How Europe and US stumbled into spat over China-led bank

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Sometime geopolitical shifts happen by accident rather than design.

Historians may record March 2015 as the moment when China's checkbook diplomacy came of age, giving the world's number two economy a greater role in shaping global economic governance at the expense of the United States and the international financial institutions it has dominated since World War Two.

This month European governments chose, in an ill-coordinated scramble for advantage, to join a nascent, Chinese-led Asian Infrastructure Investment Bank (AIIB) in defiance of Washington's misgivings.

British finance minister George Osborne, gleeful at having seized first-mover advantage, stressed the opportunities for British business in a pre-election budget speech to parliament last week.

"We have decided to become the first major western nation to be a prospective founding member of the new Asian Infrastructure Investment Bank, because we think you should be present at the creation of these new international institutions," he said after rebuffing a telephone plea from U.S. Treasury Secretary Jack Lew to hold off.

The move by Washington's close ally set off an avalanche. Irked that London had stolen a march, Germany, France and Italy announced that they too would participate. Luxembourg and Switzerland quickly followed suit.

The trail of transatlantic and intra-European diplomatic exchanges points to fumbling, mixed signals and tactical differences rather than to any grand plan by Europe to tilt to Asia.

That is nevertheless the way it is seen by some in Washington and Beijing.

Read MoreWhy Europe is breaking ranks with US on China bank

As recounted to Reuters by officials in Europe, the United States and China who spoke on condition of anonymity because of the sensitivity of the subject, the episode reveals the paucity of strategic dialogue among what used to be called "the West".

It also highlights how the main European Union powers sideline their common foreign and security policy when national commercial interests are at stake.

China's official Xinhua news agency reflected Beijing's delight.

"The joining of Germany, France, Italy as well as Britain, the AIIB's maiden G7 member and a seasoned ally, has opened a decisive crack in the anti-AIIB front forged by America," it said in a commentary.

"Sour grapes over the AIIB makes America look isolated and hypocritical," it said.

Of the main U.S. allies in Asia, Australia appears close to joining, though no formal decision has been made, and Japan and South Korea are considering the possibility.

"The Americans are starting to look very mean-spirited with their criticism," said a Beijing-based Asian diplomat. "This is not a battle they are winning. Even their closest allies in Asia are starting to fall in line."

Anger at stalled IMF reform

In Europe as in Washington, China's launch of a new institution to channel a fraction of its massive currency reserves into infrastructure investments in Asia posed a political conundrum and provoked turf disputes.

Western countries had long urged Beijing to recycle some of its trade surplus into building transport, energy and telecommunications networks in developing nations, but they wanted it to use the World Bank and the Asian Development Bank, dominated by the United States and Japan.

China, angered that the U.S. Congress has not ratified a 2010 agreement to increase its voting share and that of other emerging economies in the International Monetary Fund, chose to go its own way instead.

With initial capital of $50 billion, the Beijing-based AIIB can offer at most a complement to the larger World Bank and ADB, but it is starting point for expanding Chinese influence.

Officially, the United States says it is concerned about whether the bank will uphold human rights, environment and labor standards and be open and transparent in its governance.

In private, senior U.S. officials acknowledge this is about power. One Obama administration member said Congressional foot-dragging on IMF reform had "created an opportunity forChina to assert itself".

Lew gave a blunt assessment last week, telling U.S. lawmakers: "It's not an accident that emerging economies are looking at other places because they are frustrated that, frankly, the United States has stalled a very mild and reasonable set of reforms in the IMF."

Republican Senator Jeff Sessions of Alabama acknowledged irritation about IMF voting rights may have been a factor.

"I think this could be an unfortunate event and it might be bigger than we understand today," he told the Brussels Forum, an annual transatlantic dialogue organized by the German Marshall Fund of the United States.

In Washington, the issue resided between the State Department, the Treasury and the White House National Security Council, which may have muddied U.S. communication with European allies, officials say.

"There just wasn't a clear and coherent and unified message on this from the beginning. It kind of languished for a while in a state of indecision and that produced the outcome that you've seen," said a Congressional source familiar with the discussions.

Within European governments there were debates about tactics and timing but the prevailing view was that it was better to try to influence the Chinese project from inside, several officials said.

"The debate mostly pitted national security advisers, who leaned towards hugging the Americans close ... against economic and Asia advisers, who argued that this big train was leaving the station and it was in our interest to jump aboard," a European diplomat involved in some of the discussions said.

In Berlin, the ministries of foreign affairs, finance and overseas development - run by rival wings of Chancellor Angela Merkel's coalition - jostled for influence.

Merkel's office instructed the finance and foreign ministries to take charge. Given Germany's prioritizing of Chinese trade, there was never much doubt Berlin would join the AIIB.

"It was a no brainer," a German aide said.

"Eyes open"

British, German, French and Italian officials held several meetings to discuss a common approach then London leapt first, causing resentment if not surprise.

"We want to be a Chinese partner of choice in international finance," a British government source said.

Inconclusive talks were also held by officials of the Group of Seven economies, which includes the United States, Japan and Canada alongside the four European states.

"We knew the U.S. was not in the same place as us on this, we went into it with our eyes open," the source said.

The Chinese invitation to join the AIIB was delivered to individual states. The issue was discussed only once in the EU's 28-nation Economic and Financial Committee, which prepares meetings of finance ministers.

It was never raised to EU ambassadorial level, let alone to ministers. The big four did not include the European Commission or smaller EU states in their deliberations.

A French government source said issues such as governance were unresolved. "But it was important for the Europeans to show an interest from the outset. We'll see how it goes."

In Italy, the decision took a single phone call from Economy Minister Pier Carlo Padoan to Prime Minister Matteo Renzi, the European diplomat said.

Dutch Prime Minister Mark Rutte will meet Chinese President Xi Jinping this week. Officials said the Netherlands was weighing whether to join but it may have missed the deadline to become a founder member.

Having failed to persuade European allies, U.S. officials are looking to regain the initiative, but partisan battles on Capitol Hill may continue to stymie a response.

The administration is using the spat to press Congress to grant President Barack Obamafast-track powers so he can conclude a Trans Pacific Partnership trade pact with 11 Asia-Pacific nations other than China, and to finally ratify the IMF reform.

"We are acting proactively with trade promotion authority and TPP because other countries are acting. We want to be on the field, defining the rules of the road," the Obama administration member said.