Stagflation: the economic challenge that paralyzes the markets

Summary Stagflation combines two normally contradictory economic phenomena: rampant inflation and stagnant growth, coupled with persistent unemployment. This toxic cocktail creates a deadlock for policymakers, as the usual remedies for one inevitably worsen the other. This situation particularly affects cryptocurrency investors, who are exposed to the volatilities it generates.

Why is stagflation a real nightmare for governments?

Normally, the economy follows a simple logic: when employment rises and growth accelerates, prices also go up. In contrast, during a recession, inflation weakens. But with stagflation, these two mechanisms occur simultaneously. It's like trying to cool and heat a room at the same time.

To combat a recession, central banks generally increase the money supply and lower interest rates, making loans cheaper for businesses and consumers. At the same time, reducing stagflation requires the opposite: tightening the money supply and raising rates to curb rising prices. The result? Any action exacerbates the opposite problem. Governments find themselves paralyzed.

Where does this phenomenon come from?

The term “stagflation” was coined in 1965 by Iain Macleod, a British politician, to describe that uncomfortable situation where economic growth stagnates ( or even declines ) while inflation accelerates. The causes vary depending on the economic context, but several factors recur regularly.

The contradictory economic policies on the front line

A government can increase tax revenues to reduce spending, while the central bank massively injects money into the economy. The result: consumers have less to spend, but more currency circulates, creating inflationary pressure without reviving growth. This is the perfect scenario to trigger stagflation.

The end of the gold standard: a dangerous freedom

Before the 1970s, most major economies backed their currencies with gold reserves. This system naturally limited money creation. Its abandonment removed these safeguards, allowing central banks to create fiat money without limit. While this flexibility has facilitated short-term economic management, it has also opened the door to inflationary excesses.

Supply shocks: when costs explode

A sudden rise in production costs—mainly due to energy prices—can trigger stagflation. If oil becomes unaffordable and goods cost more to manufacture, prices soar. At the same time, consumers, impoverished by these energy costs, cut back on their purchases. Growth collapses while inflation spirals out of control.

How to get out of it? The three schools of thought oppose each other.

The monetarist approach: controlling inflation first

Monetarists consider inflation to be the primary enemy. Their prescription: aggressively reduce the money supply to crush demand and lower prices. The major drawback? This strong medicine further slows growth. Stimulus must wait until inflation is tamed, temporarily allowing unemployment to worsen.

The school of supply: increase production

Another strategy is to increase overall supply rather than to reduce demand. Subsidizing production, controlling energy prices, investing in energy efficiency—all of these levers reduce production costs. Prices decrease for consumers, production accelerates, and unemployment declines, all without additional inflation.

The free market: waiting for it to pass

Some economists advocate for a laissez-faire approach: supply and demand will eventually self-regulate. If inflation makes goods too expensive, consumers will cut back on their purchases. Demand drops, inflation eases, and the market efficiently reallocates labor. The only problem is that this process can take decades, leaving populations in precarious situations. As Keynes ironically remarked: “In the long run, we are all dead.”

Stagflation of 1973: When Geopolitics Changes the Economic Game

The year 1973 left a lasting impression. The Organization of Arab Petroleum Exporting Countries (OPEC) imposed an oil embargo in response to Western support for Israel during the Yom Kippur War. The global oil supply collapsed and prices skyrocketed.

The consequences were immediate: disruptions in supply chains, drastic increases in the prices of goods and services, rampant inflation. In the United States and the United Kingdom, central banks responded by lowering interest rates to stimulate the economy. But this usual strategy failed: consumers, burdened by prohibitive energy costs, were not spending. Inflation remained high while growth stagnated. A classic case of stagflation.

Impact on cryptocurrencies and investment markets

Stagflation affects cryptocurrencies in a complex and multidirectional way.

Less liquidity in circulation

A stagnant economy means eroding or disappearing incomes. Individual investors drastically reduce their allocations to risky assets, including Bitcoin and other cryptocurrencies. Major institutional investors do the same, repositioning themselves in defensive assets. As a result: the demand for crypto collapses and prices plummet.

The reaction of central banks: a painful two-step process

Generally, authorities start by fighting inflation. They reduce the money supply and raise interest rates. This period is bad for crypto: liquidating less, borrowing costs more, and risky investments become unappealing. Bitcoin and its counterparts see their outflows increase.

Once inflation calms down—which usually takes some time—governments pivot towards stimulus. Quantitative easing ( “printing money” ), lowering interest rates, increasing the money supply. At this stage, crypto can rebound spectacularly thanks to regained liquidity.

Bitcoin as an inflation hedge: a nuanced debate

Many investors see Bitcoin as a hedge against inflation, citing its limited supply and programmed issuance. Historically, accumulating BTC during periods of inflation has rewarded those who held on for the long term. However, over shorter horizons and in a stagflation context, this strategy shows limitations. The increasing correlation between cryptocurrencies and stock markets further complicates the picture. When equities plummet, even crypto-assets that are supposed to be uncorrelated follow.

Conclusion: a dilemma without an easy solution

Stagflation remains a macroeconomic puzzle. It combines two phenomena that should not coexist, destabilizing investors and decision-makers. The tools available to solve each problem individually become counterproductive when both arise together.

Navigating a period of stagflation requires careful consideration of all the factors at play: the trajectory of the money supply, the evolution of interest rates, the dynamics of supply and demand, and especially employment rates. For cryptocurrency investors, this period remains particularly volatile and requires sharp risk management.