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What is Stagflation and How Does It Affect the Crypto Market?

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2023-01-30
What is Stagflation and How Does It Affect the Crypto Market?

What is stagflation?

Stagflation is a combination of stagnation and inflation. It is characterized by slow economic growth, high unemployment rate, and inflation. Stagflation was once thought impossible by economists but the developed world experienced repeated stagflations in the 1970s.

Stagflation is particularly difficult to tackle. To drive economic growth, most economists resort to monetary policies that increase the money supply, which will result in higher inflation. To combat inflation, hawkish policies are often the obvious choice but they will hinder economic growth and harm employment rate.

Currently, economists have yet to reach a consensus as to what leads to stagflation. Some say an accident from the supply-side, such as the oil crisis in the 1970s, may have a great impact on the economy as a whole and possibly lead to stagflation. Others argue that poor fiscal and monetary policies should be the culprit behind a stagflation.

Does stagflation always lead to recession?

Whatever the cause, a stagflation is often the fruit of both misfortune and mishandling. There is no silver bullet for stagflation and all we can agree on at the moment is that a major leap in productivity - one that drives massive economic growth without causing inflation - may put an end to stagflation. Such a leap does not come when we call it so the best course of action is to try our best to avoid it.

Should we fail to do that, however, and a stagflation is well on its way, does that mean a recession is inevitable?

No.

There is still some distance between a stagflation and a recession and the difference makers are the fiscal and monetary policies. Many suggest that the central bank should raise interest rates and decrease the money supply. At the same time, the government should engage in expansionary fiscal policies such as increasing government spending or cutting taxes. Other policies such as labor market reforms, price controls, and deregulation may also be implemented to address stagflation. We will be treading on thin ice as even the slightest misstep may tip the balance, taking the economy into a downward spiral.

How will a stagflation affect crypto?

It’s been 14 years since Bitcoin was released and the crypto market as a whole has undergone some major transformations. Bitcoin and Ethereum are now widely accepted as digital commodities. The case for Bitcoin being the ‘digital gold’ was even brought up for discussion. The same cannot be said for most altcoins, sadly.

While most would agree that a widespread recession will severely damage the cryptocurrency market as a whole, what stagflation may or may not be capable of is still unclear. Currently, Bitcoin’s Market Value to Realized Value ratio is still at a historical low - a ‘Sell-a-kidney-to-buy-more territory’ situation, according to Messari’s Crypto Theses for 2023. Thus, if a post-COVID stagflation is imminent, there is still a chance that Bitcoin may start a rally when people seek risk hedging from this ‘digital gold,’ but if a recession follows, Bitcoin will most likely go down in price.

Ethereum has always displayed a close price correlation to Bitcoin but with higher volatility and risk than Bitcoin. Most other altcoins are even more volatile and risky and have little chance in an overall bear market, since capital tends to seek stability in times of uncertainty.

That said, there are tens of thousands (and counting) of altcoins and each of them has its unique purposes and traits. Since most cryptocurrencies are not tied to any country and therefore less likely to be affected by regional monetary and fiscal policies, some of them may survive a stagflation and a selected few may even thrive (at least for a while) in a recession. Don’t get your hopes up, however, because no one can predict which coin will moon and stakes will be higher than ever during a stagflation or recession.

Closing thoughts

Many say we will be facing a stagflation and recession soon. Such things may not be definitive but it’s always good to educate yourself about the basics of investing, especially in a bear market. It’s always wise to thoroughly evaluate your risk appetite and bide your time for more ideal situations.

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