A Precarious Balance

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Yet for the moment, these risks seem manageable. Central banks, especially in Europe, have been raising rates to head off inflation. And there are several initiatives underway between Europe and the U.S. that aim to counteract protectionist pressures at home and abroad. German Chancellor Angela Merkel visited Washington this month to push a plan that would harmonize investment and trade rules across the Atlantic. And the European Union and the U.S. recently got back together in a new and perhaps final attempt to salvage the World Trade Organization's Doha Round of negotiations. "We are in the endgame," says Peter Mandelson, the E.U.'s Trade Commissioner.

Economic forecasting is a dismal science, and this year could well turn out to be very different from the "happy slowdown" that Goldman's O'Neill predicts. Here are some of the factors that will influence the outcome:

AMERICA'S HOUSING BLUES
After years of torrid price increases that made homeowners feel more confident about spending, the U.S. housing market has tumbled. Construction of single-family homes dropped 18% in the third quarter of 2006, and real estate prices have cooled, particularly in overheated markets like California. Steve Steele, 53, made a good living buying houses on credit in San Diego, fixing them up and then reselling them for a lush profit. But now he's shifting his focus to New Mexico. "I think reality has set in," he says. "California is going to be flat for some time."

What economists are struggling to predict is how extensive the impact of this housing slowdown will be. Many other real estate markets around the globe rose in tandem with the U.S. in recent years, but so far none have come back down to earth with the same force. Perhaps most surprisingly, American consumers are continuing to spend, regardless: automobile purchases are sluggish, but monthly retail sales rose by a higher-than-forecast 0.9% from November to December. "I'm not prepared to bet against the American consumer. That's a highly dangerous proposition," says Jesper Koll, chief Japan economist for Merrill Lynch.

Jean-Philippe Cotis, chief economist at the Paris-based Organisation for Economic Co-operation and Development, says the critical question is whether America's housing woes are a signal that the entire U.S. economy is overextended. "For the moment it looks like there is only marginal overheating," he says. That's very different from the situation in 2000, when massive overinvestment in technology around the world created the Internet bubble. When that popped, it sent global financial markets and economies into a tailspin. Today, though, Cotis sees the issue as "an idiosyncratic problem in the U.S. spilling over only moderately to the rest of the world." But he adds: "We need to watch what happens very carefully."