Stagflation in What to Invest - A Guide for Investors in Times of Economic Uncertainty

What Are the Risks of Combining Recession with Inflation?

Stagflation is a macroeconomic phenomenon that terrifies both economists and policymakers. The term first appeared in economic discourse in 1965 when Iain Macleod, a British politician serving as Chancellor of the Exchequer, described the situation of an economy experiencing simultaneous unemployment, stagnant growth, and rising consumer prices.

The problem lies in a fundamental paradox: the tools traditionally used to combat one phenomenon usually exacerbate another. Increasing the money supply can stimulate economic growth and reduce unemployment, but it leads to inflation. Conversely, restricting the money supply by raising interest rates curbs inflation, but at the same time slows down the economy and increases unemployment.

Causes of Stagflation - When Everything Goes Wrong

Stagflation in what to invest depends primarily on understanding why it occurs. There are many factors that can trigger this dangerous scenario.

Conflictual Political Decisions

When the government raises taxes, thereby reducing the disposable income available for consumers to spend, and the central bank simultaneously conducts an expansionary policy, increasing the money supply through quantitative easing or lowering interest rates - an ideal storm for stagflation arises. Government spending cuts slow down the economy, while the actions of the central bank drive inflation.

Supply Shocks and Energy Crisis

History will provide us with an excellent example. In 1973, the Organization of the Petroleum Exporting Countries (OPEC) imposed an oil embargo on selected countries in response to the support given to Israel during the Yom Kippur War. The drastic reduction in the availability of the resource caused a sharp increase in energy prices, shortages in supply chains, and an increase in production costs in virtually all sectors of the economy.

While central banks in the United States and the United Kingdom lowered interest rates to stimulate economic activity, inflation remained high. The economy found itself in a trap: consumers had no money to spend due to rising living costs, and businesses were not growing despite cheaper loans. The result was a high level of unemployment combined with rising prices.

Transition from Gold Standard to Fiat Currency

The abandonment of the gold standard after World War II and the transition to fiat currencies removed the natural constraint on the growth of money supply. Central banks gained greater flexibility in managing the economy, but at the same time, the risk of losing control over inflation emerged. Without the physical backing of gold, the increase in money supply can be virtually unlimited, which opens the door to price collapses.

Different Approaches to Exiting Stagflation

Economists are divided into several schools, each proposing different solutions.

Monetarists argue that the priority is to combat inflation by limiting the money supply. Reduced credit availability discourages spending, demand falls, and prices may stabilize. However, the issue is the lack of momentum for economic growth in this scenario.

Supply-side economists advocate for increased production efficiency and cost reductions. Investments in energy, subsidies for producers, and policies supporting innovation can raise aggregate supply. When there are more goods and costs decrease, prices fall for consumers, unemployment decreases, and the economy grows.

Supporters of the free market argue that only market forces can naturally find equilibrium. When consumers are unwilling to pay for goods, demand will decrease, and inflation will cease on its own. Unemployment will also fall as the market adjusts to new conditions. The drawback of this approach is the potentially long transitional period during which society suffers from low incomes and difficult living conditions.

Stagflation and Cryptocurrency Investments

The question of what to invest in during stagflation is not simple, especially when it comes to assets like Bitcoin and other cryptocurrencies.

Decline in Investment Capability

During stagflation, consumers have less money available. A weak economic situation means stagnation or a decline in income. People need to earn more to cover bills for energy, food, and transportation. They have less left for speculative investments.

Institutional investors tend to withdraw from high-risk assets, such as technology stocks or cryptocurrencies, to secure their portfolios. This leads to a decrease in demand and price declines in the crypto markets.

Impact of Higher Interest Rates

Governments usually first attack inflation. Raising interest rates by central banks reduces liquidity in the system. People prefer to keep their money in banks, where they receive interest, rather than spend it or invest in risky assets.

Cryptocurrencies, including Bitcoin, become less attractive when safe, interest-bearing bank products are available. An increase in interest rates typically indicates a bearish trend in the cryptocurrency markets.

Bitcoin as a Store of Value

On the other hand, in the long term, inflation growth may be positive for Bitcoin. Many investors believe that Bitcoin is an excellent hedge against the erosion of fiat currency value. Due to the limited supply of (21 million coins), BTC can maintain or even increase its real value during times of rising consumer prices.

History shows that investors who accumulated Bitcoin over the years, especially during inflationary periods preceding or following economic growth, achieved significant gains. However, in shorter time frames, especially during stagflation, Bitcoin can serve as a safe haven for capital.

It is worth remembering that cryptocurrency markets are increasingly correlated with traditional stock markets. In times of market panic, these connections can strengthen, and Bitcoin may not provide full protection against declines.

Post-Inflation Scenario - Opportunity for Cryptocurrencies

When the government has inflation under control, a natural next step will be stimulating economic growth. At that point, central banks usually implement quantitative easing and lower interest rates. In such a scenario, an increase in the money supply typically leads to a rise in demand for riskier assets, including cryptocurrencies.

Conclusions for the Investor

Stagflation is a unique scenario that requires an unconventional approach to investing. While traditional strategies for combating recession deepen inflation and vice versa, investors must be aware of the current macroeconomic conditions.

In times of stagflation, capital security is a priority. Cryptocurrencies can be a part of a long-term strategy for value protection, but they should not be the main investment vehicle in the short term. Monitoring political decisions, interest rate levels, and inflation trends is crucial for making informed investment decisions.