Grayscale's Latest Research Report: Tariffs, Stagflation, and Bitcoin, A Major Shift in the Global Economy

Original Title: Market Byte: Tariffs, Stagflation, and Bitcoin

Original Author: Zach Pandl

Original Compilation: Asher, Odaily Planet Daily

Editor’s Note: This article analyzes the recent changes in U.S. global tariff policy and their impact on financial markets, particularly the unique performance of Bitcoin during this process; it explores the long-term effects of tariffs on the economy, especially in terms of asset allocation choices during stagflation, and the performance of Bitcoin compared to gold in such an environment; it analyzes the current trade tensions' impact on the dollar and the potential adoption of Bitcoin, and finally provides an outlook on the economic prospects for the coming years, indicating that scarce commodity assets like Bitcoin and gold may attract more attention and demand in a high-inflation environment.

Since the U.S. announced its new global tariff policy on April 2, global asset prices have plummeted, only gradually recovering after Trump announced a suspension of tariffs (excluding China) this morning. However, the initial tariff announcement affected nearly all assets, and during this period, Bitcoin's decline was relatively small on a risk-adjusted basis. Therefore, if the correlation between Bitcoin and stock market returns is 1:1, the decline of the S&P 500 should imply a 36% drop in Bitcoin's price. However, the reality is that Bitcoin only fell by 10%, highlighting that holding Bitcoin as part of a portfolio can still provide significant diversification benefits even during deep market pullbacks.

On a risk-adjusted basis, Bitcoin's price decline is relatively small

In the short term, the outlook for global markets may depend on trade negotiations between the White House and other countries. While negotiations may lead to lower tariffs, setbacks in negotiations could trigger more retaliatory actions, and the actual volatility and implied volatility in traditional markets remain high, making it difficult to predict how trade conflicts will evolve in the coming weeks. Therefore, investors should cautiously adjust their positions in a high-risk market environment. Moreover, the increase in Bitcoin's price volatility is far lower than that of stocks, and multiple indicators show that speculative traders in the cryptocurrency market hold relatively low positions. If macro risks ease in the coming weeks, the market capitalization of cryptocurrencies should be expected to rebound.

The implied volatility of stocks is close to that of Bitcoin

Regarding Bitcoin, despite its price decline over the past week, from a longer-term perspective, the impact of higher tariffs on Bitcoin will depend on their effects on the economy and international capital flows. Tariffs (and changes in related non-tariff trade barriers) may lead to "stagflation" and could result in structural weakness in dollar demand; therefore, in this context, the increase in tariffs and changes in global trade patterns may be positive factors for Bitcoin adoption in the medium to long term.

Asset Allocation During Stagflation

Stagflation refers to an economic state characterized by slow or slowing economic growth alongside high or accelerating inflation rates. Tariffs have raised the prices of imported goods, which will likely lead to inflation rising (at least in the short term). At the same time, tariffs may slow economic growth due to reduced real income for residents and adjustment costs for businesses. In the long run, this impact may be partially offset by increased domestic manufacturing investment, and most economists expect these new tariffs to continue to weigh on the economy for at least the next year.

Historically, the asset returns of the 1970s vividly illustrate the impact of stagflation on financial markets (Bitcoin's existence is too short to backtest its performance). During that decade, the annualized returns of U.S. stocks and long-term bonds were both around 6%, below the average inflation rate of 7.4% at the time, while gold prices increased at an annualized rate of about 30%, far exceeding the inflation rate.

Traditional assets had negative real returns in the 1970s

Typically, extreme cases of stagflation are rare, but their impact on asset returns tends to be consistent over time. The following chart shows the average annual returns of U.S. stocks, government bonds, and gold from 1900 to 2024 across different economic growth and inflation cycles.

Stagflation reduces stock returns while increasing gold returns

Historical data reveals three key points:

• When GDP is high or accelerating and inflation is low or slowing, stock market returns typically improve. Therefore, during stagflation, stock market returns are expected to decline, and investors may need to reduce equity allocations;

• When economic growth is sluggish and inflation rises, gold often performs well, especially during stagflation, where gold becomes a primary tool for hedging inflation. This indicates that in such an environment, gold is usually a more attractive investment choice;

• Bond performance is closely related to changes in inflation. When inflation is low, bond yields are typically favorable, while when inflation rises, bond performance usually suffers. Therefore, during periods of rising inflation, bond investors may face the risk of declining returns.

In summary, different assets perform differently throughout economic cycles, and investors should adjust their asset allocations based on the macroeconomic environment. This is particularly important during stagflation, as it often negatively impacts stocks, while gold may see growth.

Bitcoin and the Dollar

Tariffs and trade tensions may drive the adoption of Bitcoin in the medium term, one reason being the pressure on dollar demand. Specifically, if overall trade flows with the U.S. decline, and most trade flows are denominated in dollars, the demand for dollar transactions will decrease. Additionally, if increased tariffs lead to conflicts with other major countries, they may weaken the dollar's demand as a store of value.

The dollar's share of global foreign exchange reserves far exceeds its share of global economic output. This situation exists for many reasons, but the network effect plays a significant role: countries trade with the U.S., borrow in the dollar market, and typically price commodities in dollars. If trade tensions weaken ties with the U.S. economy and dollar-based financial markets, countries may accelerate the diversification of their foreign exchange reserves.

The dollar's share of global reserves far exceeds its share of the global economy

Many central banks have increased gold purchases following Western sanctions against Russia. Currently, apart from Iran, no other country's central bank holds Bitcoin on its balance sheet. However, the Czech National Bank has begun exploring this option, the U.S. has established a strategic Bitcoin reserve, and some sovereign wealth funds have publicly announced investments in Bitcoin. In our view, disruptions to the dollar-centered international trade and financial system may lead central banks to further diversify their reserves, including investing in Bitcoin.

The moment in U.S. history most similar to President Trump's "Day of Liberation" declaration may be the "Nixon Shock" on August 15, 1971. That evening, President Nixon announced a comprehensive 10% tariff and ended the dollar's convertibility into gold—a system that had supported the global trade and financial system since the end of World War II. This action triggered diplomatic activities between the U.S. and other countries, ultimately leading to the Smithsonian Agreement in December 1971, where other countries agreed to revalue their currencies relative to the dollar. The dollar ultimately depreciated by 27% between the second quarter of 1971 and the third quarter of 1978. Over the past 50 years, several rounds of trade tensions have been followed by (partially negotiated) dollar weakness.

It is expected that the recent trade tensions will again lead to sustained dollar weakness. According to relevant indicators, the U.S. dollar is currently overvalued, the Federal Reserve has room to lower interest rates, and the White House aims to reduce the U.S. trade deficit. Although tariffs will alter effective import and export prices, dollar depreciation may gradually achieve the desired effect of rebalancing trade flows through market mechanisms.

The Child of the Era—Bitcoin

The abrupt shift in U.S. trade policy is causing adjustments in financial markets, which will have short-term negative effects on the economy; however, the market conditions of the past week are unlikely to become the norm for the next four years. The Trump administration is implementing a series of policy measures that will have varying impacts on GDP growth, inflation, and the trade deficit. For example, while tariffs may reduce economic growth and increase inflation (i.e., causing stagflation), certain types of deregulation may enhance growth and reduce inflation (i.e., alleviating stagflation). The ultimate outcome will depend on the extent to which the White House implements its policy agenda in these areas.

U.S. macroeconomic policies will have a range of impacts on growth and inflation

Despite the uncertainty in the outlook, the best guess is that U.S. government policies will lead to sustained dollar weakness and overall inflation above target in the next 1 to 3 years. Tariffs themselves may slow growth, but this impact may be partially offset by tax cuts, deregulation, and dollar depreciation. If the White House actively pursues other growth-promoting policies, GDP growth may remain relatively strong despite the initial shock from tariffs. Regardless of whether actual growth is robust, history shows that sustained inflationary pressures over a period may be beneficial for scarce commodity assets like Bitcoin and gold.

Moreover, like gold in the 1970s, Bitcoin now has a rapidly improving market structure—supported by changes in U.S. government policy. This year, the White House has implemented a series of broad policy changes that should support investment in the digital asset industry, including withdrawing a series of lawsuits, ensuring the applicability of assets to traditional commercial banks, and allowing regulated entities (such as custodians) to provide cryptocurrency services. This, in turn, has triggered a wave of mergers and acquisitions and other strategic investments. The new tariffs represent a short-term disadvantage for the valuation of digital assets like Bitcoin, but the Trump administration's cryptocurrency-specific policies have consistently supported the industry. Overall, the rising macroeconomic demand for scarce commodity assets and the improved operating environment for investors may create a powerful combination for the widespread adoption of Bitcoin in the coming years.