But does that really end the war when Japan still has troops on the ground and weapons? With their fanatical determination, they can still wage war under desperate circumstances and can still attempt measures to procure supplies of oil and steel, however inadequate. There will be a huge incentive to take big risks as the economic situation gets bad, won't there?
Depends on the alternatives & their consequences. In latter 1941 Japan made the decision for war in the face of collapsing economy and cessation of key industrial activity, due to the embargos. In that case the alternative to war with the US/Britain was a withdrawl from China, Indo China, & other concessions that would effectively leave Japan a client state of the US.
If the Europeans & US simply sit back and watch into 1942 as Japans economy sinks under the weight of war with China the the bankruptcy of the 'strike China' strategy is clearer, & with the European empires not weakened by a war underway striking anywhere else is more clearly not a option. Consolidation of the pre 1937 empire could be seen as a option. Particularly if the other nations with interests in China pressure the KMT into accepting (even if only temporarily) a peace with some further concessions to Japan.
Ultimately it was the Zaibatsu & related leaders at the top who controlled the central government. In 1937 they allowed the China War faction to proceed as that looked like it would settle the problems with the KMT for a generation & gain further economic benefits in China. The opposition was out voted and intimidated by possible assination. At some point the collapsing economy shifts the concensus in favor of ending a failing policy. The hard core supporters of the China war will become politically isolated & their lives or at least fortunes at greater risk.
Could japan just pull out of large parts of china or would that be politically unacceptable
Depends on what the KMT will concede. The KMT was not in a good position either. If some third party, maybe a group of European empires, can broker a face saving white peace between Japan & China. The current war can be ended. The Europeans and the US both had some economic leverage over the KMT.