What is Stagflation in Relation to the Crypto Market?

Introduction

Stagflation came into the public limelight from 1973 to 1975 when the world faced economic hardship due to an oil crisis. Fast forward to more recent times, the wake of COVID-19 in 2020 caused another global economic scare that led to an intercontinental halt in economic activities. Thanks to the concerted and cooperative measures instituted by nations against the pandemic, economists were expecting 2022 to be the moment of economic turnaround. However, a double shock of post-Covid turmoil and Russia-Ukraine tension raised inflation rates beyond expectation and deteriorated economic growth forecasts.

Once again, stagflation is on the cards, and its potential return puts fear into policymakers’ minds. As cryptocurrencies are gaining a stronghold within the economic mechanism of the world, crypto enthusiasts seek answers to the possibility of this economic catastrophe affecting the crypto markets. This article aims to explore the meaning of stagflation, how it affects the crypto market, how cryptocurrencies can help during stagflation, and whether it is safe to invest in crypto in case stagflation breaks out.

A Background on Stagflation

Stagflation is a period of persistent inflation, slow economic growth, and a high unemployment rate. Economic policymakers find it difficult to manage because the solution to one of the factors may exacerbate others. Thus, stagflation is the trickiest situation for economists because they battle multiple problems simultaneously.

Although stagflation is not something to look up to, it has recently become a hot topic among analysts and economists. This is because the consumer price index (CPI), which evaluates the impact of price changes on the cost of living, has increased to 7.5% in the past year. Additionally, the annual growth in economies worldwide keeps plummeting, worsening the global economic situation and potentially plunging economies into another stagflation.

History

The most adequate record of stagflation first occurred in the 1970s when many developed economies experienced high unemployment, slow economic growth, and rising inflation caused by global fuel scarcity. Due to prolonged disputes, the Organization of Petroleum Exporting Countries (OPEC) placed an oil embargo on countries, causing oil shocks that brought oil prices to over 300%.

Those oil shocks were accompanied by another monetary policy change in which former president Richard Nixon took the US away from the gold standard. This, in addition to the global economic downturn, elicited all necessary factors that justified stagflation. In essence, high inflation, slow economic growth, and high unemployment happened simultaneously and for a prolonged time.

As oil prices rose, transport and production costs increased, causing consumer prices to soar. At the same time, businesses could not keep up with the weakening economy, causing many to downsize workers or fold up totally. These led to unforeseeable macroeconomic and geopolitical consequences that no one would imagine could happen again.

Source: Trading Economics — Graph showing the US inflation rate during the 1970s

How Does Stagflation Work?

Source: E-Crypto News

Stagflation is an uneasy situation because policymakers have to curb multiple problems at once. Economic growth slows down while unemployment and inflation increase. A step to solve one of the problems will make the others worse. If the government increases interest rates to slow inflation, economic growth will slow down because businesses will not be able to afford loans for their businesses, harming employment.

On the other hand, if the country injects money into the economy to boost economic growth and employment, the inflation situation of the country will rise to unprecedented levels. This crisscross situation in solving stagflation is the reason it is dreadful. It was once thought impossible and removed from likely economic theories before the 1970s.

Causes

Source: Coinmarketcap

There are many postulations about the causes of stagflation because, before the 1970s, it was generally accepted that unemployment was inversely correlated to inflation. Experts have identified the possible theories behind stagflation, and we will discuss them in more detail below:

• Bad monetary and economic policies: Poor economic decisions are proven causes of stagflation. Governments and central banks can unintentionally increase inflation and negatively impact economic growth and employment in their countries.
• Supply shocks: Supply shocks are also incriminated as causes of stagflation. When there is a sudden drop in the supply of goods and services associated with high prices, the lower profit margin on goods causes most businesses to fold. This slows down economic growth and can lead to massive unemployment.
• Differential accumulation: This theory examines stagflation in a global sense and relates it to mergers and acquisitions. Mergers and acquisitions concentrate the control of prices and supply of commodities to a few players, raising the risk of stagflation.

What is Inflation?

Source: Moralis Academy

To further understand the concept of stagflation, let’s explore inflation and stagnation, the two concepts that birth the term “stagflation.” Inflation occurs when the purchasing power of a currency reduces. In such instances, the cost of goods and services increases, and the amount of money that bought them previously is no longer enough. Therefore, there is a decline in disposable income, and people are less likely to spend often. People are also less likely to save or invest money, and the economy generally slows down.

What is Economic Stagnation?

The second term that makes up stagflation is economic stagnation. During stagnation, the economy experiences little or no growth. Traditionally, economists have agreed that less than 2% annual growth is stagnation, and it can happen to any industry or country. It is usually attributed to high unemployment, little economic output, and general hardship. It is noteworthy that natural disasters, pandemics, wars, supply chain shortages, and economic shocks can all lead to economic stagnation.

How to Curb Stagflation

Experts have proposed several ways of handling stagflation, but no one-size-fits-all solution exists. There will be a need for opportunity cost in the short term because a solution directed to one factor can worsen others. Therefore, solving stagflation poses difficult economic choices to policymakers.

Governments generally solve inflation first before tackling unemployment and economic stagnation. This is because if inflation is not managed on time, it can escalate to further damage, bringing more economic chaos.

To control inflation, central banks can increase interest rates. Governments can improve economic activities by reducing business taxes and launching other stimulus packages. Increasing government expenditures through inflationary fiscal policies can trigger economic growth, too.

Another measure that may prove helpful is an attempt to lower unemployment through active labor market policies. Cryptocurrencies can also prove to be a valuable tool in curbing stagflation because they allow everyone to engage with global markets without intermediaries or financial institutions in between.

How Stagflation Affects the Crypto Market

Source: Wojak’s X Account

Cryptocurrencies have been around for a relatively short while, so there is no adequate data to prove whether they are a good asset class during stagflation. However, since the crypto market is already correlating with traditional markets, especially after ETF approvals, one can study the response of traditional markets during the past stagflation for context.

Stagflation is bad for traditional markets, and the effects may reflect on crypto markets. This negative sentiment has implications for holders and acquirers of crypto assets. For holders, they may be willing to cash out their crypto assets because of the economic uncertainty and the high volatility of crypto assets. This will lead to less demand for cryptos and possible market instability.

Digital asset acquirers also may be less likely to acquire more assets because of stagflation. This is because prolonged high inflation directly affects the amount of cash people have to invest or buy crypto. Because cryptos are highly risky investments, there is even more likelihood that acquirers will stay away from them.

Crypto markets may be favorable in some cases, though, especially if the bad economic situation happening in one nation does not get to another. Since cryptocurrencies run on decentralized blockchains not controlled by a specific country’s economic policies, they can help people escape their country’s economic problems. Investors can use blockchain to capitalize on the general crypto market gains even amidst stagflationary pressures in their home countries.

Finally, regardless of the economic situation, savvy investors will always find a way of profiting during any market condition. This is why crypto enthusiasts should be well-equipped with the best market research methods and learn to remove emotions while investing in or trading digital assets.

What Stagflation Means for Cryptos

Since stagflation happens alongside severe economic downturns and high inflation, some analysts have suggested that Bitcoin and other cryptocurrencies may serve as possible hedges. Although the risk with hedging using cryptos is high, we can analyze this possibility by exploring three crypto assets that may be used:

Bitcoin

Source: Bitbo.io — Bitcoin Price Temperature (BPT) showing BTC’s current position in the market

Gold has been used for hedging against inflation for a long time, and Bitcoin may also thread in a similar path. Because Bitcoin is now called the “digital gold,” and is a decentralized payment method beyond central control, it is unaffected by economic policies or corruption. Furthermore, Bitcoin is a scarce asset with a finite supply, consolidating its status as an actual store of value. Because of its many properties that resemble gold, investors may consider Bitcoin as they aim to preserve their purchasing power during stagflation.

As the world gets more receptive toward Bitcoin, the cryptocurrency is continuously gaining ground as a reliable investment vehicle. If Bitcoin can break its correlation with the traditional market, it will consolidate better and will not be affected by traditional market conditions. In response, the awareness and injection of money into Bitcoin will increase, leading to a more stable currency that can be a safe store of money during any economic uncertainty.

Ethereum

Because Ethereum has a very close correlation with Bitcoin and has been consistently trailing it in global cryptocurrency charts, Ethereum is also noticeable in this conversation. Although Ethereum may not soon catch up with Bitcoin regarding value, ETH has a clear leadership and a unique utility, claiming a spot as the “decentralized world’s computer.” Before considering Ethereum as a hedge against stagflation, it is important to note that it has a higher beta (higher percentage highs and lower percentage lows) than Bitcoin, and you should conduct a risk assessment before investing.

Other Altcoins

Compared to Bitcoin and Ethereum, other altcoins have a much higher beta, and investors should take significant caution before hedging with them. During bear markets, which are likely during stagflation, altcoins may dip lower than imaginable, making them too risky. Therefore, always endeavor to inspect altcoins closely and consider their long-term utility, use cases, profitability, and community following before taking any steps.

Conclusion

Although the world is not experiencing stagflation at the moment, unfolding events suggest great caution. The World Bank, in its June 2022 global economic forecast, warned that the risk of stagflation has increased because of a steep slowdown of global economic activities and a surge in the inflation rate. Furthermore, the United States Federal Reserve and the Bank of England have sounded warnings that recession is looming due to the persistent inflation in the United States and the United Kingdom, respectively. Many other countries worldwide are also experiencing different levels of economic decline.

We live in a decade where the world is rightly concerned about stagflation breaking out. As the world is taking active steps to guide against it, the crypto market is also involved in the mix. Since cryptos are closely correlated with traditional markets, an economic downturn may affect the crypto market. However, as Bitcoin consolidates its role as digital gold, cryptocurrencies may become a haven for investors seeking to hedge against economic uncertainties.