Original title: Market Byte: Stagflation, and Bitcoin

Original article by Zach Pandl

Edited by Asher, Odaily Planet Daily

Editor's note: This article analyzes the impact of recent changes in the US global tariff policy on the financial market, particularly the unique performance of Bitcoin in this process; explores the long-term impact of tariffs on the economy, particularly asset allocation choices during the stagflation period, and the performance of Bitcoin and gold in this environment; analyzes the impact of current trade tension on the US dollar and the potential adoption of Bitcoin; and finally looks forward to the economic outlook for the next few years, pointing out that scarce commodity assets such as Bitcoin and gold may receive more attention and demand in the high inflation environment.

Since the US announced a new global tariff policy on April 2, global asset prices have fallen sharply, and only gradually picked up until the suspension of tariffs announced by Trump this morning (excluding China). However, the initial tariff announcement affected almost all assets, and Bitcoin's decline was relatively small on a risk-adjusted basis during this time. Therefore, if Bitcoin's correlation with stock market returns is 1:1, a fall in the S&P 500 should mean a 36% drop in Bitcoin's price. However, the reality is that Bitcoin has declined by only 10%, which highlights the significant diversification benefits of holding Bitcoin as part of an investment portfolio even in the event of a deep market retracement.

Bitcoin's price decline was relatively small after risk adjustment

In the short term, the outlook for global markets will likely depend on trade negotiations between the White House and other countries. Although negotiations may lead to lower tariffs, setbacks in negotiations may also trigger more retaliation. The actual and implied volatility of traditional markets is still very high, making it difficult to predict how the trade conflict will evolve in the next few weeks. Therefore, investors should carefully adjust their positions in a high-risk market environment. Furthermore, the increase in Bitcoin's price volatility is far lower than that of stocks, and several indicators show that speculative traders in the cryptocurrency market hold relatively low positions. If macro risks are mitigated in the next few weeks, the cryptocurrency market value should be expected to rebound.

The implied volatility of stocks is close to Bitcoin

Regarding Bitcoin, although its price has declined over the past week, in the longer term, the impact of higher tariffs on Bitcoin will depend on its impact on the economy and international capital flows. Tariffs (and associated changes in non-tariff trade barriers) may cause “stagflation” and may cause structural weakness in demand for the US dollar, so in this case, increased tariffs and changes in global trade patterns may be positive factors for Bitcoin's adoption in the medium to long term.

Asset allocation under stagflation

Stagflation refers to an economic state where economic growth is slow/slowing, while the rate of inflation is high/accelerating. Tariffs raise the price of imported goods, and as a result (at least in the short term) will cause inflation to rise. At the same time, tariffs may also slow economic growth by reducing residents' actual income and enterprises facing adjustment costs. In the long run, this impact may be partially offset by increased domestic investment in manufacturing, and most economists expect that these new tariffs will continue to weigh on the economy for at least the next year.

From a historical perspective, asset returns in the 1970s most vividly showed the impact of stagflation on financial markets (Bitcoin was too short to backtest its performance). In that decade, the annualized return on US stocks and long-term bonds was about 6%, lower than the average inflation rate of 7.4% at the time. In contrast, the annualized increase in the price of gold was about 30%, far exceeding the inflation rate.

Traditional assets actually had negative returns in the 1970s

Generally, extreme situations during periods of stagflation are rare, but their impact on asset returns has been more or less consistent over time. The chart below shows the average annual return of US stocks, government bonds, and gold over different economic growth and inflation cycles from 1900 to 2024.

Stagnation reduces stock returns and increases gold returns

Historical data reveals three key points:

Stock market returns generally improve when GDP is higher or grows faster and inflation is lower or slower. Therefore, during the period of stagnation, stock market returns will fall as expected, and investors may need to reduce their share allocation;

When economic growth is sluggish and inflation rises, gold often performs better, especially during periods of stagnation, when gold becomes the main tool to hedge against inflation. This shows that gold is generally a more attractive investment option in this environment;

The performance of bonds is closely linked to changes in inflation. Bonds generally yield better when inflation is low, while bonds generally perform worse when inflation rises. As a result, bond investors may face the risk of falling returns during periods of rising inflation.

In summary, the performance of different assets in the economic cycle varies, and investors should adjust asset allocation according to the macroeconomic environment. Stagnation periods are particularly important because they often have a negative impact on stocks, while gold is likely to grow.

Bitcoin vs US Dollar

Tariffs and trade tensions may drive Bitcoin adoption in the medium term, in part due to pressure on dollar demand. Specifically, if overall trade flows with the US decline, and most trade flows are denominated in US dollars, then demand for US dollar transactions will decrease. Furthermore, if additional tariffs also lead to conflicts with other major countries, then they may weaken the demand for the dollar as a means of storing value.

The share of the US dollar in global foreign exchange reserves far exceeds that of the US in global economic output. There are many reasons for this situation, but the network effect plays an important role: countries trade with the US, borrow in the US dollar market, and usually export commodities in US dollars. Countries may accelerate diversification of foreign exchange reserves if trade tensions lead to weakening ties with the US economy/dollar-based financial market.

The share of the US dollar in global reserves far exceeds that of the US in the global economy

Many central banks have stepped up gold purchases after Russia was sanctioned by the West. According to information, apart from Iran, no central bank currently holds Bitcoin on its balance sheet. However, the Czech National Bank has begun exploring this option, the US has also established strategic Bitcoin reserves, and several sovereign wealth funds have publicly announced their investment in Bitcoin. In our view, disruptions to the dollar-centered international trade and financial system may cause central banks to further diversify their reserves, including investing in Bitcoin.

Perhaps the most similar moment in US history to President Trump's “Emancipation Day” statement was the “Nixon Shock” of August 15, 1971. On the same night, President Nixon announced the imposition of a full 10% tariff and the end of the US dollar exchange system for gold — a system that has supported the global trade and financial system since the end of World War II. The action sparked diplomatic activity between the US and other countries, culminating in a Smithsonian agreement in December 1971, where other countries agreed to appreciate their currencies against the US dollar. The dollar eventually depreciated 27% between the second quarter of 1971 and the third quarter of 1978. Over the past 50 years, the dollar (partly negotiated) has weakened after several rounds of trade tension.

It is expected that the recent trade tension will once again cause the dollar to continue to weaken. According to relevant indicators, the US dollar is already overvalued, the Federal Reserve System has room to lower interest rates, and the White House wants to reduce America's trade deficit. Although tariffs will change effective import and export prices, the depreciation of the US dollar may gradually rebalance trade flows through market mechanisms, thereby achieving the expected results.

Child of an Era — Bitcoin

Sudden changes in US trade policy are causing financial markets to adjust, which will have a short-term negative impact on the economy. However, market conditions in the past week are unlikely to become the norm in the next four years. The Trump administration is implementing a range of policy measures that will have different effects on GDP growth, inflation, and trade deficits. For example, while tariffs may reduce economic growth and increase inflation (that is, cause stagflation), some types of deregulation may increase growth and reduce inflation (i.e. reduce stagflation), and the end result will depend on the extent to which the White House implements policy agendas in these areas.

US macroeconomic policies will have a range of effects on growth and inflation

Despite uncertainty about the outlook, the best guess is that the US government's policies will cause the dollar to continue to weaken and overall higher-than-target inflation over the next 1 to 3 years. Tariffs themselves may slow growth, but this effect may be partially offset by tax cuts, deregulation, and depreciation of the dollar. If the White House actively pursues other policies to promote growth, GDP growth is likely to remain relatively good despite the initial impact of tariffs. Whether actual growth is strong or not, history shows that continued inflationary pressure over a period of time may be beneficial to scarce commodities such as Bitcoin and gold.

Furthermore, just like gold in the 1970s, Bitcoin now has a rapidly improving market structure — supported by changes in US government policy. Since this year, the White House has implemented a wide range of policy changes that should support investment in the digital asset industry, including withdrawing a series of lawsuits, ensuring the suitability of assets for traditional commercial banks, and allowing regulated institutions (such as custodians) to provide cryptocurrency services. This in turn triggered a wave of mergers and acquisitions and other strategic investments. The new tariffs are a short-term downside to the valuation of digital assets such as Bitcoin, but the Trump administration's crypto-specific policies have supported the industry. Taken together, the rise in macroeconomic demand for scarce commodity assets and the improvement in the investors' business environment may be a strong combination of Bitcoin's widespread adoption in the next few years.