Stagflation: The Perfect Storm for the Economy and Digital Markets

What would happen to your cryptocurrency wallet in times of stagflation?

Imagine a situation where you lose money twice simultaneously: your purchasing power is eroded by rising prices, but at the same time your income stagnates or decreases. This dual scenario is precisely what defines stagflation, a macroeconomic phenomenon that combines economic stagnation and rampant inflation.

For cryptocurrency investors, this combination presents unique challenges. During periods of stagflation, the demand for digital assets tends to decrease because consumers need to preserve liquidity for everyday expenses. At the same time, governments often tighten monetary policy through interest rate hikes, which discourages high-risk investments like Bitcoin and other cryptocurrencies.

Definition and Origin of the Concept

The term “stagflation” was coined in 1965 by Iain Macleod, a British politician and Chancellor of the Exchequer, merging two words: stagnation and inflation. It describes an economy that simultaneously experiences minimal or negative growth, high unemployment, and sustained increases in consumer prices.

What makes stagflation unique is its fundamental paradox: the conventional economic tools that work to combat each problem in isolation contradict each other when both occur together.

Why Stagflation Arises

Stagflation emerges when the purchasing power of money deteriorates while the supply of goods and services decreases. Its causes vary according to historical context, but the most common include:

Conflicts between macroeconomic policies

Central banks control the money supply through monetary policy (interest rates, quantitative easing), while governments directly influence through fiscal policy (taxes, public spending). When these policies work in opposite directions, they can generate rampant inflation combined with weak economic growth.

The fiat coin system

After abandoning the gold standard after World War II, economies lost constraints on the supply of money. Although this facilitates intervention by central banks, it also increases the risk of uncontrolled inflation.

Production cost shocks

A drastic increase in energy or raw material costs reduces aggregate supply while simultaneously making goods more expensive, pushing prices higher. Consumers, facing higher expenses for energy and transportation, reduce their purchasing power.

The Dilemmas of Economic Solutions

Combating stagflation presents a puzzle for economists and policymakers. There are multiple approaches depending on the economic school:

Monetarist perspective

Monetarists prioritize controlling inflation by reducing the money supply and raising interest rates. This curbs spending and reduces demand, but the trade-off is that it discourages economic growth, which must be addressed later.

Supply Focus

This school proposes to reduce production costs and improve efficiency through the control of energy prices, investments in innovation, and strategic subsidies. By increasing aggregate supply, inflation is reduced while production is stimulated, although with limited effects on unemployment.

Free market solutions

Some economists argue that allowing supply and demand to operate naturally is optimal in the long run. However, this process can take years or decades, leaving the population in adverse conditions while the market adjusts.

The Concrete Impact on Bitcoin and Cryptocurrencies

Stagflation presents a complex scenario for digital assets. In contexts of weak economic growth, retail investors need liquidity and typically reduce exposure to high-risk assets, including cryptocurrencies. Institutional investors also tend to deleverage under these conditions.

When governments raise interest rates to combat inflation, liquidity decreases significantly. Bank deposits become attractive again, while high-yield speculative investments like Bitcoin lose their appeal. The effect is a bearish pressure on cryptocurrency prices during these phases of monetary tightening.

However, there is a counterargument: many investors view Bitcoin as an inflation hedge due to its limited supply and programmed issuance. During prolonged periods of inflation, holding wealth in fiat currencies without yield erodes real value. Historically, those who accumulated Bitcoin in previous years during inflationary contexts subsequently saw significant appreciation.

The key is in the timeframes. As a counter-cyclical investment, Bitcoin can perform well over long horizons during inflation, but over short timeframes during acute stagflation, the effects of deleveraging and monetary tightening typically dominate.

The Oil Crisis of 1973: A Historical Lesson

The oil embargo declared by the Organization of Arab Petroleum Exporting Countries (OAPEC) in 1973 provides a perfect case study. In response to the Yom Kippur conflict, the drastic restriction of energy supply caused widespread shortages and a spike in prices.

Western governments responded in a contradictory manner: while orthodox policy indicated raising rates to curb inflation, central banks lowered them in an attempt to stimulate growth. The result was inevitably severe stagflation. With energy and oil dominating consumption expenditures, lower rates did not generate enough growth while inflation soared.

This episode illustrates how supply shocks can generate stagflation when policy responses become misaligned.

Final Reflection

Stagflation represents a unique challenge because it violates the typical relationship between growth, employment, and inflation. There is no perfect solution; each economic tool to resolve one component worsens the other.

For cryptocurrency investors, the message is clear: during acute stagflation, economic cycles generally weigh more than short-term inflation hedge narratives. Monitoring macroeconomic dynamics—money supply, rate trajectories, unemployment, and aggregate supply—is essential for navigating these turbulent periods.