China is the big winner in the Ukraine-Russian war

China continues to benefit from Russia's desperate need for supplies to prosecute its quixotic war in Ukraine. Russia is unable to stop in its offensive goals (despite those goals repeatedly shrinking) because to do otherwise would be to acknowledge the failure of the entire enterprise. Which, in turn, must lead to some sort of political consequences.

The opportunities for arbitrage are just too great right now, and the chance to deplete a regional rival is too precious. Russia is quickly denuding itself of resources and will lose, indeed has perhaps already lost, the ability to defend its lengthy borders. Setting up barter trade systems in the face of rampant Russian inflation will not change the calculus that China is prepared to bleed Russia dry. And so they should; no judgement here.

This will not abate until the Russian treasury is well-raided, but the trend cannot continue for long. China must be wary of penalties restricting access to other, much more important markets. The profit-taking is elevated, so these are highly attractive trades, but the penalties come in waves, and each time impose a cost.

China must be careful not to create too much friction with the vast majority of its trading partners, who are unhappy about China's involvement in continuing the conflict. If this issue comes to a head China would be in a very bad position. To choose Russia over the West would be economically-catastrophic; to choose the West over Russia would be a painful capitulation.

Still, the ability to balance Russian inflation against Chinese deflation has been a precious gift, given the reality that China housing will continue to sag, and there seems to be little hope for a new economic driver that is acceptable to the regime. It is this as yet unknown new driver that China must find in order to stabilize the economy and ensure job growth, because a consumer-led recovery is still not an option.

One might ask whether China could hope for a Russian victory and some benefit as a result. Such an outcome would seemingly not benefit China much, and would also create risks for China. Ukraine as we all know by now is a grain-producing country, grain that stabilizes world markets. Indeed the popular perception in China of Ukrainians couldn't be more positive: Sunflower seeds, grain and tall blonde women. It wasn't that long ago that China was considering the notion that Ukraine's fields could be rented for China's benefit.

Having that grain under Russia's control in theory benefits China as a trusted trade partner. In practical terms, however, the opposite is true: Russia will either attempt to drive prices higher, or incompetence and corruption will degrade their output. China, as a net food importer, should be much happier dealing with Ukrainians on open global markets rather than negotiating with Putin and managing his market manipulations.

In order to change China's economic and political calculus, it may be possible to create a grand bargain. Ukraine has initiated talks with China, asking China to take a leading role in ending the conflict. Indeed it is clear that China could end the conflict quite swiftly, if properly motivated. Russia has become so dependent on China that any significant reduction in trade between the two countries will begin to cripple production.

The consensus is that China is able to influence the timing of the end of the war. A move for a peace settlement (at an appropriate time) would catapult China's standing in the world enormously, as a global peace-maker.

If China were to make important steps and help reach a peace deal, I would have to say this would establish Xi Jin Ping as the greatest Chinese leader on the world stage in modern history. But this can only happen with economic concessions, and Ukraine doesn't have much to offer (more on that later).

The biggest economic carrot that the US and EU could hold out to China in exchange would be market access for Chinese-produced electric vehicles (and perhaps legacy vehicles as well). This could be an economic driver that benefits China for at least the next several generations, a high-value export that can provide good jobs to Chinese workers for the foreseeable future. Cars also require a wide variety of components, meaning additional high-value jobs. While it is always useful to adopt established standards and components, many of the subsequent patents would likely be Chinese.

I propose offering limited market access to the US and EU markets for one or two of the biggest, most established Chinese producers, with an expectation that the limits will be relaxed over time. However this in turn must absolutely require China to adhere to labor standards and cleanse its factories, including solar-cell factories, of forced labor. China at some point must demilitarize Xinjiang, and it must allow inspectors into factories there.

The benefits of a group of forced laborers, no matter how large, is tiny compared to the benefits of selling cars to the world. The added value of having one or three of the top car companies globally just cannot be overstated.

Those of us who have experience in the US auto sector have seen this movie before: An Asian nation enters the market selling low-end cars, and then evolves into a full-fledged brand worth billions of dollars. First the Japanese fought through the protectionist laws of the 1960s and 1970s with their tiny, cheap, front-wheel drive cars. The steel back then wasn't good, but the price point got them out there. Then the Koreans entered the market. Today both countries enjoy global sales of their high-value products.

The process would be difficult, as Chinese producers would have to be committed to adhering to Western standards of quality, support and customer-care. Massive overseas investments will need to be made, but the potential is substantial.

There are also some areas that Ukraine could focus on to help sway China. such as long-term grain deals. Additionally, once the war is over a lot of construction will need to begin, and China could get some of this business.

No settlement is possible so long as Putin believes that he will win, so nothing can happen until the facts on the ground change. Given recent developments in Kurst Oblast, the Ukrainians are unlikely to be interested in discussing peace at the moment either.

But, by the end of the year, a new calculus may be possible. After the US election, an announcement of another round of sanctions could lead to discussions with China.