Grayscale's Latest Research Report: Tariffs, Stagflation, and Bitcoin

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

Written by: Zach Pandl

Compiled by: Asher (@Asher_0210)

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

Since the United States announced a new global tariff policy on April 2, global asset prices have plummeted, until this morning when Trump's announcement of a suspension of tariffs (excluding China) began to gradually recover. However, the initial tariff announcement affected almost 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 drop in the S&P 500 should mean a 36% decline in Bitcoin prices. However, the reality is that Bitcoin only fell by 10%, which highlights that even during deep market pullbacks, holding Bitcoin as part of a portfolio can still provide significant diversification benefits.

After risk adjustment, the decline in Bitcoin price is relatively small.

In the short term, the global market outlook may depend on trade negotiations between the White House and other countries. While negotiations may lead to reduced tariffs, setbacks in talks could trigger further retaliatory actions. The actual volatility of traditional markets and implied volatility 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 price volatility of Bitcoin has increased at a much lower rate compared to stock volatility, and several 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 is expected to rebound.

The implied volatility of stocks is close to that of Bitcoin.

Regarding Bitcoin, although its price has declined in 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) could lead to "stagflation" and may result in structurally weaker demand for the dollar. Therefore, in this scenario, the increase in tariffs and changes in global trade patterns could be positive factors for the adoption of Bitcoin in the medium to long term.

Asset Allocation Under Stagflation

Stagflation refers to an economic state where growth is slow / slowing down while inflation rates are high / accelerating. Tariffs have raised the prices of imported goods, which will lead to rising inflation (at least in the short term). At the same time, tariffs may also slow economic growth due to reduced real income for residents and the adjustment costs faced by businesses. In the long run, this impact may be partially offset by increased domestic manufacturing investment, 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, the asset returns of the 1970s vividly illustrate the impact of stagflation on financial markets (Bitcoin has not been around long enough to backtest its performance). During that decade, the annualized return on U.S. stocks and long-term bonds was approximately 6%, below the average inflation rate of 7.4% at the time; in contrast, the price of gold increased at an annualized rate of about 30%, far exceeding the inflation rate.

The real returns of traditional assets in the 1970s were negative.

Typically, extreme situations during periods of stagflation are relatively rare, but their impact on asset returns is generally consistent over time. The chart below shows the annual average returns of U.S. stocks, government bonds, and gold across different economic growth and inflation cycles from 1900 to 2024.

Stagnation reduces stock returns and increases gold returns.

Historical data reveals three key points:

• When GDP is high or accelerating and inflation is low or slowing, stock market returns tend to improve. Therefore, during a stagflation period, stock market returns are expected to decline, and investors may need to reduce their equity allocation;
• When economic growth is sluggish and inflation rises, gold often performs better, especially during stagflation, where gold becomes a primary tool for hedging against inflation. This indicates that in such an environment, gold is typically a more attractive investment choice;
• Bond performance is closely related to changes in inflation. When inflation is low, bond yields tend to be better, while when inflation rises, bond performance typically declines. Therefore, during periods of rising inflation, bond investors may face the risk of declining returns.
• In summary, different assets perform differently during economic cycles, and investors should adjust their asset allocation based on the macroeconomic environment. The stagflation period is particularly important, as it often has a negative impact on stocks, while gold may experience growth.

Bitcoin and US Dollar

Tariffs and trade tensions may drive the adoption of Bitcoin in the medium term, one reason being the pressure on demand for the dollar. Specifically, if the overall trade flow with the United States decreases, and most trade flow is denominated in dollars, then the demand for transactions in dollars will decline. Furthermore, if increased tariffs also lead to conflicts with other major countries, then they may weaken the demand for the dollar as a store of value.

The proportion of the US dollar in global foreign exchange reserves far exceeds its share in global economic output. There are many reasons for this situation, but network effects play an important role: countries trade with the United States, borrow in the dollar market, and usually price commodities in dollars. If trade tensions lead to a weakening of connections with the US economy / dollar-based financial markets, countries may accelerate the diversification of their foreign exchange reserves.

The proportion of the US dollar in global reserves far exceeds its proportion in the global economy.

Many central banks have increased their gold purchases after facing Western sanctions in Russia. It is understood that, apart from Iran, no other country's central bank currently holds Bitcoin on their balance sheet. However, the Czech National Bank has begun to explore this option, the United States has also established a strategic Bitcoin reserve, and some sovereign wealth funds have publicly announced their investment in Bitcoin. In our view, the disruption 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 American 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 underpinned the global trade and financial system since the end of World War II. This action sparked diplomatic activity 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, there have been several rounds of trade tensions followed by (partly through negotiations) declines in the dollar.

The recent trade tensions are expected to lead to a sustained weakness of the US dollar once again. According to relevant indicators, the US dollar has been overvalued, and the Federal Reserve has room to lower interest rates, while the White House aims to reduce the US trade deficit. Although tariffs will alter effective import and export prices, the depreciation of the dollar may gradually achieve a rebalancing of trade flows through market mechanisms, thus achieving the desired effect.

Child of the Era - Bitcoin

The abrupt changes in U.S. trade policy are causing adjustments in the 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 different impacts on GDP growth, inflation, and the trade deficit. For example, while tariffs may reduce economic growth and increase inflation (leading to stagflation), certain types of deregulation may boost growth and lower inflation (thereby reducing stagflation). The final 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 series of impacts on growth and inflation.

Despite the uncertainty in the outlook, the best guess is that U.S. government policies will lead to a continued weakening of the dollar 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 also actively promotes other growth-friendly policies, GDP growth may still 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 of time could be beneficial for scarce commodities 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 the withdrawal of 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. New tariffs are a short-term disadvantage for the valuation of digital assets like Bitcoin, but the specific cryptocurrency policies of the Trump administration have consistently supported the industry. Overall, the rising demand for scarce commodity assets in the macroeconomy and the improvement of the operating environment for investors may be a strong combination for the widespread adoption of Bitcoin in the coming years.