The Overflow Mechanism
How the dollar built Silicon Valley and why no one else can replicate it
Welcome to the 7th edition of the 2026 season of Drift Signal. I’m Nicolas, Head of Research at Vsquared Ventures. This is my personal newsletter, which examines macro and markets through the lens of late-cycle investment theory, and the views expressed are my own.
Here is some recently published content that could be of interest:
In The Deep Brief, Vsquared’s deep tech newsletter, my colleague Herbert Mangesius and I argue that the defence innovation playbook has always been the same — urgent demand, freedom to iterate, and an ecosystem that emerges as the byproduct — and that two active wars in Ukraine and Iran are now making that playbook impossible to ignore for Europe: The Byproduct Theory of Defense Innovation.
In Currency of Power, my colleague Marieke Flament and I argue that the war in Iran did not merely disrupt oil markets — it severed the financial architecture that Washington was building to replace the petrodollar, and handed China a ten-year head start on the alternative it has been quietly constructing: Petrodollars vs. Electroyuans.
Also in Currency of Power, Marieke and I interview Sean Neville — co-founder of Circle, inventor of USDC, and now founder of Catena — on why AI agents are the next customers for stablecoin infrastructure, and what it actually takes to build a financial institution for a world where machines move the money: Stablecoins Were Just the Beginning.
Finally, Marieke and I also examine the de-dollarisation debate, arguing that it misses the point because it treats the dollar as one thing when it is really two — a reserve currency and a trade currency — with different sources of power and very different prospects, and that the real contest is not whether the dollar survives but who controls the settlement layer of the next world economy: The Dollar’s Many Lives.
Now, in today’s edition, I want to explain why America’s innovation economy is not a cultural phenomenon, not a regulatory one, and not simply a matter of having more capital or talent than everyone else. Instead, it is the product of two forces: deliberate state engineering over three decades of genuine urgency, and a macroeconomic structure that continuously floods the US with foreign capital. When those two forces combined, in the 1980s and 1990s, they created something no other country has been able to replicate.
I call the mechanism at the heart of it the overflow mechanism: the process by which foreign capital, flooding into US Treasuries and blue-chip stocks, displaces domestic institutional capital up the risk curve and into venture, financing innovation at a scale that no deliberate policy could produce. Understanding it also explains why China took a radically different path, why Europe spent thirty years competing on the wrong terrain, and why that may be about to change.
1/ America races ahead, and almost nobody understands why
For 17 years I have worked in tech, and for 17 years I have heard the same lament: Europe is falling behind the US, and something must be done about it. The explanations on offer tend to fall into three categories, none of which, on close inspection, holds up.
The first is cultural: America rewards risk-taking while Europe rewards prudence and caution. But Europe cannot be treated as a single unit in this way. Entrepreneurial culture exists all across the continent, in pockets large and small, and the fact that it does not translate into racing ahead in tech has nothing to do with attitudes toward risk.
The second explanation is about freedom. Too much regulation in Europe, the argument goes. But Europe is not less free than the US — it is more fragmented, which creates friction where none exists in a single unified market, but that is a different matter. The American business world is at least as regulated, if not more so. What entrepreneurs in the US have, and their European counterparts largely lack, is two things: a Common Law system that lets you move forward with confidence that disputes will eventually be settled in court in an equitable manner, and an enormous supply of lawyers whose expensive and abundant work — what my friend Dan Wang calls a “lawyerly society” — absorbs the regulatory burden so that founders rarely have to think about it directly.
The third explanation is resource-based: more capital, more talent in the US. But by most measures, Europe has more of both. Talent is more abundant here, and Europe as a whole is a net saver while the US is a net borrower, which means the raw capital exists in abundance on this side of the Atlantic.
What actually explains America’s lead is something else entirely, and it has two parts:
The first is deliberate state engineering: successive waves of public investment, driven by genuine urgency, that built an entrepreneurial ecosystem from the ground up over three decades.
The second is macroeconomic structure: the dollar’s role as the world’s reserve currency turns the US into a magnet for foreign capital, generating a structural surplus of risk capital that no other country can manufacture by policy alone.
Together, these two forces created a flywheel that has been spinning faster and faster since the 1980s — and that other countries, whether they copy Silicon Valley’s surface features or pour public money into accelerators, cannot replicate simply by wanting to. China found an alternative path, running the opposite logic with its own coherent model. Europe, for 30 years, competed on the wrong terrain entirely. But the current wave of innovation — hardware, energy, defence, industrial systems — may be the moment when Europe’s particular strengths finally come into their own.
2/ The reason America races ahead is that the dollar makes it a magnet for foreign capital
How the dollar became the world’s reserve currency is a story of war, pragmatism, and raw power.
The reserve currency foundation was laid at Bretton Woods in 1944, when forty-four nations agreed to anchor the global monetary system to the dollar, pegged to gold at $35 per ounce.
That foundation cracked in August 1971, when President Nixon unilaterally ended the dollar’s convertibility to gold, freeing the currency from physical constraints and launching a profound reconstruction of global financial markets.
Then to replace the gold anchor, the Nixon administration struck an agreement with Saudi Arabia in 1974: oil would be priced in dollars, and surplus revenues would be recycled into US Treasury bonds—something known as the petrodollar recycling system. Because the world needed oil, it needed dollars to buy oil, and the self-reinforcing loop was complete.
The system, however, comes with a genuine burden. To supply the world with the dollar liquidity it needs, the US must run persistent trade deficits, importing far more than it exports. The continuous influx of foreign capital keeps the dollar strong, which makes American exports expensive and American manufacturing structurally uncompetitive. As a result, American manufacturing hollowed out steadily from the 1980s onward, and the communities that depended on it paid the price for a privilege they never asked for and rarely benefited from.
But the same mechanism turns the US into what I call America Capital Partners: a vast investment platform that absorbs the world’s excess savings and redeploys them into the most dynamic business ecosystem on earth. Foreign capital flows back into US Treasuries, stocks, and real estate in such volumes that it effectively saturates every conventional asset class. The domestic investors who would otherwise hold those assets — pension funds, university endowments, insurance companies, foundations — find themselves crowded out of the safe end of the market.
Venture capital is at the far end of that curve. Foreign capital does not typically flow directly into Silicon Valley; it flows into Treasuries and blue-chip stocks, where it crowds out domestic institutions and sends them looking for yield elsewhere. This is the mechanism I call the overflow: foreign capital, by saturating the safe end of America’s financial markets, creates pressure that travels all the way up the risk curve — spilling, finally, into venture capital.
3/ The overflow mechanism explains why only the US has a venture capital industry
To understand exactly how that displacement works in practice, you need to follow the domestic money one level down — to the institutional allocators who actually deploy it:
The rulebook for those was written by David Swensen at Yale, whose endowment model redefined how large pools of capital should be deployed: a broad allocation between equity and fixed income, then within equity a further split between public markets and private markets, with each bucket sized according to expected returns and liquidity needs.
Venture capital sits awkwardly within that framework, for three reasons. First, it is too small to model with any precision. Second, it does not follow the normal rule whereby more capital flowing into an asset class compresses returns across the board. Third, as Andy Rachleff has observed, returns are so skewed toward a handful of top firms — which remain largely inaccessible to most allocators — that any quantitative return expectation is essentially fictional for the majority of LPs. You cannot build a serious portfolio model around an asset class where the returns you are counting on are, in practice, out of reach.
What this means in practice is that venture capital is not really part of a quantitative allocation framework at all. It is, instead, a small discretionary pocket: capital that a large allocator can deploy freely in pursuit of outsized returns, without worrying too much about modelling the outcome. And in normal circumstances, that pocket stays small, because there are plenty of conventional assets to absorb the bulk of the portfolio.
Now apply this to America Capital Partners as a whole. With the US being a magnet for foreign capital due to the dollar’s status, Foreign capital floods into US Treasuries, equities, and real estate, driving up prices and compressing yields. Domestic pension funds and endowments, already crowded out of their preferred safe assets, find that their conventional buckets are overallocated and underperforming. As a result, that tiny discretionary pocket — venture capital — becomes one of the few places left where the return expectations, however uncertain, still justify the allocation.
At the level of any individual institution, that pocket remains small of course. But at the scale of the entire US economy, with trillions of dollars of domestic institutional capital all making the same calculation simultaneously, the aggregate discretionary pocket becomes enormous. And because the expected returns never quite materialise for most of the capital deployed into venture, that surplus remains flexible and versatile, not locked into any particular commitment. It sits ready to meet the moment when a large innovation wave begins to gather — the dotcom boom, the shale revolution, the mobile and cloud era, the current AI build-out.
This is the overflow mechanism, seen from the inside: every institutional allocator, crowded out of the safe assets they would prefer to hold, finds the same discretionary pocket waiting at the top of the risk curve — and fills it.