Still afraid of Inflation? Then you don’t know stagflation yet
What it is and why adding Bitcoin to your portfolio makes sense
Recently, countries like the United States have started re-opening businesses and hospitality in a bid to save the economy. From a public health point of view, that seems irresponsible at best considering that infections are increasing — but then again, what can you expect from a president who is so eager to hold his rally in a packed hall despite a raging pandemic.
While at the beginning of the crisis the argument has often been public health vs. economy, that seems to be invalidated by examples such as South Korea or Germany, both countries that got the crisis better under control than many of their peers and have as a reward also seen less of a down-turn in GDP. Ironically, the UK that apparently followed an economy first approach, in the beginning, is expected to see the biggest drop in GDP of all developed nations. Guess that didn’t work out too well.
To get us through the crisis, central banks have massively engaged in Quantitative Easing (injecting money into the economy) and governments have spent to support their citizens. From the very beginning, economists have discussed the consequences of this significant intervention in the economy would be.
And while most of us have been trimmed by traditional economic theory and in crypto especially to be afraid of high inflation, there’s actually something out there that could be worse: Stagflation.
Staglaftion is high inflation but accompanied by slow economic growth and a high unemployment rate. It’s a portmanteau of stagnation and inflation.
The word was termed by Iain Macleod, a British Conservative Party politician who said during a time of high inflation and high unemployment the following:
“We now have the worst of both worlds — not just inflation on the one side or stagnation on the other, but both of them together. We have a sort of “stagflation” situation.”
So stagflation is really a combination of the worst and it’s not supposed to happen naturally according to economic theory.
Why? Because slow economic growth should keep inflation rates low. So stagflation only happens as a result of government policies or monetary policies that disrupt the normal market function. You could say that the invisible hand of the market is being kept from doing its magic.
Causes for stagflation
Stagflation can be caused by the following 2 events:
- supply shock: a supply shock describes the sudden increase or decrease of a commodity or service. This changes the equilibrium of demand and supply. A sudden increase in supply will push the aggregate supply curve to the right, resulting in increased output and decreased prices. A sudden decrease in supply, for example to a sudden rise in price for a commodity such as oil — will reduce aggregate demand, hence move the curve towards the left resulting in lower output and higher prices.
- poorly made economic policy including the creation of money or credit by the central banks while at the same time having policies that constrain supply such as tax increases.
The Stagflation in the US in the 70s
The most prominent example of stagflation took place in the 70s in the US, where the economy experienced 5 quarters with negative GDP, high unemployment rates peaking at 9% in May 1975, and inflation between 10–12% throughout.
It all started with a mild recession in 1974 and 2 quarters of negative GDP while unemployment stood at 6.1%. However, it was also the time of presidential campaigns and Nixon wanted to be re-elected. And as we all know, for a US president to be re-elected, a booming economy is key. Nixon introduced 3 policies aimed at boosting the struggling economy:
- a 90-day freeze of wages and prices
- 10% tariff on imports
- removed the US Dollar from the Gold Standard.
Until then, technically anyone could exchange their dollars for a set amount of gold. However, at some point, the UK wanted to redeem $3.5 Billion for gold. An amount of gold that the US didn’t have in their reserve. Abandoning gold standard = problem solved, one could think. Unfortunately, all three policies together had quite the opposite effect on the economy.
By abandoning the gold standard, the value of gold rose while the value of the dollar dropped, which increased the price for imports even further (on top of the tariff). This led to slower economic growth, as companies couldn’t afford to import as much as before to increase output and even worse, they couldn’t increase prices nor lower wages either to make up for the higher cost. Ultimately, that just led to more redundancies, higher unemployment, and less demand. Nixon did not achieve what he had intended with his policies. In reaction, the Fed tried to fight inflation by raising the interest rate just to later lower it in an attempt to fight the recession. This approach had businesses confused so much so, that they’d keep prices high even when the interest rate was lowered. All in all, the Fed’s attempts were fruitless.
Until Paul Volcker was appointed Chair of the Federal Reserve and in a drastic move increased the interest rate to 20%. This action finally ended stagflation for good, but it came at a high cost: recession.
The main dilemma when facing stagflation is that policies designed to lower inflation, usually drive up unemployment while policies aimed at lowering unemployment lead to high inflation. So there’s really no easy fix.
During this time, prices of commodities like oil haven’t soared. Quite the opposite: oil futures traded below zero earlier this year. At the same time, the unemployment rates across the world have risen, in the US even up to 13.3%. Who thinks that’ we can just bounce back is naive, to say the least. High unemployment rates are expected to remain with us for a while, which most definitely decreases aggregate demand, but also has a negative impact on the aggregate supply.
Even with governments supplementing income and unleashing some demand, the imbalance between the restrained supply and demand will persist, which could be followed by inflation. On top of that, many of us will be a lot less likely to go on huge shopping sprees when the future is so uncertain. Let’s face it, all the activities we spent a lot of money on, are a lot less fun under social distancing.
At the same time, we can observe growing backlash against globalisation with governments trying to bring offshore companies home. While this move secures supply, another result could be a higher cost of domestic products.
All in all, it seems the quick bounce-back is far off. Inflation so far is not much higher than it used to be. Quite the opposite actually, but that can change. Currently, businesses are still reluctant to raise prices. However, who would definitely benefit from inflation are governments that have taken out huge loans to serve their citizens. Inflation will make it cheaper for them to pay back in the future, so it’s not too far off the table. And even if the Fed could increase interest rates to fight inflation, it seems unlikely with a president in the white house, who wants to keep those rates at zero.
For the second ingredient for stagflation, we’re already there. Growth is stagnant if not negative and unemployment high. Will it happen again? We will see.
What can you personally do? Diversify. The most obvious digital asset to add to your portfolio is Bitcoin.
Bitcoin during Stagflation?
So far, Bitcoin doesn’t have a track record in stagflation, because it wasn’t around in the 70s. However, it already is seen as an alternative store of value especially in cases of high inflation. And if you’re already buying gold, why not check out Bitcoin? After all, it’s said to be digital gold. The supply of bitcoin is fixed so that after the maximum of 21 million Bitcoin has been created, no new Bitcoin will ever enter circulation. It’s trustless in the sense that no middleman is required to validate transactions and it’s run on top of a decentralized network of miners all around the world, which makes it resistant to not only attacks but censorship. It’s also digital and therefore easier to store than if you were to buy gold and keep it. You can also buy any amount of it starting with as little as $10.
And when investing in Bitcoin, you get the priceless feeling of being part of a digital revolution on top — for free. 😉
When inflation is high, one thing you should avoid is to just keep cash in your bank account. You will definitely lose. However, putting it all into crypto isn’t feasible for most of us either. And I wouldn’t recommend it for a beginner trader anyway. It’s very high risk and the likelihood of seeing your gains wiped out in just one day, not small. Nevertheless, adding some Bitcoin or other cryptocurrencies to your portfolio during times of economic uncertainty is worth considering. It won’t make you rich quick (sorry), but why not let it run alongside your other investments (stocks, shares, options, whatever you fancy) for a while with a stop-loss you can live with.
After all, you will regret what you didn’t do more than what you did do.