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.

4. Meanwhile there are major disruptions in the global economy and no-one knows how they will play out. The oil price is a great example, with universal expectations of steady increases dashed as the Saudis for their own reasons have forced the price down to very low levels. The price could jump suddenly and by a huge margin for reasons that are beyond economic rationality. This makes all forms of economic planning extremely difficult.

5. In most wealthy countries the population is stable so the economic stimulus of simple expansion has disappeared. Population growth is very high in the poorest countries where it serves to limit economic development and create civil wars and other crises.

6. Meanwhile globalisation has reached a critical turning point. For at least two decades developing nations have been growing strongly (on average) and creating demand for the products of wealthy nations. Plus, the boom in resources has been driven by the developing nations requiring rapid upgrades of infrastructure and housing.

But jobs have been transferred from rich to developing nations resulting in lower prices but also in the expectations of steady improvements in living standards in those wealthy nations not being met. The gap was filled by governments borrowing or just creating money. But cash flowed to the owners of the resource and high level manufacturers, who lived in rich nations. Thus workers got poorer and the rich got richer.

Now the resources boom is over. China for example has more highways that the US and a vast array of new airports, power stations, apartment blocks and everything else it needs. Demand will continue but it will not grow. The capitalists have met demand for resources by expanding production so the price falls.

As stock markets fall the wealthy share the fate of the workers in getting poorer.

Economists love to talk about 'equilibrium' but they have assumed that developing nations will adjust upwards to rich nation levels. The idea that we will go down as they go up is bit unpopular so they dismiss it, for no rational reason.

For these six reasons, and many others, the growing crisis is dissolving vast financial assets.

Australia is better placed than most nations but national strategies have limited value in the highly globalised world. What we need most is a government ready to move beyond the small picture to deal with the unexpected and make some very tough decisions.