The world is teetering on the brink of a new economic policy. Not one that was written about by capitalism’s founding father Adam Smith, or even John Maynard Keynes, but a giant experiment in which we will all be the subject.

Negative interest rates threaten to turn the whole financial world upside down — punishing savers and paying borrowers in a complete reversal of normal circumstances.

Investors wishing to protect their hard-won wealth in this distorted economic environment must quickly adjust. But how are assets likely to behave once negative interest rates are put in place? And will the centuries-old safe haven of gold still offer a refuge?

Why are interest rates going negative?

Negative interest rates are a shocking idea. After all, who in their right mind would pay someone to take their money?

The answer can be found by delving deep into the mechanism of the modern monetary system.

Central banks, which are responsible for monetary policy, adjust interest rates to control inflation. This impacts people’s ability to borrow money with mortgages, business loans and other forms of credit.

By keeping inflation at a certain level—usually 2-3%—central banks aim to create steady growth and economic stability.

In economic boom times, people will be confident in the future and borrow more funds—leading to more money sloshing around the economy and higher rates of inflation. To bring levels of inflation down, central banks will raise interest rates and curb the amount of borrowing—making it more attractive for people to keep funds in the bank, and more difficult for them to borrow. 

In economic downturns, people are less likely to borrow and spend and more likely to horde funds in the bank. To stimulate the economy, central banks will lower interest rates, incentivising commercial banks to stop storing cash with the central bank at a poor rate, and start loaning it out to businesses, making new ventures more economically viable, creating jobs and boosting the economy. 

At least, that’s the theory…

However, since the financial crisis in 2008, confidence in the economy has remained at a low ebb. People are saving more money, and banks are lending less. This has caused inflation and growth to stay below targeted levels, leading banks to continually lower interest rates.

But with interest rates now approaching zero, banks are forced to consider a last-ditch attempt to keep the economy afloat: negative interest rates.

This policy was tried for the first time in Sweden in 2009 as a temporary measure, and since then has been introduced by Japan and other European central banks.

At the moment, the negative rates are mostly confined to the domain of large financial institutions and governments, but they are gradually starting to trickle out from the upper echelons of global finance to high street banks. As seen in Denmark with the introduction of the world’s first negative interest rate mortgage in July 2019.

What happens when interest rates go negative?

Twenty years ago, nobody would have considered negative interest rates to be a possibility. And even today, economists still disagree on the implications for the global economy.

Some policymakers, like President Trump, are keen to embrace negative interest rates to bolster economic growth.  Others are more skeptical, like JP Morgan’s Jamie Dimon who said negative rates are “one of the great experiments of all time”, and have “adverse consequences which we do not fully understand.”

One of the potential problems with negative interest rates is that they would not lead to more spending, but actually cause another catastrophic event — a bank run, where people rush to withdraw all their cash at once.

Whether this will happen or not is difficult to say, but banks are certainly likely to face squeezed margins and lower profits, which could discourage them from lending entirely and lead the negative interest rates to pull the economy down further into the quagmire.

Competitive high street banks may also be reluctant to pass on the negative interest rates to customers, for fear of losing them. This attitude is already playing out in Denmark, as the Housing Economist of Danish bank Jyske told The Guardian, “no bank wants to be the first mover into negative deposit rates.”

But with digital cash looming on the horizon, central banks are consolidating power over their currencies — tightening the reins over the money supply and ultimately gaining more power to enforce controversial policies like negative interest rates.

How to invest with negative interest rates

It is a commonly held belief among investors that high interest rates exert a gravitational pull on asset valuations — pulling prices down as investors choose to park funds in cash at the bank to earn regular interest.

Some investors even suggest that the only reason the stock market has performed so well over the last decade is because interest rates have been pushed down so low by central bankers.

On the surface, negative rates would seem to make holding cash even less attractive and further pump up the stock market as the yield of bonds falls.

But the enforcement of negative interest rates is likely to be triggered by very weak growth, or even a recession. This would create a “risk-off” environment that could counterbalance the appeal of equities.

Are negative interest rates good for gold? 

Gold and interest rates traditionally have a negative correlation, with gold prices going up as interest rates go down.

This correlation makes negative interest rates bullish for gold, and the metal is also likely to benefit from safe haven demand as the public begin to question the new and experimental central bank policy.

Until now, the impact of negative interest rates has been largely limited to central bank reserves. But when implemented in places like Japan, the results of pushing rates to the negative has been lackluster, with inflation falling instead of rising as the measure failed to stimulate the economy.

The danger is that the poor results could lead central banks like Japan’s to go deeper into negative interest rates, and potentially unleash even more bizarre and dystopian consequences — like mortgages that stretch for many decades to keep that sweet debt for as long as possible, or children being glad at the prospect of inheriting debt.

In this new strange world, the idea of sound money might just make more sense than ever.