Many people in the markets, investors, analysts and commentators, still insist that Europe isn’t a big deal for economies like the US, or Australia, or China. Others claim the instability in Australian markets is being driven by the mining tax argument, forgetting prices for major exports like copper, lead, zinc, nickel and oil have all fallen by 10% or more in the past month, helping drag the Australian dollar lower.

But Europe does matter: it is now China’s biggest export market, and China is one of our top two markets (the other is Japan). Japan’s major export market is China and that growth helped push Japan’s growth up by 1.2% in the March quarter (compared with the December quarter). And 0.7% of that growth came from exports.

And just over half of America’s exports went to China in the first quarter (while US exports to the rest of the world have risen by 20% so far this year). US Treasury Secretary Tim Geithner says export-driven China was shifting its development strategy to rely more on domestic consumption, a move he described as “encouraging.” Geithner said Beijing’s strategy change partly had resulted in a jump of almost 50% in American exports to China compared to a 20% rise to the rest of the world in the first quarter of 2010.

Asia is growing faster than any other region and it’s being driven by China — not so much the Chinese export machine, but more the growth in Chinese imports (they are growing faster than exports) from countries like Australia, Japan, Taiwan, the US and Singapore.

Too many commentators look at the superficial statistics (as they did with Greece) and say linkages are too small; it would hurt us. But they ignore the growing level of interdependence, just as many of the same people ignored the way the sub-prime crisis ate the heart out of the US financial sector and then sucked the rest of the world into a black hole.

Europe has that capacity, as Financial Times assistant editor Wolfgang Munchau said in April, that Greece is Europe’s sub-prime crisis. It is and it’s being handled in a startlingly similar way by the Europeans, starting with the Germans, as we have seen with the stupidly handled ban on naked short selling this week which merely panicked the horses and caused a stampede for the exit.

Overnight in Washington a member of the Fed, Don Dan Tarullo, laid out for the US Congress (which is returning to its old, ignorant, little America ways) how the European crisis could badly wound the US.

He said the crisis could cause US banks “to pull back on their lending, as they did during the period of severe financial market dysfunction that followed the bankruptcy of Lehman Brothers”. His comments are worth repeating at length:

“One avenue through which financial turmoil in Europe might affect the US economy is by weakening the asset quality and capital positions of US financial institutions.

“There are, to be sure, good reasons to believe that these institutions can withstand some fallout from European financial difficulties. In the past year, the Federal Reserve has pressed the largest financial institutions to raise substantial additional capital.

“Moreover, the direct effect on US banks of losses on exposure to one or more sovereigns in peripheral Europe — which, in the current context of sovereign debt concerns, is generally understood to mean Greece, Portugal, Spain, Ireland, and Italy — would be small.

“According to the Federal Financial Institutions Examination Council, almost all US exposure to peripheral European sovereigns is held by 10 large US bank holding companies, whose balance sheet exposure of $60 billion represents only 9% of their Tier 1 capital.

“However, if sovereign problems in peripheral Europe were to spill over to cause difficulties more broadly throughout Europe, US banks would face larger losses on their considerable overall credit exposures, as the value of traded assets declined and loan delinquencies mounted. US money market mutual funds and other institutions, which hold a large amount of commercial paper and certificates of deposit issued by European banks, would likely also be affected.

“In addition to imposing direct losses on US institutions, a heightening of financial stresses in Europe could be transmitted to financial markets globally. Increases in uncertainty and risk aversion could lead to higher funding costs and liquidity shortages for some institutions, and forced asset sales and reductions in collateral values that could, in turn, engender further market turmoil.

“In these conditions, US banks and other institutions might be forced to pull back on their lending, as they did during the period of severe financial market dysfunction that followed the bankruptcy of Lehman Brothers. Moreover, aggregate bank lending, particularly to businesses, continues to contract. The result would be another source of risk to the US recovery in an environment of still-fragile balance sheets and considerable slack. Although we view such a development as unlikely, the swoon in global financial markets earlier this month suggests that it is not out of the question.

“The agreement of the Federal Reserve to reinstate foreign exchange swap arrangements was designed not to insulate banks and investors from losses they may incur, but as a prudent effort to help minimise the risk of financial turmoil in Europe, with the consequences that would ensue for the global financial system, including the United States.

“In the worst case, such turmoil could lead to a replay of the freezing up of financial markets that we witnessed in 2008.

“With unemployment remaining quite high, and with continued need for balance sheet repair by many businesses, financial institutions, and households, it is particularly important that the United States not sustain a significant external shock.”

The same could be said about Australia, even though our economy is in a better position that either the US, or Europe.