Home / Petrodollars and Consumption (March 2026)

I'm not convinced anyone truly understands marcoeconomics, there are simply too many variables at play. However, over the past few years I've learned about two broad dynamics that I wish I understood sooner, because they explain a lot about what feels broken in our economy [1].

1. The Petrodollar System
Back in the day, people used gold instead of dollars. It was obviously inefficient and risky to carry around physical gold, so people started storing it in banks. Then they started trading the gold receipts they got from the banks because it was easier than withdrawing and trading actual gold. Eventually, governments replaced the receipts with currency notes that were backed by gold.

At least they were until 1971, when Nixon took us off the gold standard. It was too tempting for the government to print more dollars than they had gold to back. Eventually there was a run on the bank and instead of admitting there wasn't enough gold to go around, Nixon declared that US dollars were no longer backed by gold. Instead, they were backed by the full faith of the US government [2].

The faith of a government wasn't usually enough to give pieces of paper value. Normally if this happened, you'd expect people to ditch dollars and switch back to gold or a currency that was actually backed by gold. But that didn't happen with dollars, because the US made a deal with Saudi Arabia where the Saudis agreed to only sell oil for dollars, and in exchange, our military would protect Saudi Arabia and global supply lines. What the "full faith and credit" of the government actually meant was that dollars had value because you could only buy oil in dollars.

When I was younger, I couldn't understand why we kept warmongering in the Middle East, irrespective of which person or party was in power. Now I understand. If we don't play international police and protect our Saudi friends and international trade routes, global demand for dollars will drop and we'll lose the priveledge of printing money out of thin air. Of course, requiring that citizens pay US taxes in dollars and the fact that dollars are now the default currency creates value too, but it's hard to overstate how important the petrodollar arrangement was to solidifying dollars as the global reserve currency.

The Saudi arrangement also created another side effect. Currencies are subject to supply and demand just like anything else. Imagine you are the president of an island and your currency is Coconut Bucks. If there is demand for the goods and services your island exports, people need Coconut Bucks, so the price of Coconut Bucks rises in relation to other currencies. However, if demand for your exports goes down, the price of Coconut Bucks also goes down and your exports become cheaper, until eventually they become affordable enough for demand to start rising again.

What's unique about America is that there's global demand for US dollars because there's demand for Saudi oil, not just because there's demand for US exports. As a result, our dollars are overvalued relative to our exports, which makes our exports expensive relative to other countries. It's no wonder US manufacturing has been destroyed over the past 50 years. Irrespective of how hard our local businesses work, they are up against a headwind of being forced to sell their goods and services in a currency that makes them more expensive than they should be.

It's also no surprise that industries like finance and technology have done well over the past 50 years. If manufacturing has headwinds, they have tailwinds. Since US dollars are the global reserve currency, there's demand for banks sanctioned to buy, sell, and lend dollars. And if you are selling software with high margins and network effects, you can afford for US dollars to increase prices much more than someone who exports physical goods with low margins, little to no network effects, and global competition.
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2. Lending for Consumption vs Production
When you put $1 in a US bank, the bank is allowed to lend out $10. Fractional reserve banking is risky because if everyone went to withdraw their $1 of savings at the same time, the bank wouldn't have enough money to pay everyone. To protect against this risk, the government subsidizes banks with FDIC insurance, which guarantees up to $250k per account and enables the banks to lend out 10x more money than they actually have in deposits.

The government can afford to provide FDIC insurance because if there is a run on the banks, the government can print money out of thin air to repay everyone. The problem with this scheme is that the newly printed money will increase the supply and decrease the purchasing power of dollars, so while everyone will technically get their money back, their money will buy a lot less than it would have before the bank run. FDIC insurance repays you by taxing you.

I can't print money out of thin air to lend so why can banks? The government lets banks do this, because when done well, it's good for the economy. If a bank receives $1 in despits and lends out $10 to businesses, and those businesses turn $10 into $15, which is enough to repay the $10 loan plus interest, taxes and a little profit, then the economy grows and the whole system keeps working. However, if banks make a bunch of bad loans, it can trigger a bank run and/or a recession and blow up the economy like in 2008. So what matters in a fractional reserve system like this is what the money is lent out to do.

The problem in America is that the top 10 banks now manage around 70% of the assets, and when forced to decide between making loans that are profitable in the short term vs making loans that are good for the economy in the long term, they prefer the former, despite the fact that the priveledge of printing money out of thin air, the FDIC insurance that backs it, and military that enables it, is all paid for by the US taxpayers. US banks are less like businesses operating in a capitalist system and more like public-private partnerships, which is why it's funny so many bankers are self-described free market types.

Going back to loans. Imagine you are a big bank and you're deciding between a strategy of making $10k loans at 10% to small businesses or $10M loans at 7% to big corporations. Sure, you could make more in interest lending to small businesses but all those loans are going to take so much more effort to sell, underwrite, and service relative to the risk of default that it ends up being more profitable to lend to big corporations. Big banks like to make big loans to big businesses, giving them an unfair advantage over small businesses that have less access to capital.

The problem with this is not just that small business owners get screwed, it's that while making big loans to big businesses is better for bank profits in the short-term, it's worse for the economy and taxpayers in the long-run, because small businesses contribute more to GDP growth and growing the middle class. As a country, we'd be better off with small banks giving more loans at lower rates to small businesses at the expense of lower bank profits.

However, the bigger problem with big banks, and banks in general, is that they often prefer lending for consumption over production. And politicians support this, because when people can buy more stuff, even if it's on credit, they feel like the economy is doing better in the short-term and they are more likely to get re-elected. For example, the role Bill Clinton's administration played in the leadup to the 2008 financial crisis by pressuring banks to expand access to mortgages is criminally under-discussed.

Imagine you are a bank deciding between lending $1M to someone to buy a house vs lending $1M to a growing small business. If the small business goes bankrupt you could lose your entire $1M loan, but the $1M loan to purchase a house is collateralized by an actual house. How crazy that a bank can make a bad loan, the borrower defaults, and despite failing at their job as a lender they still manage to turn money printed out of thin air into a real house.

Lending for consumption has two negative side effects. First, consumptive loans flood the economy with money for things like houses and cars, which increases demand and makes them more expensive. And worse, these loans aren't used to produce more value, like a business that goes on to grow, employ more people and pay more taxes. When banks give out too many loans for consumption, they are enabling the country to live beyond its means, and eventually that bubble will pop when there's not enough economic growth to allow people to repay their loans and fund the government to the extent needed to keep the whole system afloat.

When it comes to these two dynamics, it's interesting to compare China and the US's policies. The Chinese force their banks to make lots of cheap, small loans to small businesses, while in America we encourage our big banks to make cheap loans to big businesses and for consumption, then we bail them out when they fail. Meanwhile, the Chinese have historically tried to keep the price of their currency low, making their exports competitive, while we play international police to keep our currency expensive so we can keep printing money to live beyond our means.

It seems like a country can have an effective government or an effective private sector, but not both. In America, we have a vibrant private sector, but because the market rules, big corporations and private interests are able to bend the government to their will, giving them an unfair advantage at the expense of taxpayers. Meanwhile, countries like China are able to leverage centralized control to run a more effective government, but that comes at the expense of allowing the private sector to maximally flourish.

In the race between China and America over the next 50 years, I believe the winner will be the country that figures out how to have both an effective government and an effective private sector, which means we need to fix our government before China fixes its market. Fortunately, we live in a democracy where the people are ultimately in charge, even if it doesn't feel that way. A lot of government problems can be solved by following the money and there's a reason people make finance seem complex. Where there's mystery there's margin (and sometimes, corruption). As a society, we should focus more on how our tax dollars are used than who can use what bathroom.

We also need to get away from thinking along political party lines, which present false dichotemies. For example, I wish more people were mentally flexible enough to realize that when it comes to something like healthcare, it's superior to have the government more involved because only the government can mandate universal coverage (which maximally distributes risk and lowers cost), wheras when it comes to something like startup innovation or taxes, we need the government to step aside and simplify things. The question is not more or less government, it's focusing the government on the things government can do well.

Until then, our lack of protest is inadvertently allowing our government to act like a trust fund kid, running up our credit card and doing favors for their rich friends, while China is acting like a ruthless small business owner, plowing everything back into growing their economy, even if it hurts their standard of living in the short-term. I believe it's possible to have a good government and a good private sector and I wish America would start prioritizing the long-term again, because I know a lot of incredible entrepreneurs working day and night to build the future who could use some tailwinds right about now.

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[1] To learn more about the petrodollar system and lending for consumption vs production check out Lyn Alden and Richard Werner, whose work informed a lot of this post.

[2] "I don’t believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can’t take it violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop.” - F.A. Hayek