The U.S. economy was never going to grow at 4% forever. A slowdown was always expected. And now it’s here. The economy is throttling back to its 2% trend.

If this economic moderation were all that were happening, the reaction in markets probably wouldn’t be too severe. The smart money always knew that the fiscal stimulus would be temporary and that the Federal Reserve would take away the punch bowl gradually.

What few counted on was that the chaos in the White House would be permanent.

President Donald Trump hasn’t settled in to his office and never will. Even after his party suffered a catastrophic loss in the House (largely due to the voters’ disapproval of Trump himself), Trump refused to change.

What’s more, he refused to accept facts: That he lost, and that he will have to deal with Democrats one way or the other for the next two years.

The departure of Chief of Staff John Kelly and Defense Secretary James Mattis signaled that this White House will only get more Trumpian. Instead of trying to expand his appeal to the broader public, Trump has retreated into a corner with his small band of loyal supporters, insisting on a border wall that’s symbolic of his own defensive posture.

He’s doubled down on chaos and that’s what’s hurting the markets — and the economy.

The renegotiation of NAFTA may have fooled some people into thinking that Trump would always back down in a crisis of his own making. With its minor tweaks and marginal improvements, the new trade deal with Canada and Mexico isn’t going to make America great again, but Trump declared victory anyway, just as he did at his inconclusive summit with the North Korean dictator.

That may have led some people to assume that Trump would take the same approach to other crises, such as the increasingly tense trade war with China, or to budget negotiations with the Democrats.

But Trump isn’t using the NAFTA or Kim Jung-un template; he’s using the Brett Kavanaugh fight as his guide: No retreat, no surrender.

“ In this environment, it’s no surprise that Wall Street is a bit panicked. ”

So far, Trump isn’t budging on China or the wall. He seems to be enjoying China’s economic problems, perhaps because he believes in a zero-sum world where China’s losses are America’s gains. Similarly, he’s in no hurry to get the government up and running again.

In this environment, it’s no surprise that Wall Street is a bit panicked. U.S. businesses, too, are becoming more defensive, pulling back on their plans to invest and expand. Consumer behavior hasn’t been affected much yet, but if people get a whiff of hard times coming, they’ll surely hunker down to ride it out.

The Wells Fargo animal spirits index is a weighted average of five sentiment indicators. Wells Fargo Economics Group

The signs of a slowing economy are everywhere, but that doesn’t imply that the economy will inevitably plunge into recession. The risks are rising however. Tighter fiscal and monetary policies would weaken animal spirits.

Pushing China into recession would boomerang on the American economy (as Apple’s AAPL, -1.77% warning portends). Locking down the borders (as Trump threatened) would be a disaster.

The risks are many. First, that the Trump administration might act deliberately in a way that harms the economy; for instance by clamping down hard on trade or immigration. Second, that an administration ruled by Trump’s gut instincts might misplay its hand.

Third, that, in a crisis, the Trump administration might be unable to staunch the bleeding because its economic policy makers are inexperienced and untrustworthy hacks. (Treasury Secretary Steven Mnuchin’s clumsy attempts to reassure the markets accomplished the reverse. And what was Kevin Hassett thinking when he said on TV that he expects more U.S. companies to warn of declining sales?)

Despite all the missteps, the economy is still growing. There may be a panicked mood on Wall Street, but on Main Street, business is booming.

Payrolls are expanding at about 200,000 per month, far more than is necessary to keep up with population growth. Real, after-tax disposable incomes are rising at about 2.8% per year. Real consumer spending is rising at the about same pace. Industrial output is expanding at about 4% per year. Consumer confidence is still high. Wages are growing, and profits are high.

But cracks are showing.

Housing, never very robust during the expansion, is weakening. Business investment boomed for a short period after the tax cut, but softened quickly. The drop in the stock market could demoralize businesses wishing to expand, and the selloff could damp consumer spending because so much wealth was destroyed.

Consumers’ expectations for future income growth have fallen, while one poll suggests that a majority of consumers believe a recession is likely in 2019.

And of course the trade-war jitters could have a big impact on the U.S. and global economies.

That’s why a lot of people are sure that both the U.S. and China will back down; each side has far too much to lose to continue the hostilities.

I’m not so sure. The more pressure on Trump to cave, the more he may dig in. For its part, China may not want to concede too much because it senses that Trump has been weakened. A workable, face-saving compromise wouldn’t be easy for either party to achieve, even if the U.S. side had capable policy makers on board.