China’s love affair with the dollar

Despite the internationalisation of the yuan, the US dollar remains China’s currency of choice.

China middle class will be more than one-third of population to be in middle class level by year 2030
According to the Economist Intelligence Unit China's middle class will be more than one-third of the mainland population by 2030, with consumer spending being on the level now seen in the EU [EPA]

When former Chinese Politburo member Zhou Yongkang was arrested in 2014 on corruption charges, the scale of his ill-gotten gains was astounding, totalling some $16bn. When sums that large are involved most of the assets have to be invested in financial instruments and real estate.

But the list of physical currency found in his homes is revealing: 152.7 million Chinese yuan (valued at the time at $24.5m), 662,000 Euros, 10,000 British pounds, 55,000 Swiss francs – and $275m.

The former head of China’s internal security services and one of the 10 most powerful men in China apparently preferred to keep his “petty cash” mainly in US dollars.

He’s not alone. China lost around $1 trillion to capital flight in 2015, before clamping down hard at the beginning of 2016. Much of this money leaves China via fake invoicing in Hong Kong, where the local currency is pegged to the US dollar. Illicit outflows are also facilitated by casinos in the Philippines, South Korea, and on remote Pacific islands, all of which operate primarily in dollars.

Predictions of the dollar’s demise, and eventual replacement by the Chinese yuan, are a staple of global economic punditry, but they have little basis in reality. Of course, China has become an important component of the global economy, accounting for more than 15 percent of global gross domestic product. But when Chinese people themselves prefer to hold dollars, there is little chance that the Chinese yuan will ever replace the US dollar as the world’s key currency.

The almighty dollar

On December 1, 2015, the Chinese government met one of its most cherished goals when the International Monetary Fund (IMF) added the Chinese yuan (also known as the Renminbi) to the basket of international currencies that are used to calculate the value of Special Drawing Rights (XDR), the IMF’s benchmark unit for international reserves.

The yuan received a weighting of 10.92 percent of the value of the XDR. The IMF made room for the inclusion of the yuan by substantially reducing the weighting of the euro. The euro now makes up just 30.93 percent of the XDR basket, down from 37.4 percent. The pound is down to 8.09 percent (from 11.3 percent) and the Japanese yen fell to 8.33 percent (from 9.4 percent).

In a largely symbolic gesture, the weight of the US dollar in the calculation of XDRs was also reduced: from 41.9 percent to 41.73 percent. The yuan might displace the euro, the pound, and the yen, but it has had little impact on the dollar. In fact, the almighty dollar remains the dominant currency on world markets, involved in 88 percent of all international currency trades (PDF).

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For the Chinese government itself, the dollar-yuan exchange rate is the only relevant exchange rate. The Chinese yuan is benchmarked daily to the dollar through the management of the central parity rate, the average of the start-of-day exchange rates offered by major dealers.

Considering that all the major dealers in China are state-owned banks, the dollar-yuan central parity rate is effectively an official exchange rate. Other currency rates are set with reference to the dollar rate.

Duty-free but not dollar free

The world’s largest duty-free shopping operation isn’t in flashy Dubai or Singapore. The king of the duty-free shopping world is Seoul, South Korea – and the buyers are nearly all from China.

Seoul’s Incheon Airport generates nearly $2bn of duty-free sales every year, putting it neck and neck with Dubai International Airport at the top of the global rankings. But in Seoul, sales at the airport are just the tip of the iceberg.

Chinese travellers shopping in central Seoul pick out their perfumes, alcohol, and cigarettes at dedicated downtown outlets, take their receipts to the airport, and pick up their goods at their departure gates.

There they leave behind mountains of trash as they repack their purchases into carry-on bags. Adding in these downtown sales brings Seoul’s duty-free total to just over $8bn, a figure that dwarfs all other venues.

But don’t go to Seoul expecting to shop duty-free in local Korean won. All the prices are posted in US dollars. That’s not for the convenience of the Korean retailers, American tourists, or Korea-based American troops heading home to their families. The prices are set in dollars because the dollar is the currency of choice for Chinese shoppers.

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Over the last four decades, China has accomplished unprecedented feats of economic growth. But it’s marred by corruption and ruled by an authoritarian state.

As long as China’s political reforms lag decades behind its economic ones, the country will remain a place to make money, not a place to keep money. It is unrealistic to expect the world to turn to the yuan when the Chinese people themselves prefer to trade in dollars.

Salvatore Babones is a comparative sociologist at the University of Sydney. He is a specialist in global economic structure.

The views expressed in this article are the author’s own and do not necessarily reflect Al Jazeera’s editorial policy.