Two and a half months since the full-scale war began, China’s posture on it is uncertain. Beijing was confident in the trade war against the US. As a result, it is seen as an obvious candidate for global leadership. We saw that China clearly sided with Russia in the meeting between Xi Jinping and Vladimir Putin three months ago, supporting its claims about non-enlargement of NATO and opposition to “color revolutions”; “attempts… to undermine the stability of the world order ” and “power politics, bullying, unilateral sanctions,” and declared that, “friendship between the two States has no limits.” Since the full-scale war began, however, all that has come from China is mumbling of officials and ambiguous moves of the business. This looks strange. And unexpected. China may turn out to be a paper tiger after all. Why is it so?
There were many attempts to analyze China’s possible posture from a theoretical perspective before the war and in the first days of it. These attempts accurately pointed to a number of basic elements in Beijing’s foreign policy, such as its tendency to maintain balance in geopolitics — and beyond — and its critical dependence on keeping the global economy stable. But the majority of the analysts were wrong in their conclusions. Even those who know China from inside. Nobody managed to forecast the starting conditions in which Beijing would have to act, showcasing its tendencies and features. As a result, the Chinese tiger is proving less scary for Ukraine than projected. Its lack of economic self-sufficiency is holding it back. This is the weakness that can be exploited to benefit Ukraine.
Early signs of weakness
It started before the war. Late 2020 showed the first signs that China’s economy would not be ready for a wide-scale clash with the West. Global financial markets found themselves under serious pressure from the US $12trn added to the balance sheets of the central banks that issue international reserve currencies to counter the economic impact of the COVID19 pandemic. As a result, global commodity prices went up. The rise started in November 2020. Over 2021, S&P GSCI for 24 commodities grew 40.4%.
The People’s Bank of China refused to support the policy of massive money printing. It was right in theory as China managed to deal with the pandemic without introducing a nationwide lockdown. Therefore, China’s economy did not experience the devastating impact that the rest of the world faced and did not need such support. Since virtually all other major economies were printing money, the yuan’s exchange rate to the US dollar grew 12.2% between late May 2020 and early 2021.
This hurt the Chinese economy. It found itself unprepared to carry the burden of global problems. In November 2020, China recorded a -0.5% deflation. It signaled that gross domestic demand was too weak to push the economy out of potential problems. This was the first red flag.
It was followed by several months of global economic recovery. It fueled China’s economy that showed decent dynamics of exports and GDP. Eventually, this turned out to be temporary. Domestic demand remained weak despite the expensive yuan. The annual inflation rate stayed at 1.0-1.5% for most of 2021, with small temporary fluctuations, while rising in other economic centers of the world. Meanwhile, a sharp increase of global commodity prices boosted the cost of imports. The annual growth of price index for imported goods ranged between 15% and 18% for most of 2021. Chinese producers ended up squeezed between feeble demand and a fast growing production cost. The producers oriented at the domestic market and unable to shift higher costs to external consumers were hit especially hard. Hence the problems in China’s construction sector, including the default of China Evergrande Group. Intervention from the Chinese government was the only way to stop the fire. The People’s Bank of China launched serious quantitative easing by cutting reserve ratio twice from 12.5% to 11.5%; interest rate twice from 3.85% to 3.7%; and reverse repo rate from 2.2% to 2.1%; and increased its balance sheet by over 5% by issuing refinancing loans. A similar increase took place as a response to the pandemic. In the last months of 2021, China faced an unusually high budget deficit. This was the second red flag.
Current trends and limits
When the Russia-Ukraine war began, China’s economy was not in its best shape. This is a critical factor. No matter how strategic the China-US rivalry is and how great of a friend Vladimir Putin is for Xi Jinping, China’s people and domestic problems always mattered more for its government. This posture is associated with one of the key elements of Eastern philosophy: start by dealing with internal problems because the external world is just a projection of the internal one. This is where it differs from the approach of Russia — and others. In the latter, internal emptiness is filled with external adventurism. This is the foundation for understanding the current situation.
After this, problems began to emerge exponentially. The war triggered a new leap of global commodity prices because both Ukraine and Russia are the key exporters of a range of goods. Over some 75 days of the war, the S&P GSCI jumped 14.6%. Many commodities hit record-breaking prices. All this triggered further rise in the cost of imports for China. It is not clear yet how long this cost persists. But Chinese producers already have serious profitability issues, and quite possibly liquidity problems. If this spins out of control, a wave of defaults and bankruptcies like that of China Evergrande Group will follow.
COVID19 comes as the second problem. It has caught up with China, and Omicron is much more contagious than the previous variants. As a result, China was not applying the draconian administrative restrictions that helped it take the pandemic under control earlier. Therefore, this variant is spreading despite all the existing restrictions. Moreover, the Chinese did not go through the previous waves. This is why they do not have acquired collective immunity, which makes them vulnerable to this variant while most Ukrainians, for example, are living through it without much trouble. Over 500 people have died of COVID19 in China over the two months of the active phase of this latest wave. This pushes the government to very harsh measures, such as shutting down entire cities, and stifles business activity in the country and has an adverse effect on its macroeconomic data.
Mass exodus of private foreign business from Russia is the third problem. This is a very interesting trend which the Chinese have not yet understood or experienced fully yet. Over 750 companies have so far declared full or partial closure of their operations in Russia. These are mostly Western companies. Some of them made this decision as a result of Western sanctions against Russia. Many thought of bypassing them initially, before facing public criticism in developed countries. What does Chinese business have to do with all this? Many Chinese companies that own global brands have a lion’s share of their consumers in the developed markets of North America and Europe. These consumers can boycott their products just like they did or threatened to do in response to the refusal of Western companies to leave Russia. China’s economy might thus face critical losses that will make China’s support for Russia impossible and force Beijing to side with the West in this war.
This trend is very important, so it deserves a few more words. Firstly, it is very serious. It is new for the world in the sense that the world has not yet seen a massive decentralized international boycott of a certain economy. But it should not be underestimated. A prototype of it emerged after the annexation of Crimea when lists of Russian brands were distributed in Ukraine, and their sales shrank so much as a result that these businesses barely survived or were forced to shut down. This time, Ukraine has managed to scale this trend to the entire civilized world. This has changed things for many, and will change things for many more. Importantly, this is a result of the successful pilot project within Ukraine and the information war won by Ukraine abroad. Subsequently, up to two thirds or more citizens of many countries in Europe and North America support Ukraine. This makes the ongoing Russia-Ukraine war largely an information war. From this perspective, it will become part of the textbooks on modern wars.
Secondly, this trend is far from reaching its full potential. When the war began, the Americans and the Europeans were skeptical about Ukraine’s chances in it. This manifested in the refusal of Western companies to stop their business in Russia. The resilience of Ukrainians on the frontline and the proactive refugees and diaspora abroad helped shift public opinion in developed countries to side with Ukraine. There is increasing realization in the world that, by launching its war in Ukraine, Russia has made global mistakes. And they will expand further, especially if a global economic crisis beings (more on this below). Subsequently, the Americans and Europeans may have started to buy less products of the tainted companies, or simply declared their readiness to do so. But the ice has broken and the exodus of the Western business from Russia has become massive. The main thing is that this is working. Public opinion in rich societies is as important as the decisions by the most influential politicians. Some might need more time to come to full terms with this. If these actions can push huge Western companies to take key strategic decisions, why can the same not be done with the Chinese business that operates in external markets? How are its principles of work and competition different from those of the Western business? China’s companies will obviously be next. Regardless of whether Xi Jinping wants it or not. This will affect the approach of Chinese businesses to the Russia-Ukraine war and its strategic actions.
In fact, this is what we see gradually. The Wall Street Journal wrote several days ago that Chinese tech giants Lenovo and Xiaomi are quietly folding down their business in Russia. These are globally known brands that earn billions in revenues from the developed countries. They fear a boycott from their citizens. Apart from that, Chinese producers and transportation companies are slowly quitting the sections of the Belt and Road that pass through Russia and Belarus despite billions invested in this logistics. Once again, China is afraid that the isolation of Russia and Belarus will make Europe reluctant to accept Chinese goods from that direction.
There is an impression that the international community is managing to slowly turn the Chinese business and force it to accept neutrality or side with the West. If this trend develops, Chinese businesses will have to tolerate the forced shift of its export-oriented sections regardless of personal preferences of the Chinese government and its leaders. Because these sections bring jobs, revenues in foreign currency and strategic prospects of China’s economic development.
Fourthly, a potential economic crisis in the US and EU aggravates the three challenges listed above. So far, this is a risk rather than reality. But the way things are developing signals that this is a highly likely outcome. Skyrocketing commodity prices caused a steep rise of consumer inflation — at 8.5% in March in the US and 7.4% in the EU, year on year. High inflation has been pushing market interest rates up. For example, YTM on ten-year US treasury bonds has grown from 1.5% to 3.1% since early 2022, while 30-year mortgage interest rate has gone from 3.3% to over 5.3% in a record-breaking growth in the past ten years. Commodities, financing and hired labor are now very expensive in the US. There is a shortage of labor force as the 3.6% unemployment is close to a multiyear minimum. All this is already adding to the production cost for manufacturers. Meanwhile, FRS is looking to raise interest rates to get inflation under control. As a result, the US stock markets are sliding down, getting close to the year low, and this downward trend is likely to continue, signaling that the US economy might face a decline and provoke a global recession. The same is true for the EU economy.
This trend is important for China in several aspects. First and foremost, China’s economy relies heavily on exports. In 2021, it accounted for 19.3% of the country’s GDP. Economic decline in developed countries will add another serious problem to the list above. Given the sympathy for Ukraine amongst consumers in developed countries and the effect it will have on the businesses that continue their operations in Russia — or not, Chinese companies might lose foreign markets faster than they would without a global recession. In the 2008-2009 global crisis, China and other developing Asian economies had enough internal resources and economic policy tools to support growth. Now, its economy is the most indebted in the world and its domestic market is limited. China’s GDP has been growing for 40 years in a row, so nobody knows how long this pyramid will crumble if it starts to do so at one point. The global history of economic crises shows that the strong are the ones that rise after they fall, not the ones that do not fall. China is yet to live through this existential truth.
Consequences, conclusions and recommendations
These problems and risks are not purely theoretical. They already manifest themselves in market indicators and economic data. Over the past few weeks, the US dollar to yuan exchange rate went 5.6% down. This is a huge development for the currency exchange market with its usually narrow fluctuations. Unemployment grew from 4.9% to 5.8% in the six months until March 2022, and this growth accelerated in March, even if it stayed at around 4.0% for many years except for the period of the pandemic. Annual exports growth shrank from nearly 20% in 2021 to 3.9% in April 2022. By contrast, the annual imports growth rate has been at 0% for two months now (the actual amount is negative as import prices are growing) after exceeding 15% in 2021. Cumulative PMI that reflects the survey of managers on sales, new orders, employment, stocks and prices, has been plummeting for two months now to 37.2 in April. Any number below 50 reflects shrinking business activity. In March, retail sales shrank 3.5% year on year. This is the first decline in at least 30 years beyond the several months of the pandemic.
This means that China’s economy is gradually tumbling into a crisis. It already has one foot in that swamp and is rapidly going deeper.
This leads to three conclusions. Firstly, China has too many problems of its own now to pay any serious attention to the Russia-Ukraine war. It has no time to formulate a clear posture in it, let alone spend serious resources on supporting any of the sides. The Chinese government will priorities its efforts on dealing with the crisis. This essentially means that nobody will prohibit Chinese businesses to seek any ways to reduce the losses, including by leaving Russia, if continued operations there create excessive risks. Nor will anyone prohibit their expansion in the Russian market if that allows them to earn revenues while not losing clients elsewhere. Xi Jinping or the Chinese Communist Party cannot say anything publicly to avoid souring relations with Russia. But this is a case where silence is golden. As a result, the Chinese government will take the posture that the Chinese business maps out with its actions. The latter’s choices can perfectly be influenced by politicians and consumers in the West.
Secondly, China does not have the resources strategically to turn the Russia-Ukraine war into any serious clash with the US that Beijing could win. At this point in time and space, China is too weak to act aggressively. The current crisis in China’s economy is caused by too great a number and variety of factors for it to be light or temporary. It will take China quarters if not years to overcome it. All this time, China will essentially be excluded from geopolitics. Therefore, it will be unable to guarantee strong backing for Russia, if it takes such a role at all.
Thirdly, if the West manages to minimize the impact of a possible economic crisis for itself, with Ukraine’s victory it will be able to dictate China the rules of the post-war international order. Or to trade economic support for China’s loyalty with Ukraine rather than Russia. The best scenario for Ukraine in this is that China stops supporting Russia and helping it bypass Western sanctions, and joins oil and gas embargo until the war ends. This scenario may now seem unrealistic. But this is a matter of pressure and control over the dynamics of China’s economy. China went for a rapprochement to the US when Henry Kissinger was young, countering what the Soviet Union wanted. Now is the case where “we can do this again” acquires a positive sense.
China’s problem is that whoever seeks to find a balance or minimize losses externally is forced to side with the stronger. When the war was a clash between Ukraine and Russia, China was speaking about the need to respect the Kremlin’s demands, interests and zones of influence. Now that the war has turned into a clash between Russia and the West that shares the values defended by Ukraine, Beijing will be forced to take into account the posture of our side of the frontline. And it might perfectly stab Putin in the back. It is capable of doing so.
This analysis leads to obvious recommendations. For now, China is a paper tiger that is strategically not dangerous for Ukraine or the West. This should be exploited. Politically, China should be threatened to face sanctions for helping Russia or an intensified trade war. Given the economic situation in China, this might only take an effort from the US, without the EU and its bureaucracy. In the public domain, an information campaign should shift to encouraging consumers from the developed markets to reject Chinese products and replace them with the ones produced at home or in friendly countries. When the Chinese economy gets into a deep enough crisis, China should be offered economic support by lifting trade restrictions or buying their products directly in exchange for full rejection of supporting Russia until the war ends. All these are perfectly realistic steps that can be taken fast. China’s neutrality or siding with Ukraine is a huge step towards Ukraine’s victory. This is worth an effort.
Finally, an uplifting conclusion. The analysis above signals that this war is gradually moving to the level and scale where the use of nuclear weapons makes no sense. What could Putin achieve by pressing the red button? Which of the problems he created can be solve to his benefit? This level of a clash is an unachievable league for the Kremlin which it has no influence over, including with nuclear weapons. Therefore, it cannot be used for rational reasons. If anyone in the Kremlin wants to use it for irrational reasons, there will definitely be someone who thinks rationally in the complex launch mechanism. Such rational actors are the ones to negotiate with.