Economic View: What will it take for the markets to see we have the weapons to resist disaster?

Does the share collapse change everything? Or is it a classic market panic, such as occurs every generation – as irrational as the euphoria that precedes it?

Yesterday, German President Horst Köhler reportedly criticised the bankers for their "unfettered greed". It is not the first time he has expressed similar sentiments: back in May he described financial markets as "a monster that must be put back in its place".

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The earlier comment was picked up by Professor Niall Ferguson in the final chapter of his new book, The Ascent of Money, a financial history of the world, to be published next month along with a Channel 4 series. His response deserves quoting, for he argues that they are not a monster, rather "... financial markets are like the mirror of mankind, revealing every hour of every working day the way we value ourselves and the resources of the world around us. It is not the fault of the mirror if it reflects our blemishes as well as our beauty."

The parallel I find most helpful is not the crash of 1987 or the gradual but brutal deflation of the dot-com boom that ended in 2000, but rather the more general loss of confidence that took place in 1973-74, with the final stock market collapse in the first days of 1975. There was, then as now, a series of threatened bank failures and many of the so-called "fringe banks" had to be rescued. There was also the bankruptcy of Burmah Oil. But the aspect of that period that seems most relevant now was the loss of confidence in the power of governments to cope. The Bretton Woods fixed exchange rate system had collapsed and inflation had begun to soar. The UK government seemed particularly inept, needing a bailout from the International Monetary Fund and savage cuts in public spending in 1976, leading to the breakdown of labour relations in the winter of 1979. But there was a loss of confidence in all governments, including the US.

The world's monetary authorities have spent the past months firing more and more ammunition in an effort to reassert their authority. So far they have failed. You could say that they have done too little, too late. But they will succeed in restoring order for they have two powerful weapons that have done the job on every such occasion since the Second World War.

These are the ability of central banks to create liquidity almost without limit, and the ability of the modern state to borrow up to and beyond the size of its GDP. We are seeing both weapons deployed to the full and we will see more in the coming weeks. But the markets don't believe this. I don't think we should expect too much from this weekend's G7 talks led by a baffled George Bush. So the panic may continue a while yet and the longer it does, the worse for the world economy.

What might convince the markets that this is still a normal post-war cyclical downturn and nothing worse? Let me set out two propositions. The first is that shares are now cheap, the second that the modern state has plenty of firepower to fix the banking crisis.

Regarding the prospective price/earnings ratio for the FTSE 100 index, we are back to the level of the 1980s in terms of share value, with the p/e into single figures. We have fallen off the ledge at about 12, the level that many of us thought was fair value, and we are a long way back from the mad valuations of 1999-2000. True, this is prospective p/e, so if there is a collapse in company earnings looming, the market is not such good value. The calculation was done ahead of Friday's falls and Mike Lenhoff, of Brewin Dolphin, calculates that even if profits fall by 20 per cent, the p/e would only be 11 – still quite cheap by 1980s standards.

So is the global outlook worse now than it was in the 1980s? Well, surely not. Inflation and unemployment were much higher and global growth was lower. The principal justification for thinking that things might be worse now is that the scale of the banking crisis is unprecedented. The answer to that is: it is and it isn't. It is in the sense that this is pretty much global. It isn't in the sense that relative to the GDP of the countries concerned, it is only middle-ranking. ING Bank has done some fascinating historical comparisons, looking at the losses run up by the US banks and the scale of the bailout relative to GDP. As you can see (and assuming the bailout will be double the present estimates), this crisis is worse than the previous US savings and loans crisis, about the same as the Swedish bank crisis, and much better than the Japanese or Thai crises. ING has not done a calculation for the UK, but my quick tally would put it, relative to GDP, at about the same scale as the Swedish bailout. So it will be big but not nearly as bad as Japan's.

The fact that the problem is global and complex will make things harder. That inflation and interest rates are lower than they were in the run-up to the 1980s or 1990s recessions will make it easier. My own principal concern for the UK is the scale of our personal indebtedness. The UK national debt is smaller relative to GDP than it was in the early 1990s but our household debt is much higher, not only than it was then but also much higher than debts in Germany or the US. This has to be a worry.

So to try and answer the first question, does the collapse change everything? I thought I had better look back at the first column I wrote here this year. I said then that the downturn would be more serious than that of the early 2000s but less serious than the early 1990s. I was too optimistic about house prices, which I thought would fall only gently, and I was worried that I was almost alone in thinking that 2009 would be worse than 2008. What is happening on the markets undoubtedly means that next year will be worse than this. Property apart, the real economy has got through to October in none-too-bad shape. But is the idea that this downturn will not be as bad as the early 1990s still credible?

The markets say not: they are saying this will be something like the 1990s, conceivably even nastier. It would be absurd not to acknowledge the possibility, but I still think we will scramble through in slightly better shape than we did then. It is hard to remember just how dreadful the early 1990s were. Put it this way: at least we are not going to have interest rates at 15 per cent.

For entrepreneurs, the time to start planning for the recovery is now

This is the time to start a business. Huh? Well, maybe not an estate agency or an airline, and perhaps it's more the time to start planning for one rather than hitting the market, but two people in the past week have floated ideas to me about businesses and in both cases what might seem a heroic idea makes sense.

One was an old friend who is thinking of starting a bank. Why? His argument is that banks at present are not trusted and are stuffed with bad debts. Yet plenty of liquidity is around, hunting for sensible havens, and plenty of investment opportunities are languishing because existing banks are unable to take them up. The problem is that you have to start quite big to get the appropriate banking licence, but you would be ultra-conservative and run it on low overheads. The deposit-taking side would be just a service and, being conservative, you would not try to compete with Icelandic banks (or whatever) by offering high rates. What it would offer is a path to investment opportunities.

The other is a colleague who plans to start a publishing business. Again, it has low costs and the great thing about publishing is you can start small. Distribution is much easier now thanks to the internet. All you need is the idea.

The same argument applies to other businesses. Good people and good premises are available, while money is always available for good ideas. Indeed, money may be more available for start-ups now because conventional investments have performed so badly. Above all, this is a time that gets rid of the weaker businesses, letting the best survive, and creating the discipline that it will need if it is to get itself established in the longer term. Thus new restaurants that can make it now can make it any time and won't be blown away by the next downturn.

Besides, it takes time to start anything. Your initial ideas are modified as you gauge demand and talk to potential clients. Start now and you will be ready when the green shoots of recovery start to show.