Financial contagion may be a metaphor, but it certainly feels like a physical threat at the moment. The global credit crisis that started in America has spread to Europe. After the collapse and government takeover of a string of financial giants in the US last month, it is now Europe's turn. Having reassured people for a year that its financial system was sound, leaders of the 27 member states of the European Union have finally admitted what a dire state many of their leading lenders are in and have vowed to do whatever is necessary to prop up the system. The global economy now hangs on a precipice. The world's governments must work together and co-ordinate their policy responses to tackle the systemic and global nature of the threat. This especially is the case with Asia's governments, which should take the lead in co-ordinating their response while there is still time. Already, the dominoes are falling in the region. Pakistan's economy has reached crisis stage, with its sovereign debt rating dropping to just a few notches above default. New Zealand has become the first developed economy officially to enter into a recession. Australia's central bank made a surprise one percentage point cut in the official interest rate yesterday to forestall an economic slowdown. Other central banks look likely to follow the move. The South Korean won has plunged the most of all major currencies and the country's leading banks are facing a foreign currency liquidity shortage of crisis proportions. This is especially dangerous for an economy that relies so much on exports. Sensibly, Korean President Lee Myung-bak has proposed an urgent summit of financial ministers from China and Japan to develop a concerted response. Beijing has responded favourably and gone further by calling for a worldwide co-ordinated effort among governments. The need for a global response, along with reform of the Group of Seven rich nations to include major emerging powers, has been highlighted by World Bank chief Robert Zoellick. He has called for a new entity to include emerging economies such as China, India, Brazil and Russia and which other countries could join on an informal basis. He rightly described the current crisis as 'a wake-up call' to the need for closer co-operation among more countries. This is a world crisis and all the major governments need to be involved. Unfortunately, their responses so far have been focused on their own backyards. An example of this is Ireland's unilateral and blanket guarantee of all deposits of its leading banks. This provoked the anger of fellow EU states; however, many member states were forced to follow suit after denouncing Dublin's move. Their policy U-turns may help shore-up confidence among retail bank customers, but they fail to deal with the fundamental problem of the credit crisis: the reluctance, or outright refusal, of lenders to lend. It is panic among financial institutions, not retail investors, that is causing the current crisis, and that makes it all the more dangerous. Governments must work to unfreeze the credit markets. The US$700 billion bailout plan in America has not helped to quickly restore confidence, as many had hoped; clearly it needs more time to work by buying toxic assets off financial institutions. But at least it is a general plan rather than an ad hoc response of the kind US authorities had been adopting, and as their European counterparts are adopting now. The major central banks have been co-operating to flood their economies with liquidity. Now, governments - including those in Asia - need to work together as well.