Financial crisis or correction?

Recent global financial turmoil has raised the question – is this the great collapse or just another downturn?

Media 'experts' advise that 'the fundamentals are sound', or 'this is a great buying opportunity', or 'just hold your nerve', presumably on the scientific basis that whatever goes down must come up. Others worry about global debt levels, the state of capitalism and other problems.

The essential difference is one of viewpoint. The small Australian picture looks fine, while the big picture shows disaster. But in a globalised world the big picture dominates. Here are six issues to consider.

1. Central bankers have been propping up the global economy by creating trillions of new dollars every year and keeping interest rates around zero or even negative. As critics have pointed out, all that has happened as a result of this massive money creation is a lift in the value of assets, such as shares and property.

This policy only makes sense when we remember that though the current level of global debt can't possibly be repaid, (it was around $200 trillion in 2014, or roughly three time global GDP) even with a reasonably strong economy, while markets were buoyant it has still been possible for us to delude ourselves that it will all work out eventually. Keeping asset prices up has been vital to maintaining the entire system.

But now central bank action seems to have lost a lot of its effect. Asset prices are dropping. The Japanese and EU banks have cut interest rates to negative and their currencies have gone up. Established theory no longer works.

2. Another basic problem is that capital is no longer as important as it once was.

Returns on money are now extremely low because supply is ridiculously high and demand is low. It flows into assets because there is nowhere else for it to go. There is no 'best wealth creating option' for it to be allocated to. All that is left is gambling on future price movements, based more on political than economic judgements.

The huge new IT companies, like Apple, did not need much capital to get started and now have enormous reserves. The assets they actually own are insignificant, apart from the intellectual property which is their real source of wealth. Any capital raisings these companies indulge in are generally for tax minimisation strategies.

But it is not just an IT sector problem. Most industry sectors are now global oligopolies competing fiercely on the intellectual property margins. In the car industry Toyota spends around $US8 billion per year on research and development. The price or availability of capital is the least of their worries.

3. Since 2008 US banks that were then too big to fail have grown even larger, due to government intervention, and are now too big to save. The amounts of money governments would have to create to prop them up again are so stupendously large, piled on top of already huge debts, that the financial system would lose all credibility.

National governments could legislate to split banks so that gambling activities (known as investment banking) are separated from financial management. But many banks in leading nations are so fragile, and indeed only surviving on illusions, that to make their real financial positions clear in any split or divestment would result in immediate collapse.