When the economy loses balance: understanding stagflation for crypto investors

Warning: volume material

Economists rarely encounter a situation where the economy simultaneously experiences stagnation and rising prices. For cryptocurrency investors, this circumstance is extremely important: stagflation directly affects the volume of investment in high-risk assets, including bitcoin and altcoins.

Why Stagflation Concerns Cryptocurrency Market Investors

Stagflation describes a rare economic situation in which the following occurs simultaneously:

• GDP slowdown or contraction — the economy stops growing or shrinks
• High unemployment rate — the population is losing sources of income
• Rising prices — inflation devalues accumulated savings

For cryptocurrency investors, this means a double whammy: on one hand, declining incomes force people to abandon speculative investments and sell assets for current needs; on the other hand, central banks may raise interest rates to combat inflation, making speculative investments less attractive.

The Mechanism of Stagflation

The concept of stagflation emerged in 1965 thanks to British politician Ian Macleod, who combined two words: “stagnation” ( stagnation ) and “inflation” ( price growth ). The very existence of this phenomenon is paradoxical for traditional economic theory.

The contradiction between the tools of struggle

Traditionally, economists combat stagnation and high unemployment by:

• Expansion of the money supply
• Decrease in interest rates
• Facilitating access to loans

This stimulates spending, creates new jobs, and contributes to demand growth.

However, opposite measures are required to control inflation:

• Reduction of money supply
• Increase in interest rates
• Credit Limit

When one side, for example, the government ( implements expansionary measures, while the other side, the central bank ) conducts a contraction of the money supply, a situation may arise where the economy simultaneously experiences weak growth and price pressures.

( The three main reasons for occurrence

Collision of Monetary and Fiscal Policy

Suppose the government raises taxes, which reduces consumer spending. At the same time, the central bank prints money and lowers interest rates. The result: economic growth slows down )due to taxes###, but prices rise (due to the additional money supply).

Transition to fiat currency

Before World War II, major economies tied their monetary systems to gold reserves — the gold standard. This limited the ability to print money. After the war, most countries abandoned this system in favor of fiat currency (money, not backed by tangible assets). While this made economic management easier, it created the risk of uncontrolled price growth when urgent expansion of the money supply was necessary.

Energy Resource Supply Shocks

When production costs (, especially energy costs ), rise sharply, companies raise prices on goods. Consumers, faced with rising fuel and electricity expenses, cut their overall spending. The economy slows down, prices rise — a perfect recipe for stagflation.

Historical example: the oil crisis of 1973

In October 1973, members of the Organization of Arab Petroleum Exporting Countries announced an oil embargo against countries that supported Israel in the Yom Kippur War. Oil supplies were sharply reduced, and prices increased several times.

What happened next:

• The price of oil has skyrocketed, increasing production and transportation costs.
• Prices for food and industrial goods have started to rise
• The central banks of the USA and the UK lowered rates instead of raising them, trying to stimulate the economy.

However, the reduction of rates did not lead to sufficient economic growth in the context of expensive energy. The result: high inflation and economic stagnation were observed simultaneously in Western countries. This event became a classic example of stagflation and shook economists' confidence in their models.

How Economic Schools Propose to Combat Stagflation

Monetarist approach

Monetarists ( economists, who consider the money supply the main tool) recommend prioritizing the fight against inflation. Their recipe:

• Reduce the money supply in circulation
• Raise interest rates
• Wait for the demand to drop and the prices to stabilize.

Disadvantage: unemployment may continue to rise for some time until the economy adapts.

Supply-oriented approach

Another school suggests looking not at demand, but at supply. Their strategy:

• Subsidize production and invest in efficiency
• Reduce production costs (especially in the energy sector)
• Increase the volumes of goods and services in the market

As supply increases, prices fall, the economy grows, and unemployment decreases — all happen simultaneously.

Free Market Approach

Third position: allow the market to self-regulate. When goods become more expensive, consumers buy less, demand falls, and prices normalize. Meanwhile, the labor market finds a new equilibrium.

Problem: this could take decades during which the standard of living will be low. As economist John Maynard Keynes said: “In the long run, we are all dead.”

How Stagflation Affects the Cryptocurrency Market

( Reduction of liquidity in speculative assets

With minimal or negative economic growth, households lose additional income. Retail investors begin to sell cryptocurrency to obtain fiat money for everyday expenses. At the same time, professional investors reduce portfolios of high-risk assets, including tech company stocks and digital assets.

) The tightening of monetary policy is putting pressure on cryptocurrencies.

When central banks raise interest rates to combat inflation:

• Money in bank accounts becomes more attractive
• Borrowing is becoming more expensive, which reduces investment activity.
• Speculative assets are losing value

Bitcoin and other cryptocurrencies are particularly sensitive to interest rate hikes, as they do not generate cash flow and rely on market revaluation of their value.

The prospect of soft policy offers a chance

After the central bank takes inflation under control, a phase of economic stimulation usually follows:

• Quantitative easing ###money printing###
• Decrease in interest rates
• Expansion of money supply

At this stage, cryptocurrency markets typically recover as excess money seeks to find a place in assets with growth potential.

( Bitcoin as an inflation hedge: reality and myths

Many Bitcoin advocates see it as a hedge against inflation. With rising prices, holding fiat funds without interest means losing purchasing power. Bitcoin, with its limited supply of ) million coins###, is positioned as “digital gold” — a stable store of value.

However, this works in the long term. In the short term, especially during stagflation, cryptocurrencies often fall along with stock markets, as the correlation between them remains high. Thus, Bitcoin as a hedge against inflation is most effective for those who have accumulated it over the years, rather than for speculators trying to profit in the short term.

Key Takeaways on Stagflation

Stagflation remains one of the most challenging tasks for economic policy. Tools to combat stagnation often exacerbate inflation, while attempts to suppress price growth freeze economic growth. For cryptocurrency investors, understanding the dynamics of stagflation is critically important, as it directly affects the attractiveness of risky assets and the monetary policy of central banks.

Forecasting periods of stagflation and adapting investment strategies is what sets experienced investors apart from novices. Periods of economic uncertainty often create the best opportunities for those who understand the underlying macroeconomic processes.