Indecent Exposure

Paul Krugman believes that American exposures to Europe is not bad enough to make a ballyhoo:

With American exports to Europe forming a small component of GDP, a European collapse would not necessarily mean a collapse in American demand:

The map above — taken from here — tells us that overall, exports to Europe are just 2 percent of GDP. Some states, notably South Carolina, are more exposed (presumably because of those European-owned auto plants). But Obama isn’t going to win South Carolina in any case. And more broadly, even a sharp fall in exports to Europe would be only a small direct hit to demand.

OK, caveats: this only measures goods exports, and we should mark the numbers up maybe 25 percent to take account of services. Also, exports aren’t the only channel: if European events cause a Lehman-type event, disrupting financial markets world-wide, all bets are off.

Um, that’s a pretty ginormous caveat. As far as I am aware, the case regarding America’s exposure to Europe has never been an issue of a collapse of demand in exports and has always been an issue of precipitating financial collapse.

As I wrote in September:

The global financial system is an absurd interconnected house of cards. One falling card (like a Greek default) or ten falling cards (like the European banks who were foolish enough to purchase Greek debt) might just bring down the entire banking system, and its multi-quadrillion-dollar evil twin, the derivatives system.

And that’s not fear mongering. American banks have huge exposure to the European financial system.

From Zero Hedge:

Morgan Stanley’s exposure to French banks is 60% greater than its market cap and more than half its book value

The one thing we will highlight is that $39 billion is about 60% more than the bank’s market cap and a whopping 65% (as in more than half) of its entire book (less non-controlling interests) equity value.

I feel rather sorry for Krugman. He’s analysing a factor that traditionally is very significant in international macro. And in this case it’s almost totally negligible: the real problem isn’t the economy; it’s the monstrous beast of a financial system we find ourselves encumbered with.