Financial Interdependence and Currency Internationalization — by Zhengyang Jiang
Does financial opening necessarily lead to currency internationalization? To study the competition between incumbent and rising powers under financial interdependence, we develop a model of asset demand with microfounded network effects. Search frictions with currency-specialized intermediaries generate distinct notions of liquidity at asset-market and currency-area levels, which jointly shape the trajectory of currency competition. In the U.S.-China context, China at early stages of financial development benefits from pooling its assets with the dollar area, which reinforces the status quo. As China’s financial markets deepen, RMB issuance allows China to internalize network effects and erode the dollar’s dominance, triggering a discrete shift toward fragmentation. This transition is further shaped by sanctions, financial repression, and third-country responses, highlighting how financial interdependence transforms cooperation into rivalry in the evolution of the international financial order.
