The Petrodollar System

Many of us are familiar with the idea that the dollar is the global reserve currency. This means that when other countries conduct trade, goods are often priced and paid in US dollars, even when the US is not involved in the transaction.

This gives the US tremendous power both globally and at home. Internationally, having the global reserve currency gives us immense policy influence—for example, financial sanctions. When we impose sanctions on Iran, we can basically cut them off from the global banking system entirely by cutting off their ability to use the dollar  and the SWIFT system in international trade. By essentially being able to ban them from using the dollar, they are cut off from the global economy, which is overwhelmingly priced in dollars.

But why is the dollar the global reserve currency? Well – one huge reason is because of oil. Oil is priced globally in dollars. If Russia wants to buy oil from Saudi Arabia, they do it in dollars. Why though?

In the mid-1970s, the US agreed to provide military protection to Saudi Arabia in exchange for the global pricing of oil in dollars. This is the backbone for the dollar’s international strength and provides a global demand for dollars that no other country or region can compete with.

Understanding this is where things start to get complicated and morally grey. In exchange for the power we receive in return – oil priced in dollars globally – we are protecting the regime of a country with longstanding problems and human rights abuses ( Furthermore, we are also supporting the global oil trade.

In a way, the US is reliant on oil. We need other countries to keep demanding oil because, without that, $USD would not be as needed globally, and we would lose significant international power.

It is almost hypocritical for our leaders to talk about green energy in the US when not only are we protecting the Saudi oil trade, but we need it to continue, to enforce the global dollar hegemony that has been present since the end of WWII. Hypocritical isn’t really the right word though, since most politicians don’t understand the dynamic at play here any more than the average person does. 

Can we just stop protecting Saudi oil? It’s not so simple.

The global soft power we would lose is considerable. Sanctions against Iran don’t do nearly as much if they can just buy whatever they want in Russian rubles instead of dollars.

And it’s not just international either. Global demand for dollars sucks USD out of the country, which is good since we print a ton of new dollars. If global demand for USD falls, yet we keep increasing the money supply, those dollars will stay in the country, and price inflation would likely rise. If you want more deficit spending, more social programs, more stimulus, etc., you need global demand for the dollar to stay high. This is why the US can create much more new money than, for example, Nicaragua can.

To summarize – it’s complicated. We’re protecting a corrupt Saudi oil regime and we’re protecting the global use of oil itself. We need countries to keep buying oil priced in dollars to maintain the dollar’s dominance, even though it’s at odds with the green future that we want. And if we stop that protection, it causes a ton of other problems for the US.

While the dollar may not be ‘backed’ by anything, the backbone of its strength is oil.

If you have time, check out this piece by Lyn Alden It’s like a 45-minute read, so you might want to break it into chunks.

The technological innovation of Bitcoin

It’s easy to get a little lost when trying to first understand Bitcoin. Part of the reason is that most of us are introduced to Bitcoin AND ‘cryptocurrency’ as a whole. It’s a lot to take in, and it’s natural to get confused.

So I thought I would take a moment to remind everyone why Bitcoin is a genuine technological innovation.

If I want to pay someone in cash, it’s as simple as handing them a $5 bill. I give them the money, and now it’s theirs. Digital payments today don’t work that way. In order to send someone a payment digitally, a bunch of intermediaries get involved.

At a minimum, there are two – my bank and your bank. Usually, there are more though, like Zelle, Visa/Mastercard, Cash App, Venmo, or PayPal. To pay people digitally, we need to get routed through a bunch of financial companies. It works fine for small and local payments, but it is nothing like handing someone a dollar.

What if you wanted to send a family member in Japan or Norway $15,000? How would you even do that? None of these higher-level intermediaries, like Paypal, would let you pay that much. Odds are the recipient’s bank account doesn’t accept USD, and even if they do, it will take up to a week for the wire transfer to clear. So you have to go through another intermediary like Western Union instead and pay fees there as well. It’s just complicated.

Bitcoin was created to make digital payments more like handing someone a $5 bill than the intermediary-driven system we have today. When you send a payment through the decentralized Bitcoin network, there is no intermediary the payment has to run through. It is fully peer-to-peer and direct.

If I want to send $15,000 in Bitcoin to someone in Japan, I can do it immediately, without going through a single intermediary. This is the innovation of Bitcoin. Digital payments without intermediaries.

You need to understand that before Bitcoin, this simply was not possible. That alone is valuable. How valuable? Well, now that is up for debate. And there is undoubtedly more to the Bitcoin picture than just what I described here.

But just for grounding purposes – that is the innovation. Digital payments that don’t need to run through any bank, government, or company. To make sending money over the internet just as direct as handing someone a dollar bill.

Maybe you don’t need that ability, and that’s fine. But many people do. And for the first time ever, it’s now possible, because of Bitcoin.

Is science actually getting worse?

Some time ago on Twitter I commented about how it seemed like 2020 was the year that science became politics. It makes sense in a world where everything is both polarized and politicized.

As I’ve thought about it more in recent weeks, I’m beginning to believe that much of the problem relies with science itself. Or, more specifically – data.

Back in centuries and millennia past, there was no good access to data. Much of our scientific progress came from thinkers who saw something that could not be measured and then set out to find out whether it was true or not. The thought – the scientific breakthrough – came before the data.

Today, the opposite is true. We have access to so much data, yet we have no idea what to do with it. It’s backward from how it used to be. Instead of having the breakthrough first and then looking for evidence, now we start with the numbers and then try to find significance.

This dynamic – where we take the data first and then try to assign a meaning to it – has led to a lot of bad science.

Numbers can be made to say almost anything. You can come up with 100 data points that say X is good and 100 more that say X is bad. This is sometimes done deliberately and with malicious intent, but not always. There is just too much data and it gets us confused.

So we have all these numbers – this information – and we try to make it mean something. We get caught up in it, and we try to assign meaning that isn’t really there. It’s like a mirage in a desert.

The fact is that you just can’t trust most numbers anymore. Everything should be taken with a grain of salt. There should be no one source or study that you listen to without hesitation. You can’t rely on this vague notion of ‘data’.

It’s an uncomfortable place to be. The numbers might be legitimate, but the conclusions drawn from them are very often not.  Nobody gets to be an authority anymore.  

Take a look at the chart below from a 2016 article by FiveThirtyEight about how you can’t trust nutrition information. Note the correlations.

These correlations are statistically significant from the sample, yet they mean absolutely nothing.

This is bad science, and it’s representative of why the idea of ‘science’ is getting less reliable. Experts are just as guilty of this as anyone. A lot of genuinely intelligent people – experts – do the equivalent of deriving meaning from charts just as nonsensical as this.

There are often two camps of people on this kind of stuff. The ‘trust the experts’ people and the ‘do your own research’ folks. Neither of these approaches is correct. The experts present the bad data as fact, and the DYOR people just look for different experts that match their already existing, preconceived notions.

Obviously, plenty of good also comes from our ability to measure so much. But the rise in available information has led to a world where sources that we have traditionally believed to be ‘fact’ cannot be completely relied on. You need to be more skeptical.

There’s too much data out there. And it’s making us all dumber.

Stimulus makes inequality worse, not better

Last week, the Senate passed President Biden’s $1.9 trillion stimulus package. There is no doubt that the stimulus will provide significant relief for many people suffering due to this year-long pandemic.

But there is a dark side to this as well, and that dark side rarely gets discussed. Neither party understands it, nor do average Americans. The downside of the stimulus package is not the usual hubbub about debt and deficits, either. Instead, the problem is that this stimulus package makes the poor poorer in the long run. It makes inequality worse.

So how does this work? It is simple.

All the new money that gets printed for the stimulus has to end up somewhere. For people who lost their jobs from the pandemic, they spend the money on things like food, rent, and other necessities. That’s all fine.

For people like me though – lucky enough to stay employed throughout the pandemic – what do I do with my stimulus check? I invest it.

With this much new money entering the economy, a substantial percentage of it will end up in things like the stock market, pushing asset prices higher. Because of this, the gap between the wealthy and the poor will continue to grow. This effect is natural and inevitable. The bigger the stimulus, the more inequality grows.

Note – I’m not against the stimulus. I’m happy people are getting help. But you have to understand the tradeoffs, and most people don’t. The tradeoff with stimulus is that by helping people today, you are making them fall further behind tomorrow.

For the same reason, I don’t want to hear you complain when tech stocks shoot up and billionaire net-worths go higher, the same way that happened after the first stimulus. Yes, Amazon stock is going to go up. No, don’t get mad at Jeff Bezos. The stock will go up directly becauseof the stimulus. Your support caused this. Maybe that’s not what you wanted, but it’s how money works.

Not everything is as black and white as you think. Luckily, I’m here to open your eyes to the gray.

To learn more about some of what I articulated here, check out the below two issues from my educational Questioning Money series.

How Money Drives Inequality
You Can’t Save Money In Dollars

Coinbase IPO

Coinbase released its S-1 report on Thursday ahead of its upcoming IPO. The report revealed many interesting data points, but I want to touch on one thing in particular.

Take a look at the red line in the chart below. This line represents the percent of Coinbase volume that is made up of retail investors, ie, people like you and me.

While many of us following the space have heard that institutions have driven this recent price run instead of retail, the chart from Coinbase makes it clear. While retail speculators were 80% of volume in the previous run-up to $20k in 2017, retail was only 36% of this most recent run to $50k.

Institutional investors are not like retail. They don’t get scared off after a short downturn and sell at a quick loss. They are less emotional. The institutions buying BTC are doing so with a much longer-term investment timeframe. The transfer of BTC from weak-hand 2017 retail investors to institutions in 2020 means that floor of the Bitcoin price is rising since institutions are less likely to sell.

At the same time – only the first 5% of Wall Street is invested in Bitcoin thus far. Only one S&P500 company has Bitcoin on its balance sheet (Tesla). Wall Street’s foray into Bitcoin has barely started.

The institutions that have invested so far are the front-runners, the early adopters of their kind. Many more are sure to follow.

I think a lot of people are going to be surprised by what happens next…

For other interesting numbers from the Coinbase S-1 filing, check out this Twitter thread:

Unit bias in Bitcoin

One of the most common things that you’ll hear about Bitcoin is that it’s too expensive now. ‘One Bitcoin is $45,000?? How can anyone afford that?!’

This is what is known as unit bias. While one Bitcoin may look expensive, the per-unit price of Bitcoin does not matter.

The reason why one Bitcoin looks so expensive is that there are only 18 million Bitcoin circulating. Given that the network as a whole is worth about $800 billion, that leads to a per 1.0 BTC cost of around $45,000.

This is the point that you need to understand – the only reason Bitcoin looks expensive is because there are so few units (though remember, 1 Bitcoin is divisible to the hundred-millionth of a BTC).

To understand this, you need to look at the market capitalization, which is the value of the entire network.

The calculation for market cap is – Unit Price x Supply = Market Cap.

So – in which below scenario does $1,000 buy you the most Bitcoin?

  • 18 million Bitcoin supply at $45,000/BTC
  • 180 million supply at $4,500/BTC
  • 1.8 billion supply at $450/BTC

The answer is that $1,000 buys you the same amount of Bitcoin in all three scenarios.

What you are buying with $1,000 is a percentage of the overall Bitcoin supply, which does not change in any of the above scenarios. You buy the same percent of the Bitcoin supply in choice C as in choice A.

Bitcoin is not more expensive in choice A at all, the only difference is psychological. Understand this point. The difference is only in your head. It’s not real. The feeling that ‘one whole Bitcoin is too expensive’ is just our brain playing tricks on us.

To illustrate this further – 17 billion shares of Apple have been issued, nearly 100x more than the circulating amount of BTC. Apple’s current share price is $136 and its market cap is $2.2 trillion. If there were only 18 million shares of Apple, like there are units of BTC, each Apple share would be worth $122,000.

$136 AAPL out of 17 billion and $122,000 AAPL out of 18 million are the same thing. What matters is that the market cap, Apple’s actual value, is 2.2 trillion. $1,000 buys you the same amount of Apple each way. Again, there is no actual difference. Only psychological.

Making the units/shares the same in the opposite direction is true as well, $45,000 BTC is equivalent to $47 APPL.

This is how unit bias works. We see things that look ‘cheap’ and we think that they are a good deal. When we see something ‘expensive’ we get hesitant. This is not correct, however. It’s all just a function of the circulating supply.

The sooner you understand this, the better. $45,000/BTC is not as expensive as you think it is.

Bitcoin will fuel innovation in Green technology

1. One of the most common criticisms about Bitcoin is that it consumes a significant amount of electricity. Bitcoin mining indeed uses a lot of power. This critique is uninformed, however, and mostly amounts to ‘big power number bad’.

There is a three-step progression in understanding Bitcoin’s power consumption.

1. First, it must be stated, simply consuming electricity is not the same thing as wasting electricity. Nobody would consider turning on a lamp in the dark to be a waste of electricity or the use of a fan in the summer to help keep us cool. These are not wastes of electricity at all, they are uses of it. The electricity used to mine Bitcoin is being used to secure the only neutral and apolitical digital money in existence. In my opinion (not widely shared I knowledge), there are few uses for electricity more humane and noble than mining Bitcoin.

2. Looking further into its electricity usage brings around the next important point: What makes up Bitcoin’s energy consumption? Is it dirty coal and gas?

Overwhelmingly, the answer is no. There have only been a handful of data-driven studies on the subject, with the most thorough being a 2019 study which concluded that over 74% of Bitcoin mining is powered by renewable energy, a number that makes Bitcoin more driven by renewables than almost every other large-scale industry in the world.

Why is Bitcoin so renewable driven?

3. Today, energy is generally a local business. Stored energy does not travel over long distances. Thanks to Bitcoin however, energy generation does not have to remain within a few hundred miles of civilization anymore. This changes the economics of energy completely. While fossil fuels are more efficient than renewables at providing cheap energy to consumers, renewables are the more efficient option when energy can be generated from anywhere.

Energy companies can put renewable energy sources in the locations where they are the most efficient (like solar panels in deserts) and put the energy to use mining Bitcoin, which can then be sold for dollars if desired. This significantly expands the potential market for renewables and makes using renewable energy far more profitable than it ever has been. The resulting investment in the industry will drive the cost of renewable energy down far beyond what has happened to date and make it so clean energy is even more cost-efficient than fossil fuels.

Instead of relying on politicians to take action in a hyper-partisan world, Bitcoin mining provides an economic incentive to adopt clean energy that has not existed in the industry to this point. Both the left and the right should embrace it. 

They probably won’t though. Instead, we’ll just hear more of the same. ‘Big power number bad’…

Bitcoin is more regulated than you think

European Central Bank President Christine Lagarde gave an interview this week, claiming that Bitcoin has been used by criminals for money laundering and needs to be regulated.

What her comments miss is the fact that Bitcoin is already the most regulated currency in the world. 

Unlike all other currencies, Bitcoin is governed by a predetermined set of consensus rules. These rules are publicly available, transparent, and enforced by a decentralized network of tens of thousands. There are no closed-door meetings in Bitcoin, no discussions about how to use the system to bail out fraudulent bankers, and no unexpected issuance to fund whatever politically-driven desires come to mind in a given year. None of that is possible in Bitcoin. In other words, Bitcoin is already regulated because it is self-regulated in a way where corruption of the protocol is simply not possible. 

The transparent nature of the Bitcoin ledger – where the entire history of the chain can be viewed by anyone at any time – has made it easy for law enforcement to catch Bitcoin criminals. Per this New York Times article, “illicit activity accounts for only 1 percent of all Bitcoin transactions”. Still, even that article takes a generally negative tone when analyzing Bitcoin, as many in the mainstream continue to fear what they do not understand. 

Remember – there was a report (here) this past September that revealed that over $2 trillion has been laundered through the traditional, regulated banking system over the last 20 years. It sure would be nice if our current system were as transparent as Bitcoin, right?

The reason why our financial systems need regulation today is that they were built with flawed incentive models, giving those in power the ability to change the rules of the systems to benefit themselves and their friends. With Bitcoin, that is not possible.