Aug. 16 (Bloomberg) -- So, Asia finally unshackled itself from the U.S. economy. Riiiight!

Just ask executives at Mitsubishi UFJ Financial Group Inc. Shares in Japan's largest bank fell to a two-year low yesterday amid losses from the U.S. mortgage crisis. Sumitomo Mitsui Financial Group Inc. also said it recorded losses in securities backed by subprime loans.

Financial contagion oozing from the U.S. wiped out the Nikkei 225 Stock Average's gains for the year; that benchmark was down 7.2 percent this year as of 2:14 p.m. in Tokyo. The Morgan Stanley Capital International Asia-Pacific Index lost 2.5 percent on Wednesday alone.

Arguments that Asia has decoupled from the U.S. suddenly look, dare I say, rather subprime.

Yes, Asia is a very different place than a decade ago. Banks, Japan's included, are healthier and carry significantly less debt. On top of that, the region amassed some $3 trillion of currency reserves. Asia has so much cash available to fend off crises that government investment funds are being created to take more advantage of it.

That's just one of the many ironies a decade after Asian's financial crisis. Another is how U.S. woes now threaten Asia, not the other way around. One more is that Asia may soon be gobbling up distressed U.S. assets, the way U.S. investors did in Asia in the late 1990s.

First, though, Asia's export-dependent economies must gauge just how much damage their growth will get from the U.S. troubles.

Exposure

The focus is on Asia's indirect exposure to credit market woes. The subprime crisis is dragging down derivatives like collateralized debt obligations, which became popular in Asia in recent years and increased the opacity of markets.

The problem for Asia is that this is no longer just a subprime story. While subprime default was the catalyst, markets are now melting down for a variety of reasons. Greater opacity means we don't know where the financial landmines are planted.

The bigger question is what a U.S. slowdown will do to the region. Amid China's explosive growth, it's easy to forget that the U.S. economy is nearly three times bigger than Japan's, which in turn is nearly twice the size of China's, which is nearly three times bigger than South Korea's.

If U.S. demand hits a wall, growth in Japan, China, Korea and the export economies of Southeast Asia may get slammed. The forces of globalization are masking the extent to which Asia still relies on U.S. demand. Much of the trade within Asia involves intermediate goods that are used in the production of other products -- many of which go to the U.S. and Europe.

Smart Money

Optimism Asia can stand alone comes from the view that China and India together account for roughly the same amount of global trade -- around 20 percent -- as the U.S. That's all well and good, but don't ignore the fact Asia's economies need U.S. demand to maintain their share of global trade.

China's boom is certainly getting headlines, partly because the global rout has yet to dent its stock rally. Still, China is a glaring bubble, devoid of logic and an aberration. The sense of foreboding in Asia comes partly from how even Wall Street's ``smart money'' got in trouble in credit markets. Buyout legend Henry Kravis's KKR Financial Holdings is counting losses, as are executives at Goldman Sachs Group Inc., BNP Paribas SA, Bear Stearns Cos. and others.

How quickly contagion spread from the U.S. was encapsulated today by Rams Home Loans Group Ltd. The Australian lender that went public last month failed to refinance short-term debt as buyers shun credit markets. Japanese banks also are getting hammered by investors, raising prickly questions about the industry's health.

Japan Angle

The question is: has the world taken the stability of Japan's financial system for granted?

The whole subprime mess started when investors had to refinance loans made when the Federal Reserve was holding U.S. short-term rates at 1 percent to spur growth.

Japan's central bank has facilitated the so-called yen carry trade. Untold amounts of Japanese currency have been borrowed at near-zero interest rates and moved overseas into higher-yielding markets. A surge by the yen as those funds are brought home could slam Japan's economy.

When the ``Lost Decade'' of the 1990s led to deflation and a series of banking crises, Japan came under pressure to strengthen its finances. The government focused on weakening the yen and holding down interest rates, effectively exporting a financial bubble. If that bubble bursts, the world's No. 2 economy may find itself back up the creek.

U.S. Contagion

Folks in New Zealand could be excused for thinking the yen bubble already is bursting. The New Zealand dollar is heading for its biggest weekly loss since the 1987 stock market crash as investors slash holdings of high-yield assets funded by yen loans.

Asia's emerging markets are taking particularly big hits. From Seoul to Jakarta, risk aversion is increasingly dominating trading -- and the headlines. It's a reminder that, while Asia has come a long way, it's anything but immune to turmoil in America.

To contact the writer of this column: William Pesek in Tokyo at wpesek@bloomberg.net

Last Updated: August 16, 2007 01:20 EDT