Thought a short time ago to be limited and manageable by western countries, the Asian crisis now threatens to develop into a global recession. Russia changed everything. From an economic point of view its impact is limited on the rest of the world economy, but the country's decision to default, which no Asian country did during last year's financial turmoil, redefined the pricing of risk.

The massive correction on stock markets, the high premium paid by all non-government entities and the flight to quality observed today are reflecting this situation. The reassessment of company earnings and the emergence of a credit crunch generated by this tidal outflow are today the biggest threat to the US economy.

The international environment should affect volumes, prices and margins, the three components of company earnings. The emergence of a productivity slowdown resulting from weaker world demand is now compounded by a margin effect. Intense competition for shrinking markets weighs on prices while wages are still drifting up because of a tight labour market. This new value added distribution will undoubtedly hurt company results. These gloomy prospects are reinforced by record levels in investment and borrowing. Any activity slowdown will inevitably translate into production overcapacity, greater financial instability and renewed downward profit revisions.

The emergence of a credit crunch is darkening these negative prospects. Loan standards have been tightened by banks, also market- dependent and already damaged by exposure to developing countries and shaky capital markets.

The recent Fed decision concerning the bail-out of Long Term Capital Management, as well as the interest rate cut shows that monetary authorities are aware of the dangers and the need to prop up demand. However the Fed action should have lessof an impact than on preceding cycles. The previous crisis in equity markets resulted from an imbalance between excessive growth and a savings shortage. Today, the liquidity surplus reflects investor aversion to risky investment. The fundamental problem is therefore a major supply-demand imbalance: shrinking markets and emerging over-capacity. Earnings forecasts are further revised downward pulling down equity markets, even as interest rates fall.

As long as these negatives remain and no clear solution to the crisis on the horizon, stock markets should remain volatile and fragile. As further monetary loosening actions will be needed to restore growth and confidence, bond markets appear to offer a better opportunity, especially after last week's (when?) huge correction.

Roland Calvo is chief strategist at CDC Asset Management in Paris

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