GO FIGURE

Trying to Guess What Happens Next

YOU need not be a Wall Street chieftain to feel the anxiety that has wrapped its arms around the American economy. The stock market seems locked in a downward spiral as one bank after another suffers its day of reckoning with bad mortgages. Companies are sharply cutting profit forecasts as the sense takes hold that American consumers are finally too loaded with debt to buy the next flat-screen television. The dollar has fallen to inglorious depths, turning Manhattan department stores into something like a Tijuana street market for Germans. One unpleasant word hovers large: recession.

How bad could things get? Pretty bad, say many economists. Not so bad that your grandfather’s prescriptions for enduring the Great Depression need dusting off, but nasty enough to force many Americans to get reacquainted with living within their means. That could make life uncomfortable. It may also be an unavoidable step toward purging the United States and the global economy of a major source of instability — an unhealthy dependence on the willingness of American consumers to keep buying even as debt mounts. Concerns that Americans must eventually grow thrifty, leaving factories from Guangzhou to Guatemala City scrambling for buyers, now sows unease around the world.

It is worth bearing in mind that the American economy has a history of unexpected resilience in the face of supposedly grim prospects. Moreover, some parts of the economy are enjoying good times, notably farmers able to cash in on the making of ethanol. That said, most economists think the American economy is headed for a significant slowdown, as housing prices keep falling, consumers grow tight, and businesses cut investments. The Federal Reserve last week said it expected the economy to grow 1.6 percent to 2.6 percent next year, a stark contrast from the 3.9 percent rate registered in the most recent quarter. Some see signs of a worst-case scenario — a severe recession that would feature a plummeting stock market, a lower dollar and the loss of many jobs. That would make for an unpleasant year or two for Americans from most walks of life. It would probably drag down the world economy, as Americans put off purchases of everything from computers made in China to Italian-produced sports cars.

The most bearish indulge frighteningly gloomy tones. “The evidence is now building that an ugly recession is inevitable,” declared Nouriel Roubini, an economist who was among the first to warn of the dangers of a real estate downturn, writing last week on his blog, the Global EconoMonitor. “When the United States sneezes the rest of the world gets the cold. And since the United States will not just sneeze, but is risking a serious case of protracted and severe pneumonia, the rest of the world should start to worry about a serious viral contagion.”

Most economists are not so pessimistic. The most likely outcome envisioned by many is a slowdown or a mild recession. That would increase unemployment somewhat, and it would keep the stock market in the doldrums, but it would probably not be severe enough to significantly crimp economies abroad. And while it would impose pain, some see in this more moderate path a way to fix the imbalances in world trade that are at the center of fears of a great unraveling.

Americans have been buying staggering quantities of goods from overseas using money lent by foreigners. Foreign exporters have been relying on American consumers to keep them in business. For years, this dynamic has made for increasingly lopsided terms of trade: Last year, American imports outstripped exports by $764 billion, with foreigners stepping in to cover the difference.

Economists have long intoned that somehow, some day, the United States will be forced to settle up and stop depending upon the largess of foreigners. The basic laws of economics say imbalances are eventually balanced. Some have warned of a worst-case scenario where the foreigners holding American debt get spooked that the value of the dollar is about to plummet and dump the currency in a self-fulfilling prophesy. This would jack up the price of imported goods in the United States, making it harder for Japan, China and Europe to sell their wares, and delivering a global recession.

In the more appetizing scenario, the adjustment would happen gradually. The dollar would fall, making American goods cheaper abroad and helping to correct the trade imbalance. The American economy would slow, but the world economy would continue apace, allowing American firms to export aggressively.

Faced with slower business at home, Americans would be more inclined to save. That would force Japan, China, India and other export giants to find new ways to prosper without leaning on the beleaguered American consumer. The world economy would be cleansed of its imbalances, emerging stronger. The more optimistic suggest that this very scenario is now unfolding.

“If you’re a global benevolent despot, you want a five-year period where China booms, India booms and the U.S. consumer takes a decided back seat,” said Robert Barbera, chief economist at the brokerage and advisory firm ITG. “You need to have a period where Asia booms and we limp along, because the No. 1 worry for the world economy is large, unsustainable trade imbalances.”

To grasp what may at first seem perverse — pain required to get back to gain — it is worth recalling the genesis of our current predicament.

A decade ago came a financial crisis in Asia. As losses rippled around the globe, credit dried up, threatening the willingness of consumers to spend and businesses to invest. With the health of the global economy menaced, central banks lowered interest rates, fueling a wave of spending that, for the most part, has kept things rolling along.

In the United States, cheap credit added momentum to the boom in technology. That story ended badly, of course, with many companies extinguished along with tens of billions of shareholder dollars. But it did not deter the American consumer, whose spending amounts to 70 percent of the American economy. The Federal Reserve again opened the taps of cheap credit. Spending went on.

As Americans have carried home mountains of goods manufactured in Japan, China and elsewhere, they have sent trillions of dollars across the Pacific to pay for them. Asian central banks have taken these winnings and parked them back in the United States, buying up Treasury bills, stocks and property. In so doing, they have kept American interest rates low and the dollar stronger, ensuring that consumers have the wherewithal to keep buying.

Asia’s export-led prosperity has in turn generated business for American firms. As China erects factories, office towers and modern airlines, it is snapping up construction equipment from Caterpillar, airplanes from Boeing and engines from Cummins.

Cheap credit has fostered another development that was crucial in creating the current state of things: It unleashed a wave of mortgages with exotically lenient terms, such as interest-only payments and no money down. That allowed buyers to take on more expensive homes than they could have otherwise afforded. As home values rose much the way dot-com stocks had a decade earlier, banks offered loans and no-fuss refinancing that allowed homeowners to turn increased value into money. From 2004 to 2006, Americans took more than $800 billion a year out of their homes, according to most estimates.

With prices now plummeting and banks savaged by mortgage losses, this artery of credit is drying up. The American consumer, a crucial engine of growth for the global economy, may finally be tapped out.

With recent history as a guide, many argue that the Fed and other central banks need simply step in anew, cut interest rates and send Americans back to the mall. Except a new force preoccupies those who control the credit taps: Central banks in the United States and Europe fear inflation, particularly as oil prices soar. This makes them reluctant to bring interest rates down much more.

Where foreigners have in recent years been content to keep buying American debt with the proceeds of the money they earn by selling us their goods, that is now changing. As the dollar keeps falling in value, China has sent signals that it plans to put more of its savings in the euro. Petroleum-rich countries such as Kuwait and Russia, swimming in dollars as the price of oil climbs, have been buying more euros and other currencies, too, adding to the downward pressure on the American currency.

So, for better or worse, Americans and countries whose prosperity is tied to Americans’ spending are apparently headed into uncharted territory: We are about to find out what happens when the easy money runs out.

Copyright 2007 The New York Times Company. Reprinted from The New York Times, Week in Review, of Sunday, November 25, 2007.