The U.S. Economy Faces the Guillotine

When a group of community volunteers rang the bell to signal the close of trading at the New York Stock Exchange last Friday, it brought to a close one of the most tumultuous weeks in global markets since the fall of 2001. On Tuesday, the Dow Jones industrial average, already down 9 percent in 2008 on glum economic news, plummeted nearly 600 points (5 percent) before rallying after the announcement of an emergency three-quarter-point interest-rate cut by the Federal Reserve, the biggest such reduction in 24 years. Wednesday was like Groundhog Day, with the Dow falling more than 3 percent before closing with a gain. "Yesterday was a s––t storm and today really isn't any better," said a glum broker in a green trading jacket outside the New York Stock Exchange. Cari Maher, who works in an office building on Wall Street across from the exchange, noticed a sign of market stress—an unusual number of nervous smokers outside, huddling on the cold sidewalk.

Investors also sought solace in nicotine outside a branch of Zheshang Securities in central Shanghai. Several elderly men, barred from smoking indoors, peered through the doorway at the big screen inside showing stock prices. "It was pretty scary earlier this week," said Zheng Xiaosheng, 68, puffing his cheeks against the cold. The Shanghai Composite index, which has quadrupled in the past two years, fell more than 10 percent in 48 hours—the biggest two-day fall in Shanghai's stock-market history. The same day, stunned Indian investors, angered that Mumbai's benchmark Sensex index had fallen 5 percent for two straight days, staged a protest outside the Bombay Stock Exchange, chanting "Death to [Finance Minister Palaniappan] Chidambaram."

In Davos, Switzerland, the volatility derailed the agenda at the World Economic Forum. Participants were disembarking from the rustic train that chugs into the Alpine ski resort just as all hell was breaking loose back home. Instead of discussing malaria and microfinancing, many big shots spent their time anxiously hunched over computer screens and fingering BlackBerrys like prayer beads. Treasury Secretary Henry Paulson canceled his planned visit and stayed in Washington to help hammer out a stimulus package.

The Great Global Market Freak-Out of 2008 has everyone asking whether the United States—already on the road to recession—is entering into a protracted period of economic trouble where jobs will be slashed, prices will continue to rise and the dollar will keep falling; and if so, whether the declining U.S. economy will pull the rest of the world down with it. A recession is defined as a widespread contraction in economic activity lasting more than a few months, and because of the lag in financial data, recessions typically aren't officially declared until long after they start. In short, the United States could already be in one. Though world markets stabilized by late last week, buoyed by the Fed's rate-cut action and a proposed stimulus package of $150 billion that was hastily cobbled together by leaders in the House of Representatives and President Bush, the question remains: how ugly will it get, and when will it end? The disappointing jobs and retail-sales data from December indicate the economy has stalled. Given the complex financial machinery that now connects the world's market, will a U.S. recession quash the booming growth we've seen in emerging markets like India and China and tip European economies over the edge? "We are, of course, far short of a Great Depression now," said Nouriel Roubini, professor of economics at New York University's Stern School of Business. "But in terms of systemic risk and the risks of a financial meltdown, you almost have to go back that far to find a good analogy."

The questions are open, contingent and confusing, and deeply meaningful for markets and their underlying economies—as well as for workers and consumers. And the answers probably won't be clear until a year from now, when Davos 2009 opens. In the meantime, the uncertainty acts like kindling for volatile stock action. Investors from Shanghai to Seattle, from hedge-fund cowboys to slow-and-steady 401(k) savers, today resemble circus acrobats who teeter on a board atop a ball. They maintain a precarious balance only by careening wildly back and forth. Despite the best efforts of analysts, the daily fluctuations of stock markets frequently defy reason or easy explanation. The markets endlessly process expectations, hopes and fears about the immediate future for stocks and the economic activity that ultimately underlies them.

Judging by the recent mood swings, the global economy can be diagnosed as manic-depressive. Through the haze around the markets last week, a clear reason for this bipolar condition emerges. On the one hand, the United States, the world's largest economy and the destination of many of the world's exports, may be on the brink of recession. But at the same time, the global economy—after a remarkable five-year period in which almost every major economy has been growing in concert—is showing signs of what economists call "decoupling." What decoupling means is this: even as the globe's economic engine, the United States, has stalled, optimists believe the train cars it has been pulling for the last several decades—especially emerging markets like India and China—may finally be able to chug along under their own power.