Stagflation and how it affects your portfolio

Summary The combination of low economic rise and high unemployment, along with the constant increase in prices, creates a complex macroeconomic situation. When stagflation grips the market, traditional methods of combating the crisis often exacerbate one of these factors, so for cryptocurrency investors, this means increased risk and new opportunities.

How Stagflation Affects the Crypto Market

When the economy simultaneously experiences stagnation and inflation, retail and institutional investors usually change their strategy. The decline in real incomes and the rising cost of goods forces people to reduce spending on speculative assets, including cryptocurrencies and securities.

The state chooses one of two paths: either it reduces the money supply and raises interest rates to combat inflation, or it increases spending to stimulate economic rise. In the first scenario, the value of high-yield assets ( including Bitcoin and altcoins ) decreases due to the increased cost of borrowing. In the second, the increased money supply can positively affect the crypto market, however, this effect is usually delayed.

What stagflation really means

The term “stagflation” appeared in 1965 as a combination of two phenomena: economic stagnation and inflation. This is a macroeconomic situation where the economy is virtually stagnant or contracting, the unemployment rate remains high, but prices for goods and services continuously rise.

In normal times, governments and central banks can choose tools: to increase the money supply to stimulate rise or to decrease it to combat inflation. However, stagflation puts them in a deadlock – any choice strengthens one of the mentioned factors. This paradox makes stagflation one of the most complex challenges for monetary and fiscal policy.

Why Stagflation Occurs

There are several reasons that cause this phenomenon. The first is the conflict between monetary and fiscal policy. If the state simultaneously raises taxes ( while cutting expenditures ), and the central bank increases the money supply and lowers rates, a situation arises where the economy receives both restraining and stimulating signals at the same time.

The second reason is the shortage of energy resources. When production costs sharply rise due to a lack of raw materials, companies' expenses increase, leading to a rise in prices for consumers. At the same time, people have less disposable income due to the rising costs of energy and transport, so demand for goods decreases, resulting in economic stagnation.

The third reason is related to the transition to fiat currency. The abandonment of the gold standard after World War II gave central banks more freedom in managing the money supply, but at the same time removed the constraints on inflation.

Economic Schools on the Fight Against Stagflation

Monetarists believe that controlling inflation should be the top priority. They recommend reducing the money supply and raising interest rates. The result is a decrease in demand, prices stabilize, but economic rise is not stimulated.

Supply-side economists propose an alternative strategy: to increase the output of goods through production subsidies, investments in efficiency, and price controls on energy resources. This could reduce production costs and initiate economic rise without further price increases.

Supporters of the free market believe that the best way is not to interfere. Over time, high prices will reduce demand, inflation will fall, and unemployment will decrease due to the natural reallocation of labor. However, this path may take years or decades of decline in living standards.

Historical Lesson: The Oil Crisis of 1973

In 1973, OPEC declared an oil embargo, leading to a fuel supply shortage. Prices for oil and food products sharply rose, causing massive inflation.

Instead of controlling inflation, the central banks of the USA and the UK lowered interest rates in an attempt to stimulate the economy. However, this move only intensified inflation. The result was that many Western countries simultaneously experienced high inflation and economic stagnation. This became a classic example of stagflation, which was as shocking to economists as it was unexpected.

Bitcoin as a hedge against inflation

Many crypto investors view Bitcoin as a store of value due to its limited supply and controlled issuance. During a period of rising inflation, accumulating BTC over the years has indeed shown positive results as a hedge.

However, in conditions of stagflation, this strategy works less effectively, especially in the short term. The reason is simple: when people need cash for everyday expenses and people massively cut risky investments, even a limited supply of Bitcoin does not guarantee its rise. Moreover, the fluctuations in crypto markets often correlate with movements in stock markets, so during crises, both fall simultaneously.

Key Findings

Stagflation remains one of the most critical situations for economies because traditional tools for combating the crisis often make the situation worse. For cryptocurrency investors, this means that it is important to monitor the macroeconomic situation – the level of money supply, interest rates, demand and supply, as well as the labor market. Timing the entry and exit from positions during stagflation is a deliberate game taking these factors into account.