Stagflation: Definition, Causes and its Impact on Cryptocurrencies

What is stagflation exactly?

Stagflation is a paradoxical economic combination: negative growth or stagnation alongside high unemployment and accelerated inflation. The term was coined in 1965 by Iain Macleod, a British politician and Chancellor of the Exchequer, by merging “stagnation” and “inflation.”

The peculiar thing about this definition of stagflation is that it breaks with traditional economic logic. Normally, when the economy grows, unemployment rates decrease and prices rise. But in stagflation, the opposite occurs: the economy contracts while prices continue to rise. This places governments and central banks at a crossroads: measures that combat recession worsen inflation, and vice versa.

Why Does Stagflation Arise?

Contradictory Economic Policies

A government can raise taxes, reducing the purchasing power of citizens. Simultaneously, the central bank implements quantitative easing or lowers interest rates. The result: less consumer spending but more money in circulation. This creates upward pressure on prices without stimulating real growth.

The Abandonment of the Gold Standard

After World War II, economies replaced the gold standard with fiat currency. This transition eliminated the natural limits on the money supply, allowing for unrestricted monetary expansions. The consequence: greater vulnerability to inflationary cycles.

Supply Crisis

When production costs skyrocket (especially in energy), companies face tighter margins. Consumers pay higher prices but have less disposable income. The economy freezes as inflation persists.

The Three Schools of Thought on Solutions

Monetarists prioritize curbing inflation by reducing the money supply, accepting slower growth as a cost.

Supply Economists propose investing in efficiency, controlling energy prices, and subsidizing production to increase aggregate supply.

The Free Market Perspective argues that natural supply and demand will adjust prices, although this could take years or decades.

Stagflation vs. Simple Inflation

Inflation is simply the rise in prices. Stagflation adds a critical factor: economic growth disappears or turns negative. While you struggle against higher prices, your job is at risk and the economy contracts. It is worse because everything worsens simultaneously.

How Does Stagflation Affect the Crypto Market?

Scenario 1: Economic Contraction

When the economy contracts, investors pull capital from risk assets. Cryptocurrencies suffer forced sell-offs because many need cash for basic expenses. Large investors also reduce exposure to volatile assets.

Scenario 2: Interest Rate Increase

Governments curb inflation by increasing rates. This makes saving in banks attractive again and borrowing expensive. High-risk-high-return investments, such as crypto, lose their appeal. Demand falls and prices decline.

Scenario 3: Post-Recovery

Once inflation is controlled, governments stimulate with quantitative easing and low rates. Here, the flow of money returns. If you hold cryptocurrencies during this phase, you could benefit from the increase in liquidity.

Bitcoin as Inflation Hedge

Many investors see Bitcoin as a store of value against persistent inflation. Its limited supply contrasts with fiat currencies that expand unchecked. Historically, those who accumulated BTC during inflationary periods gained valuable positions. However, during severe stagflation and in the short term, this strategy may not work due to the simultaneous contraction of credit.

The Precedent: The Oil Crisis of 1973

In 1973, OAPEC embargoed oil to certain countries in support of Israel during the Yom Kippur War. The energy shortage drove up prices and caused supply shortages. Central banks lowered interest rates hoping to stimulate growth, but the mechanism did not work.

The result? The United States and the United Kingdom simultaneously experienced accelerated inflation and stagnant economies. This classic episode teaches why stagflation is so difficult to resolve: the available tools create new problems.

Final Reflection

Stagflation challenges the traditional economic toolbox. Combating one issue worsens the other. To navigate it, investors and policymakers must consider multiple factors: money supply, interest rates, employment, and aggregate supply. In times of stagflation, there is no one-size-fits-all solution. The macroeconomic reality dictates each step.