Couched in the new terminology of decoupling versus recoupling whether the old aphorism “when the US sneezes, the world catches a cold” holds this time or not has been the subject of much debate. Growth in the rest of the world has so far seemed resilient in the face of the US credit crunch and economic slowdown but could it be that we are now at the tipping point where the US is beginning to share its pain with others? On a financial basis the US credit crunch is already well shared. The US economic expansion of this decade was supported by significant external borrowing so it was inevitable that foreign financial institutions would take some of the hit. Losses by European banks in fact equal those of their American counterparts. Of the $323 billion in losses incurred by global banks to date $152.2 billion of it has been borne by European banks and $152.5 billion by American banks. Asian banks have been relatively unscathed with just over $18 billion in losses (source: Bloomberg page WDCI).

While financial losses are easy to categorize and total, economic losses are much harder to ascribe and track. The data has significant lags, is often revised and because the major global economies are such large, complex entities it is hard to do “ceteris paribus” analysis across a number of them simultaneously. That said, however, the recent behaviour of a number of markets (Asian exchange rates, a possible breakdown in the correlation between the dollar index and the price of oil) and the unexpected weakness in some recent economic data (e.g. in Europe and New Zealand) makes us think that the sneeze is producing sniffles now and perhaps much more later. When the world’s dominant economy faces its biggest financial crisis in the post war period after running its largest current account deficit in a century at a time when its household savings rate has dropped to zero it is pretty hard for those who benefited from America’s import consumption boom not to feel its bust.
All recent major financial crises have some pretty strong similarities between them both in how they develop and how they play out. This is true whether you look at the US savings and loan mess of the 1980’s, Japan’s post bubble woes, the Scandinavian banking collapse of the early 1990’s, the Asian Financial crisis, and the current sub-prime meltdown. In no particular order these similarities include:

• An extended period of economic recovery/boom leading to rising asset prices/bubbles.
• Excessive leverage and declining lending standards.
• A rising current account deficit or declining current account surplus.
• Changes in the regulatory regime or lax oversight and/or regulatory arbitrage and financial innovation.
• Where the boom was fed by a significant component of external financing a currency devaluation or at the very least significant currency depreciation is also usually part of the “crisis”.

Likewise, the resolutions of banking and financial crises usually have a number of common elements to them:
• Economic contractions of varying severity (the steeper the decline usually the steeper the recovery).
• Monetary policy accommodation that results in a steep yield curve for an extended period of time.

Government intervention to ring-fence/recapitalize the financial system and./or assist in the separation of good from bad assets and the eventual disposal/work-out of impaired assets (i.e. a partial shift of the burden from the private sector to taxpayers)
• An expansion of the government’s deficit in part to pay for the costs of recapitalization and/or provide a buffer to the negative economic consequences of the financial crisis.
• Shrinkage of the current account deficit (or expansion of the surplus) as domestic consumption and investment falls and as currency weakness improves external competitiveness.

Comparing what is happening in the US now to the other financial crises provides some guidance as to what to look for going forward from an economic viewpoint. The first question to ask is how big is the potential loss and how does it compare? To date mortgage-market and credit losses and write-downs for major banks and securities firms in both the US and abroad total about $323 billion as noted above. The IMF, in its Global Financial Stability report released on April 8th argues that total mortgage market related losses may reach $565 billion and that there may be a further $380 billion in losses tied to commercial real estate, and consumer and corporate loans. $565 billion is about 4.3% of US GDP, which, if realized, makes the loss greater than the estimated 3% to 3.5% of GDP losses incurred during the US savings and loan crisis. The IMF figure of $945 billion, adding in the other potential loan losses is about 7.2% of US GDP.