Just because Hong Kong’s Linked Exchange Rate System is deemed appropriate today doesn’t mean it will be tomorrow. Such an assertion usually implies revisiting arguments about whether the economic mainlandisation of Hong Kong makes it appropriate to retain a link between the Hong Kong dollar and the US dollar. But perhaps the real issue is whether the 2022 greenback has the same characteristics as it did in 1983 when the peg was adopted. Back on October 17, 1983, the Hong Kong dollar was pegged at HK$7.80 to the US dollar, with the HK$7.75-7.85 band being an innovation that was unveiled in 2005. It might seem odd to even suggest that the US dollar, as it was perceived in 1983, is different from that of 2022, but currencies are more than banknotes. Currencies are a reflection of the financial architecture that underpins their value and the legal framework within which they exist. The post-1945 US dollar, which was fully convertible against gold at a price of US$35 an ounce, had already undergone a metamorphosis in 1971 when the Nixon administration, realising that the United States could no longer realistically meet its obligations, unilaterally suspended the greenback’s convertibility, resulting in a devaluation of the US dollar on the foreign exchanges. Fast forward to Riyadh in 1974, when a Saudi-US accord resulted in Saudi Arabia agreeing that its oil exports would be priced only in US dollars with the proceeds invested in US Treasuries. In return, the US agreed to buy Saudi crude and to provide military support for the kingdom. The petrodollar was born. In a financial coup for Washington, anyone who now wished to buy oil needed effectively to hold US dollars with which to pay, while the greenbacks received by the crude producers ended up being invested back in US Treasuries. Throw in the Jamaica Accords of January 1976 that legitimised the concept of floating exchange rates, and that’s broadly the structural global exchange rate environment at the time Hong Kong adopted the peg in 1983, and indeed when Saudi Arabia pegged the value of its currency at 3.75 Saudi riyal to the US dollar in 1986, a fixed peg that exists to this day. But if the petrodollar was a fundamental part of the architecture of the US dollar when Hong Kong rolled out its peg in 1983, that architecture rested on an implicit understanding that the sovereign investments in US Treasuries were inviolate. That implicit understanding is now under scrutiny after Western economies initiated a raft of sanctions on Russia following its invasion of Ukraine on February 24. These sanctions included a February 28 political decision by Washington and others to freeze assets of the Russian central bank that were within legal reach. That was a game-changer. Sovereign investors who have big US Treasury exposures can no longer assume those holdings are off-limits if bilateral relations become too fraught. Perhaps that helps explain why on March 3, with Saudi-US relations less harmonious than in the past, in reference to the country’s US investments, Saudi Arabia’s Crown Prince Mohammed bin Salman said that “in the same way we have the possibility of boosting our interests, we have the possibility of reducing them”. It has also been suggested that, in the future, Riyadh might sell oil to Beijing priced in Chinese yuan which would clearly erode the primacy of the petrodollar. Sanctions on Russia’s central bank could undermine the US dollar The fewer reasons to hold US dollars, the greater the likelihood the US dollar’s value adjusts lower. While perceived changes in the structural architecture that underpin global US dollar hegemony may not elicit an immediate market response, it doesn’t mean those shifts should not be debated. Writing on April 12, Credit Suisse’s Zoltan Pozsar equated Washington’s political decision to freeze Russian central bank assets to a weaponisation of the US dollar which will have longer-term negative consequences for the greenback’s value. Pozsar conjectured whether the changed circumstances negate the appropriateness of both Hong Kong’s Linked Exchange Rate System and the Saudi riyal’s peg to the US dollar. As it stands, on March 8, the International Monetary Fund stated that Hong Kong’s exchange rate system “remains the appropriate arrangement as an anchor for economic and financial stability”. But the IMF’s conclusion was based on a staff report that was completed on January 26, before Russia invaded Ukraine. When Hong Kong linked its own currency to the US dollar, that 1983 greenback had certain characteristics, but those features have not proved to be immutable. Just because the Linked Exchange Rate System is deemed appropriate today, doesn’t mean it will still be tomorrow. Neal Kimberley is a commentator on macroeconomics and financial markets