Here we have yet another unhappy camper:

Confessions of a Community College Dean: In Which I Get a Little Panicky: I'm not an economist. Readers who actually understand economics are invited to explain why I'm off my rocker on this one.... [T]he U.S. is running nasty and increasing deficits at the government level, the household level, and the international level. We owe more to other countries than we ever have, and much of that debt comes from selling government securities to foreign central banks (esp. in Asia). Household debt is skyrocketing, and the interest rate increases of the last year or two are poised to nab anybody stupid enough to have taken out an adjustable-rate mortgage in the great housing boom of the last five or six years. The national debt grows apace, and has been refinanced over the last few years to progressively shorter-term loans, meaning that higher interest rates will hurt badly and quickly. Think of it as putting the national debt on an ARM, then watching interest rates go up. Since we import most of our oil, and the price of oil keeps going up, our trade deficit is likely to keep increasing.... Plus we don't manufacture very much, so we don't export very much. We also borrow money for wars of choice, which themselves actually interrupt the flow of oil.... China is keeping its currency artificially low, to keep its exports cheap. Then it lends us the money to buy those exports. It underpays its own workers so that we can have cheap stuff. How long its own workers will stand for that is anybody's guess.... Since there are so many U.S. dollars flowing out of the country, their value is dropping on the world market.... The only way to entice foreigners to keep buying a depreciating currency is to raise interest rates to compensate for the depreciation. Raising interest rates kills the folks with ARMs, increases our national debt payments, and hurts the business climate.... Although productivity has been going up, real wages haven't. I know it's gauche to talk about income distribution, but there's no other way to explain.... So my question to my economics-literate readers: how are we not screwed? (That's the technical term.) If China lets the yuan float, we get inflation. If the Euro starts to displace the dollar as the denomination for international trade, demand for dollars drops and we get higher interest rates, eventually tipping us into a nasty recession.... If somebody manages to blow up a key pipeline or refinery, the sky's the limit.... I'm thinking I must be missing something really basic and wonderful that will reduce these concerns to nothing more than blips on the screen.... Please tell me why I'm wrong. I'll sleep much better if I can dismiss this as the ravings of someone who just needs a vacation.

No. You're not wrong. You're not raving. Nevertheless, the most likely scenario is one in which we come out of all of this OK.

What is this most likely scenario? It is of (a) gradual inflation in China and elsewhere (maybe 5% per year for five years), (b) gradual reductions in the value of the dollar (maybe 5% per year for five years), accompanied by (c) gradual interest rate increases in the U.S. so that the dollar decline never turns into a (d) sudden dollar crash.

If that is the case, then--gradually--U.S. housing prices deflate, construction and consumer spending fall, and imports drop. U.S.-made products become more competitive at home, and so manufacturing production and employment for domestic uses rises. The falling real value of the dollar leads to an export boom, which causes export manufacturing to boom as well. Over five years or so, we see a net of eight million jobs (relative to trend) in construction and consumer services (and supporting occupations) vanish, and eight million jobs (relative to trend) in manufacturing (and supporting occupations) appear. If the expanding sectors expand fast enough, we see a tight labor market that brings real wages back to their normal share of production. And moving an average of 1.6 million jobs a year from sector to sector--the U.S. economy can do that without any sort of uproar.

Of course, people are still likely to be unhappy with the process. Rising interest rates and rising import prices will make people feel poor--something in this process has to reduce Americans' total spending on consumption, investment goods, and government purchases from 107% of income to 100% of income, and whatever it is will crimp spending by making Americans feel poorer. But even so it is a "soft landing."

As I said, that's the most likely scenario. But there are other scenarios--the ones that you fear: stagflation, recession, financial crisis, oil shock, global depression, panic, revulsion, and discredit. The other scenarios become more probable every day.

You see, to achieve a soft landing requires that a huge number of people around the world watch the real value of their dollar-denominated assets melt away slowly for half a decade without ever being impelled to sell off the dollar-denominated positions in their portfolios. It could happen. It happened in the late 1980s, thanks to the Japanese central bank and the collected investors of Japan. It will probably happen again. It requires mammoth irrationality on the part of investors, and an extraordinary eagerness on the part of central banks to eat enormous losses on their dollar reserves. It is not a rational-expectations equilibrium. But it will probably happen.

But if it doesn't happen again--if there comes a day when the world's central banks and investors all decide that it is time to sell their dollar-denominated assets, then... Well, then we get to see how good a central banker Ben Bernanke really is. There is a really bad global equilibrium out there, which the world economy might jump to at any moment.