Financial Interdependence and Currency Internationalization

Department: Finance

Speaker: Zhengyang Jiang (Kellogg North Western)

Room: TBD

Abstract

We study how incumbent (U.S.) and rising (China) powers compete in the provision of reserve assets under conditions of financial interdependence. Our analysis emphasizes the role of network effects in shaping China’s timing of RMB internationalization. At early stages of financial development, China benefits from issuing dollar-denominated assets, as participation in the dollar system enhances its liquidity. However, as China’s financial sophistication surpasses that of the U.S., incentives reverse: issuing RMB assets allows China to erode dollar dominance and expand its own market share, triggering a discrete and destabilizing shift. In this model, U.S. sanctions accelerate this transition by prompting China’s premature exit from the dollar bloc, illustrating the limits of unilateral measures. Moreover, in the presence of third countries, network effects give rise to multiple equilibria, amplifying volatility during the transition period. These results highlight how financial interdependence can transform cooperation into rivalry in the evolution of international financial order.