Negative interest rates will act as a deflationary force that will reduce consumption and reduce investment in productive capital assets, as well as reducing consumer confidence. It will act to weaken the confidence of stock market investors thus resulting in a sell off of stocks. The central banks gambled and lost regarding their policy of negative rates. Their credibility has been diminished. Once people realize that central banks and their rate cuts can’t stimulate the economy then investors will stop believing in the myth of the central bank put option. This will exacerbate the stock sell off.
The U.S. central bank bailouts and stimulus of 1998, 2003, and especially 2008 acted to create Moral Hazard (where the availability of extra protection encourages a higher degree of risk taking that in turn makes participants less safe than before the protection was offered). Eventually a catastrophic lock limit loss will occur in speculative instruments. For example, some investors write put options hoping stocks will never crash. If they are overleveraged and undiversified and stocks crash 22% in a day as in October, 1987 these speculators could be hurt, possibly unable to fulfill their contract to fulfill the put options in a crash. In modern times there are circuit breaker rules that temporarily halt trading if the market tried to go down 22%. But if the market needed to go down then it will eventually go down even if the exchange’s rules require a slow gradual decline. This happened in commodity futures where a commodity suddenly needed to go down (because of a dramatic change in agricultural results) by an amount that required a week’s wait based on the exchange’s daily limits. There was no way for contract holders to liquidate their contract positions for a week while they sat by hopelessly and watched their assets plunge in value.
A world in which central banks lack credibility means that investors would view investments as far riskier than before and thus prices would fall deeply and stay low. Remember the NiftyFifty bubble of the 1970’s where the top 50 good quality companies became overpriced by about 4 or 5 times a reasonable valuation and then they plunged 80% (or even 90% if one counts the huge inflation of the 1970’s). Remember the dotcom 1998-2000 bubble where tech plunged 80% and took 13 years to breakeven.
As these risks become apparent to the masses they will turn to precious metals. In the 1970’s inflation short term bonds did OK because the bonds matured rapidly so that investors could reinvest into higher yielding new bonds during a period of rising rates. This time could be different if central banks are able to suppress interest rates. The end of faith in central banks is like being transported in time to the crash of 1907 which led to the inspiration for starting the Fed central bank in 1913. But if people don’t trust central banks then what will be the outcome?
Perhaps futures crashes will be dealt with by fiscal policy with the central merely acting to monetize the new issues of debt. If Republicans lose power in 2020 perhaps Democrats will be able to use fiscal policy to stimulate, assuming Republicans are unable to assemble a viable Tea Party hard money anti-deficit group in Congress. If Democrats raise taxes this will act to dampen inflation and growth, ironically achieving the conservatives’ desire for hard money by other means. But if the Democrats spend too much that would cause inflation, and higher interest rates, etc.
As much as buying long term Treasuries for a capital gain sounds interesting, I feel it is too risky. There is no certainty of the U.S. having negative rates and huge bond appreciation. This is an unprecedented situation subject to highly volatile, speculative factors and is thus more of a speculation than an investment.
Investors need independent financial advice about the risk of negative yields.