With fears mounting that the US dollar could crash one day in the future, and Beijing calling for the adoption of the special drawing right (SDR) as a global currency, it is worth wondering if it would make sense for Hong Kong to ditch its peg to the US dollar and instead hitch its currency to the SDR. That sounds like it would be a long and complicated process, but in fact, re-pegging to the SDR could be achieved with surprisingly little fuss. Bear in mind that the SDR isn't really a currency at all, it is a composite unit of account made up of 63 US cents, 41 euro cents, 9 pence and 18.40 yen. Because its constituent currencies change in value every day, so does the SDR. Yesterday, for example, one SDR was quoted by the International Monetary Fund at an exchange rate of US$1.50 (give or a take a few decimal places). With the Hong Kong dollar trading at the strong side of its convertibility band yesterday, that means one SDR was also worth HK$11.625. So if the Hong Kong Monetary Authority decided tomorrow to abandon the US dollar in favour of the SDR, all it would have to do would be to issue an announcement saying that from now on, the Hong Kong dollar will no longer linked to the US dollar at an exchange rate of HK$7.80. Instead, it will be linked to the SDR at a central exchange rate of HK$11.70 to one SDR, with the HKMA guaranteeing two-way convertibility in a band between (say) HK$11.625 and HK$11.775. Naturally, the market would be stunned. But with US$177 billion in foreign reserves (or rather 118 billion SDRs), the HKMA would have more than enough weight to flatten out any short-term volatility. In any case, dealers and investors would rapidly realise that very little had actually changed and would settle down with their spreadsheets to work out exactly what the new exchange rate system would mean to them personally. At first, the re-pegging would look like a non-event. But then problems would begin to arise. The first, strangely enough, would be exchange rate volatility. Although the Hong Kong dollar would remain stable against the SDR, it would begin to fluctuate against the US currency for the first time in 25 years. To understand the implications of this, imagine if the HKMA had pegged to the SDR instead of the US dollar back in 1983. The first chart below shows how the US dollar would have performed against the Hong Kong currency. After initially strengthening, the US dollar would have fallen steeply, and today it would be worth just HK$5.47. In other words, the Hong Kong dollar would be 42 per cent stronger against the US currency than it actually is now. More to the point, the Hong Kong currency would be much more volatile against the US dollar. In a world in which international commerce is still denominated almost entirely in US dollars, that would mean a lot of extra risk for Hong Kong businesses. It would also impose a considerable extra cost burden on local companies, with business people constantly reaching for their calculators to perform the fiendish four-way calculations necessary to work out new prices for goods and services, given likely changes in SDR basket currency exchange rates. Pegging to the US dollar has the great merit that it is simple. Linking to the SDR would be brain-numbingly complicated. Exchange rate volatility would not be the only problem. Adopting the SDR would also mean adopting SDR interest rates, which historically have tended to be lower than US dollar rates. At first, that sounds like a good thing. But take a look at the second chart, which shows the likely trajectory of Hong Kong's benchmark interest rate, three-month Hong Kong interbank offered rate, had the Hong Kong dollar been pegged to the SDR over recent years, not the US dollar. During the boom of the mid-1990s, our interest rates would have been about two percentage points lower than they actually were, exaggerating the size of the city's property and stock market bubbles and exacerbating our inflation rate. Similarly, between 2005 and 2007, the stock market bubble would have been even more severe. Clearly, linking to the SDR at any point in the past 25 years would have been a lousy idea. And the chances are that pegging to the SDR would be equally dumb at any time in the next 25 years. It would only ever make sense if the rest of the world actually started pricing its international trade in SDRs and issuing SDR-denominated debt. That, however, is extremely unlikely to happen in the foreseeable future, which means that unless the yuan ever becomes the world's reference currency of choice, Hong Kong will be much better off sticking with its peg to the US dollar.