The China Factor

15 mins. to read
The China Factor
ESB Professional /

The dragon and the bear

China’s official position since Russia invaded Ukraine on 24 February has been one of tacit support for its strategic partner. Senior Chinese officials have followed the Russian line that the conflict is fundamentally caused by a US-led policy of NATO expansion, yet they continue to describe Ukraine as a sovereign nation. China has also expressed concern about civilian casualties.

China almost certainly knew of Putin’s intention to invade Ukraine in advance; and it seems likely that it requested Putin not to launch the invasion until the end of the 2022 Winter Olympic Games. President Xi Jinping places a high priority on favourable, foreign-media coverage of his country and the Games were an opportunity to showcase China to the world.

If China did not know about the invasion, then the ‘lovefest’ when Putin and Xi met in Beijing on 4 February to declare their “limitless friendship” was a sham. But consider this. When Russian troops entered Ukraine on 24 February, China advised its citizens there to display Chinese flags prominently in their windows. A few days later, the advice changed: the message was to take the flags down and get out. China expected a rapid and decisive Russian victory – but that did not happen. On 7 March, CIA director general William J Burns told Congress that the Chinese leadership has been surprised and unsettled by events.

Given the scale of sanctions now in place against Russia, with about $300bn of the Russian central bank’s reserves effectively frozen, China will continue to support the Russian economy − but there could be strings attached. China is a major buyer of Russian oil, coal and natural gas. These imports are settled through the Chinese-controlled Cross-Border Interbank Payment System (CIPS).

Launched in 2015, CIPS was developed by China’s central bank to promote the international use of the yuan/renminbi, and largely handles yuan-denominated trade between China and its foreign trading partners. But CIPS handles around 13,000 transactions a day, whereas SWIFT processes about 40 million transactions per day. Furthermore, SWIFT messaging underpins transactions between the Moscow branch of Industrial and Commercial Bank of China (ICBC), the only yuan-clearing bank in Russia and ICBC’s Beijing headquarters.

China’s banks and its internal payments platforms could offer Russia respite from the crippling western sanctions regime. China has helped other nations evade sanctions, and both China and Russia have a long-term goal of weakening the dominant position of the US dollar in the international financial system – what China calls “dollar hegemony”. Just over a third of Russia’s exports to China were settled in dollars last year, down from 96 percent in 2013. And just over half of China’s exports to Russia were settled in dollars, down from 90 percent in 2013.

But, according to Asian sources, Chinese financial institutions have been less enthusiastic about doing business with Russian clients than their political leaders. And more so now because, under laws passed by Congress in 2017, the US can penalise foreign entities that trade with sanctioned companies, countries and individuals. So-called secondary sanctions have stymied Chinese banks in the past. When the US sanctioned Hong Kong chief executive Carrie Lam in 2020, she reportedly lost access to her bank accounts and had to collect her salary in cash. Any bank that uses CIPS to circumvent SWIFT could face the threat of secondary sanctions. That said, China is known to have set up special-purpose financial institutions to facilitate trade with two other sanctioned countries, namely North Korea and Iran.

On 28 February, JP Morgan Chase chief executive Jamie Dimon warned that excluding Russian banks from SWIFT could have unintended consequences. Certainly, banks which have large volumes of loans outstanding to Russian entities, such as Italy’s UniCredit Bank, may encounter liquidity problems. Other commentators have observed that by denying Russia access to the US dollar, the world’s reserve currency, countries may seek to hold reserves in other global currencies, in gold or even in cryptocurrencies. If the standing of the dollar in the international financial system were diminished, then fewer central banks would seek to hold US Treasury obligations. That would unleash upward pressure on US interest rates, leading to higher debt-interest payments for the federal government.

In recent years, Washington has furthered its foreign-policy objectives by means of the ‘weaponisation of finance’. The US has used the dollar’s global dominance to deny the central banks of Iran, Venezuela, and (most recently and controversially) Taliban-controlled Afghanistan access to their own reserves. The doctrine of sovereign immunity normally protects a foreign central bank’s assets, usually held at the New York branch of the Federal Reserve, if they are “held for its own account” – so this is a grey area.

No doubt the Chinese will assess the world’s reactions to the Russian invasion of Ukraine in the frame of how the international community might react to a Chinese invasion of Taiwan. Last week Shinzo Abe, the former prime minister of Japan, urged the US to drop its policy of “strategic ambiguity” over Taiwan. But if China calculates that by attacking Taiwan its dollar reserves held in the US might be frozen or seized, it may now decide to divest itself of dollar holdings. This could result in what Dylan Grice of Calderwood Capital Research calls “a bipolar monetary order”. Or what legendary speculator Doug Casey calls the “monetary reset”.

The 1997 Asian financial crisis and then the 1998 Russian financial crisis shocked developing countries into accumulating more foreign-currency funds to defend their currencies in times of financial turbulence. Aggregate central-bank reserves rose from under $2trn then to a record $14.9trn in 2021, according to the International Monetary Fund (IMF). While central banks have also sought to buy gold, that only makes up 13 percent of their total assets; though Russia’s central bank, with 2,300 tonnes of gold (74 million troy ounces), holds about 23 percent of its total reserves in gold. Foreign currency accounts for 78 percent of central-bank assets. The remainder is held at the IMF in the form of special drawing rights (SDRs). But on 3 March, the US and its partners (the EU, the UK and Canada) announced that they would no longer permit Russia to convert its SDRs into hard currency.

If the West goes ahead with a full-scale ban on the purchase of Russian oil, as now seems likely, Russia has threatened to turn off the gas pipelines to Europe (these are worth about $1bn a day to its economy). This will have consequences. German economy minister and vice chancellor Robert Habeck has warned that shortages of energy in Germany could lead to a breakdown in social order.

But Russia is already having difficulty selling its oil, even given deep discounts. Thus, Russia will most probably stockpile its oil and increase gas supplies to China. Currently, there is only one pipeline linking the two countries’ gas networks, though a second one (Soyuz Vostok), which runs across Mongolia, is now planned. Russia will start to accumulate more Chinese assets, and possibly more gold as well, especially since Russia accounts for about 10 percent of new gold mined each year.

Russia has been effectively kicked out of the global economy. Visa, MasterCard, and American Express have cut it out of their networks. The popular cryptocurrency exchange Coinbase has blocked over 25,000 accounts linked to Russia. Consequently, Russia’s Sberbank and Alpha Bank now plan to use China’s UnionPay payment platform to process Russian credit-card transactions. Rosbank, Tinkoff Bank and Credit Bank of Moscow are also planning to use UnionPay cards, which are accepted in 140 countries.

Further, China, India, Iran and Turkey, and many other countries, have announced that they will continue do business with Russia in their local currencies instead of the US dollar. These countries collectively represent a market of over three billion people.

If we are seeing the emergence of a “bipolar monetary order”, it comes at a moment when the US, which has been the cornerstone of the international financial system since the Bretton Woods agreement (July 1944), is under severe financial stress. The US is being challenged for global supremacy by a rising China; its debt-to-GDP ratio is deteriorating rapidly, as it seems incapable of running a fiscal surplus; the 25-year tech boom may be attenuating; and inflation is at a 30-year high. Surging energy and commodity prices have already put pressure on EU bank stocks and some US assets. The fear is that the equity markets could be heading for a fall.

To date, the US dollar has been the world’s premier reserve currency. That has permitted the US to conjure money out of thin air and export it to the rest of the world in exchange for real goods and services—a privilege no other country enjoys. But if de-dollarisation results from the “bipolar monetary order”, that privilege may be lost. In a bid to stop a Russia-China gold-based monetary system, the US and its partners have denied Russia access to the London Bullion Market Association. And a group of US senators is moving to sanction anyone who buys or sells Russian gold.

Agricultural commodity supply chains disrupted

China is a major consumer of Ukrainian wheat, corn (maize), sunflower oil and fertiliser (potash). About one third of all the corn it buys, mostly for animal feed, is Ukrainian. The effective closure of Odessa, which normally handles about one million containers per year, will hurt China. Western companies operating in Odessa such as Germany’s HHLA which runs the port’s container terminal, and the US giant Cargill (private) which owns a grain terminal there, have evacuated their workers. Russian naval vessels have effectively blocked the entire Ukrainian coast from Moldova to the Sea of Azov.

About one third of world exports of barley come from Russia and Ukraine combined, along with 29 percent of wheat and 80 percent of sunflower oil. Much of this is shipped out of Odessa and Kherson, which is now under Russian control.

The world was facing a grain supply crunch even before Putin invaded Ukraine. Inventories of traded commodities were already low, though China has been stockpiling for months and reportedly holds 84 percent of the world’s copper, 70 percent of its corn and 51 percent of its wheat. We can also expect that Ukrainian farmers will not plant their corn in April as they normally would – so there will be knock-on effects next year and beyond as well.

Last November, the World Food Programme warned of a “catastrophic scarcity” of food commodities across the Maghreb countries, much of Africa, Bangladesh and Afghanistan. Last week, a Russian missile hit a Bangladeshi-flagged bulk carrier, killing one of the crew. Accordingly, the Black Sea is now a no-go zone. Even China’s Cosco, one of the world’s ‘big six’ shipping lines, has suspended shipments to and from the Black Sea. Shipping insurance costs are spiralling, and banks are refusing to accept letters of credit in respect of Russian cargoes.

To make matters worse, weather patterns related to the La Niña phenomenon have brought droughts to Brazil and Argentina, affecting harvests there. We have the makings of an enduring global food crisis ahead of us – tragically, millions of people are going to go hungry in the next few years.

Indian neutrality

Indian prime minister Narendra Modi has refused to denounce Putin and his war of aggression, despite the thousands of Indian students welcomed by Ukraine each year. India abstained on the motion of condemnation passed at the United Nations General Assembly. The US has called on India to use its leverage with Russia, which is a major supplier of arms and technology to the Indian military. But with China making incursions into Indian territory along the Line of Actual Control (LAN) in Ladakh and Arunachal Pradesh, India feels it needs to maintain Russia’s influence with the Chinese. India is, like China, a civilisation state which will play a critical role in geopolitics in coming decades.

So much for “Global Britain” with a special relationship – and comprehensive trade deal – with India. Perhaps the £55.3m of British aid earmarked for India this year would be better spent alleviating the condition of Ukrainian refugees.


China, as Russia’s key trading and strategic partner, is poised to act as honest broker between Russia and Ukraine, with the aim of negotiating a ceasefire. Total trade between Russia and China rose by 36 percent in 2021 to a record $146.9bn, according to Chinese data. And last month, Beijing and Moscow announced their aspiration to raise that figure to $250bn.

That will not happen anytime soon. The Financial Times reported on 10 March that Chinese smartphone manufacturers are unable to profit from the withdrawal of Apple and Samsung from the Russian market because the collapse of the rouble means that they are now selling their products at a massive loss. Shipments of smartphones from Xiaomi, Huawei and Oppo to Russia have all but halted.

The Chinese therefore have an interest in avoiding further disruption. Putin is still taking calls from President Macron (to what purpose is not clear – is he toying with him?) but a call from Xi would be a different matter. If Xi could emerge as a peacemaker, that would lend him kudos which he could use to China’s advantage. China has stated that it wants political stability in the international community: the smouldering civil wars in Syria, Yemen and Eritrea are inimical to the fulfilment of China’s Belt and Road Initiative. In addition, there are a few areas where Russian and Chinese interests collide, such as the economic exploitation of the Arctic and the future direction of Kazakhstan (whose population is closely related to the Uighur people who are being brutalised in Xinxiang). Beijing might regard this as a good moment to get concessions from Moscow in both those spheres.

China will not permit Putin – if it can possibly help it − to use nuclear weapons on Ukraine. Xi knows that China is deeply integrated into complex supply chains with the West and is still a major recipient (unlike Russia) of western investment flows. China also knows that Europe and the US need its manufacturing capabilities, which Russia simply cannot offer.

Even if Russian forces prevail by taking the main population centres in Ukraine and forcing the Zelensky government into exile, their task will only have begun. They will face the prospect of subduing a population which bitterly resents their presence. Putin has framed the war for his own people in terms of liberating the fraternal Ukrainian people from the neo-Nazis who control their country. The Ukrainians do not see it that way. In the 2019 parliamentary elections the far-right polled just two percent of the vote. Most Ukrainians, including many Russian-speakers, don’t want to come under the yoke of Moscow. The Russians will have to negotiate at some point.

I don’t think that China, any more than the US, will want Ukraine to become another Syria – with an extended war of attrition against the hapless civilian population, including phosphorous barrel bombs and chlorine chemical attacks – though that will happen if Putin remains the sole arbiter. Kyiv would resemble Aleppo within a few weeks. On the other hand, China’s diplomatic service lacks subtlety and would struggle to win the trust of all parties.

Even if China were to broker a peace deal of some kind (probably one that greatly emasculates Ukraine), I can’t see those 850 McDonald’s restaurants in Russia reopening soon. In the same way, the likes of EY and PwC who went East after the fall of the Berlin Wall will probably never return to Moscow. And Europe is at last resolved to wean itself off Russian hydrocarbons.

Just as the international monetary system will split in two, so the internet and global social media will bifurcate into mutually inaccessible domains of East and West (the latter embracing Japan and South Korea). Indeed, Cogent Communications, one of the background companies that makes the internet work, has severed all ties with its Russian partners. No doubt there will be shrieks of angst when privileged oligarchs’ children are deprived of their Instagram accounts.

Chinese service providers of all kinds will no doubt take up the slack in a Russia which has inflicted economic desperation on itself. Ironically, the Russia that waged an aggressive war to assert its great power credentials will become increasingly beholden to an even greater power which has an economy more than 10 times its size. In 20-30 years’ time, the Chinese might seek the return of parts of northern Manchuria which they ceded to Russia in 1860. They might even accuse Russia of committing genocide against its sizeable Chinese minority. That will be interesting.

What is happening now is that 40 years of globalisation, low-to-zero inflation and bullish bond and equity markets are unwinding. Deglobalisation is now the name of the game as countries seek to ensure energy security and food security (which I discussed recently) as a corollary to their currently inadequate military expenditure, which will have to rise. That is the three-legged stool upon which statecraft will sit for the next half century. China dragged itself out of poverty in the era of globalisation: it will not prosper equally in the era that follows.

Perhaps the identity-obsessed West will now conclude that our way of life is worth defending – and tell the culture warriors where to get off. We are going to have to think strategically, not self-indulgently. But the unwelcome truth is that global living standards will continue to decline for the foreseeable future.

How democracies can cope with that grim reality is something I wish to ponder soon.


Yesterday, I fired up the motor mower for the first time this year. I made a foray into the orchard (apple, plum and greengage trees). Nothing drastic. I just mowed the paths that will become rough lawn by late spring, with plenty of islands of saplings and soon-to-manifest wildflowers. Then I seeded the bald patches with rye grass.

The birds that visit my garden may serve themselves to an all-you-can-eat buffet of bird-seed mix and stale bread near the 17th century well (which I am still excavating). But no. The pigeons, who all seem overweight to me, are now gorging themselves on my grass seed and the dog who spurns excess toast indoors is stealing the birds’ meal.

It’s not just human beings who are perverse.

Listed companies cited in this article which merit further analysis:

  • Coinbase Global Inc. (NASDAQ:COIN)
  • Hamburger Hafen und Logistik AG (Frankfurt:HHLA)
  • Cogent Communications Holdings Inc. (NASDAQ:CCOI)

Comments (3)

  • Phillip says:

    A most excellent summary. Well worth a full read, beginning to end.

  • Bob Mackintosh says:

    Apparently *, at the end of the cold War and at the dissolution of the Soviet Union, president Gorbachev of Russia came to an agreement with the West which included the promise that NATO would not be extended further east than the borders of the newly-unified Germany. There was a “near universal understanding” that any failure to honour that would be an “unwarranted provocation against Russia”. And yet there have been repeated violations ever since, with, for example, now a NATO missile base near a Polish/Russian border. Russia presumably views Ukraine’s reaching out to the West as the last straw. I don’t know whether Ukraine has made any specific new overtures to the West in the past couple of years that have precipitated Russia’s decision to act now. The West is certainly in disarray, with internal problems in the EU and UK, layered on top of the aftermath of Covid-19.
    Ukraine may now consider that we are in a new paradigm, and that historical agreements can be regarded as null and void. But apparently President Obama refused to allow arms sales to Ukraine (although that decision has since been reversed under Trump and Biden).
    None of this excuses the mode of either Russia’s initiation of the present war, nor of its prosecution (although the latter may be partly conditioned by Russia’s economic condition). But I am very surprised that Russia does not seem to have raised the above issues explicitly, instead bringing forward claims of neo-Nazis, nuclear rearmament and biological weapons programs.
    However, as you make very clear in your article, Victor, things have now proceeded far too far down the road, even though in only 2 weeks (how fast the modern world moves), for any possibility of them being reversed. But let us all hope and pray that nuclear war will not be the result.
    * Blog by Chris Hedges in, quoted in this week’s edition of MoneyWeek magazine (Issue 1094, 11 March 2022).

  • Dan Gee says:

    This is terrifically detailed and comprehensive. The Russia bashing is understandable given what most know or think they know, but I doubt the Russians want to occupy Ukraine – rather install a pro-Russian government and ensure they have a viable land bridge to Crimea.
    If China supports Russia consistently then the quid pro quo may already be that Russia supports in some form a Chinese move on Taiwan.
    (I wrote more substantively after the last blog, and am sorry it wasn’t published)

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