FINANCIAL CONFIDENCE WILL FALTER: The fallout from the U.S. subprime meltdown has already festered into a broader and more severe liquidity and credit crunch on Wall Street. That, in turn, has spilled over to financial markets in other parts of the world. This financial contagion is impossible to contain. A huge portion of the risky, radioactive U.S. securities that have now collapsed -- such as the now disgraced residential mortgage-backed securities and collateralized debt obligations -- were sold to foreign investors. That's why financial losses from defaulting mortgages in American cities such as Cleveland, Las Vegas, and Phoenix are now showing up in Australia and Europe, even in small villages in Norway.

Consumer confidence outside the United States -- especially in Europe and Japan -- was never strong; it can only become weaker as an onslaught of lousy economic news in the United States dampens the spirits of consumers worldwide. And as losses on their U.S. operations hit their books, large multinational firms may decide to cut back new spending on factories and machines not just in the United States but everywhere. European corporations will be hit especially hard, as they depend on bank lending more than American firms do. The emerging global credit crunch will limit their ability to produce, hire, and invest.

The best way to see how this financial flu spreads is by watching global stock markets. Investors become more risk averse when their economies appear to be slowing down. So whenever there's bad economic news in the United States -- say, reports of higher unemployment or negative GDP growth -- there are worries that other economies will suffer, too. Investors sell off their stocks in New York and the Dow Jones plunges. You can expect a similarly sharp fall when the Nikkei opens in Tokyo a few hours later, and the ripple effect then continues in Europe when opening bells ring in Frankfurt, London, and Paris. It's a vicious circle; the market volatility culminates in a kind of panicky groupthink, causing investors to dump risky assets from their portfolios en masse. Such financial contagion was on prime display when global equity markets plummeted in January.

PREVIOUS 1234NEXT