matter a great deal to Europe: China and NATO.

Candidate Trump promised to be tough with China. In his , describing his plan for his first 100 days in office, he promised: “I will direct the Secretary of the Treasury to label China a currency manipulator.”

But in an with the Wall Street Journal, published last week, President Trump changed his mind. “They’re not currency manipulators”, he said, reflecting the latest US Treasury Department’s finding in its on foreign exchange policies of major trading partners.

Had China been designated a currency manipulator, the Treasury Department would have had to open negotiations with Beijing with the aim to change its currency and trade behaviour. In the absence of a satisfactory solution, Washington could have imposed punitive tariffs on China, which would have led to a trade war with inevitable negative consequences for the European Union and for the entire world.

The EU follows the situation very closely. China, the EU and the US are roughly of equal economic size (see Figure 1). They are also by far the three biggest economic entities in the world; together in 2016 they accounted for:

• 60% of global GDP;
• 50% of global GDP measured in purchasing power parities;
• 45% of global trade (excluding intra-EU trade).

Trade ties between the three entities are intense:

• The EU is the 2^nd destination of exports from both China and the US;
• The EU is the 1^st origin of imports to China and the 2^nd to the US;
• The US is the 1^st destination of exports from both China and the EU;
• The US is the 2^nd origin of imports to the EU and the 3^rd to China;
• China is the 2^nd destination of exports from the EU and the 4^th from the US;
• China is the 1^st origin of imports to both the EU and the US.

Although economists rightly dismiss bilateral trade balances for having no economic meaning whatsoever, pressure groups and politicians attach a great deal of importance to bilateral trade deficits which they tend to ascribe to unfair trade practices by the partners in surplus. Bilateral trade balances are therefore a good indicator of potential trade tensions between pairs of countries.

Bilateral trade relations between China, the EU and the US are fairly imbalanced. In 2015,

• China ran a 30% surplus with the EU and a 60% surplus with the US;
• The EU ran a 30% deficit with China and a 20% surplus with the US;
• The US ran a 20% deficit with the EU and a 60% deficit China.

The large US trade deficit with China was certainly a key factor behind Donald Trump’s anti-China rhetoric during his victorious US presidential campaign. Although President Trump has decided to abandon his confrontational approach for the moment, partly because the US needs China to deal with the North Korean military threat, his top trade official has meanwhile made a new attack on the big trade surpluses of China and Europe in an with the Financial Times.

A US-China trade conflict would pose serious problems to the European Union, which would risk being caught between the two adversaries.

The EU has three reasons to side with the United States

First, its economic ties with the US are much deeper than with China. The EU exports about twice more goods and about seven times more services to the US than it does to China. The US is also a far bigger investment partner for the EU than China. In 2015, the US hosted nearly 40% of the EU’s outward FDI stocks and was home to slightly more than 40% of the EU’s inward FDI stocks; the respective shares of China were only 2 and 1%. In terms of FDI flows, however, China has become a significant partner for the EU.

Second, Europe and America have quite similar economic and political systems. Both are Western-style market economies and democracies, though Europeans clearly value social equality more than the US. China, by contrast, is an economy where the state and state-owned enterprises play a very significant role and has a political system monopolised by one party. This difference in economic systems, between the EU and the US on the one hand and China on the other, is a source of recurring trade and investment disputes between the two sides. The fact that both the EU and the US run large trade deficits with China adds to their shared interest vis-à-vis China.

Third, the political situation in the EU’s neighbourhood, both to the east and the south, raises a number of potential security and defence questions to which EU countries are currently incapable of responding without the strong participation of the United States in NATO. No doubt European leaders will have been relieved to hear President Trump change his mind last week about his campaign declaration on NATO. “I said it was obsolete. It’s no longer obsolete,” the president said during a with the secretary-general of NATO in the White House. Nonetheless, European leaders will also have received loud and clear the message of President Trump: the US commitment to NATO should not be taken for granted.

But the EU has also two good reasons to move closer to China

First, European leaders have made it clear on several occasions, including in their last month, that “standing for a rules-based multilateral system...promoting free and fair trade” is a matter of principle. The timing of this re-affirmation of the centrality of multilateral trade rules for the European Union was probably related to President Trump’s “America First” declaration during his inaugural speech, which raised the spectre of unilateral trade action by Washington. With the US potentially forsaking its commitment to the GATT/WTO multilateral system, the EU could feel compelled to seek the support of China, which has recently made strong declarations in support of a liberal trading regime, to uphold the principles of the rules-based multilateral trading system.

Second, , the EU also has an economic interest in working with China to try and discourage the United States from taking protectionist measures. For one thing, the EU also runs a trade surplus with the US and may therefore be the subject of protectionist trade measures by the US just like China would. This could be severe blow to the EU economy since the United States is its largest export customer, absorbing more than 20 percent of extra-EU shipments. In addition, regardless of whether the EU would be the subject of direct trade measures by the US, trade actions by the US against China – or for that matter against any other country – would have important indirect repercussions for the EU given its leading role in international trade and its close economic ties with China. EU firms operating in China would inevitably be collateral victims of US measures, which would provoke some form of action by the EU against the United States, possibly jointly with China and other countries. At the very least, the EU would bring complaints against the United States at the WTO, which may eventually lead to retaliatory trade measures.

What should the EU do to avoid being caught between China and the US? Five actions would be desirable:

1. The EU should remind the Trump administration that the United States has played a pivotal role in the functioning of the rules-based multilateral trading system since the creation of the GATT in 1947. It should also convey the message that the system has served well the interests of the US and its trading partners. Finally, the EU and the US should examine the possibility of relaunching the TTIP negotiations.
2. The EU should also remind China that it has benefitted a lot from its accession to the WTO in 2001. Moreover, the EU should try and convince the Chinese authorities that the time has come for China to assume its full responsibility in the strengthening of the multilateral trading system. This implies less involvement of the state in trade and investment activities. In parallel the EU and China should commit to reach an agreement on a bilateral investment treaty by 2020.
3. The EU should take an initiative - together with the United States, China and other G20 nations - to modernise the rules of the multilateral trading system. They should ask the director-general of the WTO to appoint an Eminent Persons Group tasked to make recommendations on the global trade regime and on the design of a reformed WTO.
4. The EU should seriously reflect on the desirability and feasibility of introducing a European Committee on Foreign Investment modelled after the Committee on Foreign Investment in the United States (CFIUS), which reviews the national security implications of foreign investments in US companies or operations. Such a body would give the EU greater leverage vis-à-vis China (and other countries) in negotiations on foreign investment.
5. Finally, the EU should make good the commitment of EU leaders in the Rome Declaration to strengthen Europe’s common security and defence “in cooperation and complementarity with the North Atlantic Treaty Organisation”. This would give the EU greater leverage vis-à-vis the United States within NATO.