(FORTUNE Magazine) – Lately Fed chairman Alan Greenspan has sounded upbeat and hopeful about the U.S. economy. So has the Bush administration, not to mention a large number of Wall Street economists. They keep telling us that economic fundamentals are strong and that the recovery is continuing.

We say they're full of irrational exuberance.

The U.S. economy virtually stalled in the second quarter--preliminary numbers show it grew a paltry 1%--as consumer spending and job creation both slowed. America's business leaders remained cautious and tightfisted. The upturn in manufacturing seems to be faltering, and the service sector, while still expanding, is decelerating. Clearly the recovery that so many thought was a sure thing is in jeopardy. So what happens now?

There are several possibilities. The fate of the economy still rests squarely on the shoulders of American consumers. If they buckle because of the sliding stock market and lack of confidence in corporate accounting, the economy could sink into another recession by year-end--the dreaded double dip. If consumers hang tough, possibly aided by another interest rate cut, the recovery will regain its luster. But a third alternative seems the most likely. We've dubbed it the go-nowhere economy, and it looks something like this: Consumers reduce spending enough to keep growth at a crawl but not enough to cause a recession. Stagnant growth would do nothing to boost jobs or profits, leading to the kind of recovery only an economist could love. "It's too early to tell how this will play out," says Ethan Harris, chief U.S. economist at Lehman Brothers, "but we're definitely seeing hints of trouble ahead."

The trouble is coming on three fronts. First, the stock market rout has accelerated a sharp decline in household wealth that began with the bursting of the Nasdaq bubble in March 2000. Household net worth has fallen $5.5 trillion, or 13% from its peak, with most of the drop occurring in the past four months, according to Mickey Levy, chief economist at Banc of America Securities. Second, corporate America is facing a full-blown credit squeeze as a result of accounting scandals and weak profitability. Banks have become more cautious in their lending, while credit markets have tightened considerably in recent weeks. Finally, consumer, business, and investor confidence has been badly shaken and remains vulnerable.

The latest numbers reveal that the recovery has lost its oomph. Durable-goods orders dropped unexpectedly in June, as did sales of existing homes. The July manufacturing sector index fell to 50.5, from 56 in June, and the service sector index sank for the second month in a row, from 57.2 in June to 53.1. Readings above 50 on both indexes indicate an expanding economy, but the sharp deceleration puts us very close to the edge. Consumer confidence in July plunged to its lowest level since the aftermath of Sept. 11, and the economy added a mere 6,000 jobs. These are hardly the makings of a rip-roaring recovery. And there could be more weakness to come. "I don't think we've seen much of the economic effect from the slide in the stock market yet," says Mark Zandi, chief economist at Economy.com.

Zandi is one of a growing number of economists who have recently shifted from the healthy-recovery camp to the go-nowhere camp. He and others believe that both consumers and companies will pull back on spending and that the economy will lack momentum. At the same time, they don't expect consumer and business spending to fall off a cliff. "I think we're in for a few quarters of painful growth," says Ram Bhagavatula, chief U.S. economist at the Bank of Scotland, who admits to earlier this year having been one of the most optimistic economists around. Declining household wealth and tight credit for businesses have made him more gloomy.

Here's how a go-nowhere economy functions: The tight credit market has increased the cost of capital, making it more expensive for companies to invest in plants and equipment. At the same time, credit-rating agencies are downgrading the debt of their struggling corporate clients, making it harder for those clients to obtain funds to invest. All this is occurring at precisely the wrong time. CEOs and CFOs are sitting down now to plan their budgets for 2003. They will be more cautious in their decision-making, delaying investments or cutting back on projects. Still, investment can't be put off forever, since much of a company's budget involves replacing old equipment and technology. And on the bright side, spending on equipment and software actually rose last quarter for the first time in almost two years. Profits have also started to recover, up 13% from a year ago in the first quarter of 2002. Between the poor investment climate on the one hand and signs of improving earnings on the other, companies are likely to sit tight until the credit climate improves--in other words, go nowhere.

The same goes for consumers. If companies aren't hiring or firing, consumer spending will remain more or less at a standstill. The job market will stay tight for most industries. Promotions and raises will be slow in coming, mobility between employers will decline, and people out of work will find the job search discouraging. Still, consumers are unlikely to cut back on spending substantially. Housing prices have remained strong, helping offset some of the pain of falling 401(k)s. And mortgages can be refinanced at near-record low rates. On balance, then, most households will be cautious about the future, tending to increase savings and spend modestly.

There are other reasons to expect a go-nowhere economy in the months ahead. The latest data from Europe and Japan indicate that those countries may be sliding back into a downturn. Car sales dropped throughout Europe in June; industrial production, machine tool orders, and construction fell in Japan. While a slowdown in the rest of the world isn't likely to deliver a devastating blow to the U.S. economy, it would hurt our exports, which in turn would slow growth.

Then there's the Fed. If the economy starts to weaken quickly, Greenspan & Co. will come to the rescue by cutting interest rates. "If you expect another recession, you have to believe that the Fed will fail," says Robert DiClemente, economist at Salomon Smith Barney, "and so far Greenspan's track record of managing the economy has been pretty good." Yet here, too, there's uncertainty. With the federal funds rate at 1.75%, its lowest level since 1960, interest rates don't have much further to fall. Most economists believe the Fed will hold its fire and wait for clear evidence of major economic weakness before it lowers rates. "Policymakers are in a tight corner," says Lehman Brothers' Harris. "The Fed has a lot of power to turn things around, but it will wait until it is absolutely sure the recovery is weakening."

Now that we've made the case for a go-nowhere economy, let's play devil's advocate for a moment. What could derail it and send us reeling back into recession? Alas, there are several plausible answers: Another terrorist attack. An invasion of Iraq. A spike in oil prices, which have, in fact, been creeping up. And then there's the fallout from a possible collapse in one or more of South America's major economies. "If anything goes wrong in the next six months, the recovery will be short-circuited," says Zandi of Economy.com.

That's why it's hard to entirely dismiss the possibility of a double-dip recession. "Double dip" is the term wonks use for two recessions in quick succession--more precisely, two or more quarters of contracting GDP, followed by a growth spurt lasting a few quarters and then by two or more quarters of contracting growth. In the past 50 years the U.S. has had just one, from 1980 to 1982. At the time the Federal Reserve was trying to break the back of double-digit inflation by raising interest rates, which kept returning us to recession.

Only a few months ago, when the economy looked to be growing at a 6% annual rate, Morgan Stanley's chief global economist, Stephen Roach, was ridiculed by colleagues for predicting a double dip. Not anymore. Although most economists don't believe another recession is inevitable, they do think it's more likely, given deteriorating financial conditions. Roach's argument goes like this: Businesses under pressure to be profitable will begin another round of cost cutting. That will mean layoffs, which will hurt consumer spending at a time when it's already vulnerable. When the one pillar holding up the economy finally cracks, a recession is inevitable. "This is about how strong our economic fundamentals are," says Roach. "Contrary to what most politicians say, we're still in a post-bubble economy, and we've still got massive imbalances to work out."

The economy will always face plenty of risks. The question is which ones will play out. Not many, Roach's critics say. They believe the economy has weathered so many shocks in recent years --the tech bubble, the terrorist attacks, cooked books, countless international financial crises--that it has proved its resilience beyond any doubt. So let's play devil's advocate again by asking what could goose the go-nowhere economy into real, sustainable growth. Merrill Lynch's chief economist, Bruce Steinberg, is about as bullish as Roach is bearish. Earlier in the year he said we had a "roaring recovery" on our hands and predicted annual growth of 4.5% in the second half of 2002. Although he has backtracked a bit, he's still forecasting 3.5% growth for the rest of the year and 4% in 2003--not exactly a roaring recovery but decent enough to boost jobs and corporate profits.

How does Steinberg get from here to there? He believes that both business and consumer spending will grow between now and the end of the year, helped by the recovery in profits and investment. He notes, for instance, that spending on technology in the second quarter grew at a remarkable 12.2% annual rate. As the recovery gains momentum, companies will increase their hiring, helping to underpin growth in consumer spending. While Steinberg concedes that job growth may be slow at first, he argues that households have more of a cushion than originally thought, citing the $50 billion upward revision in personal savings over the past six quarters. "All we need is a little bit more from the consumer and a little bit more from business, and it's not hard to get to 3.5%," he says.

Split the difference between Steinberg and Roach, and what do you get? That's right--our go-nowhere economy. Two opposing forces are at work right now: negative ones, which include tight credit, questionable accounting, and a shaky stock market; and positive forces, such as strong housing activity and surprising productivity growth (see following story). Steinberg focuses on the positive forces, Roach on the negative ones. But each side is missing the point. The opposing forces are in balance now. The key question is, How long will they stay in balance?

The next few months will be critical, as forecasters read every possible tea leaf for signs of the economy's direction. We suggest they forget about tea leaves and focus on the unemployment numbers. If businesses begin a new round of retrenchments, watch out: Consumer spending won't be able to withstand rising unemployment and falling household wealth. On the other hand, if companies create more jobs, Roach's double-dip argument will finally be put to rest. But if we're right about the truth lying somewhere in the middle, then we can expect a repeat of 1992's jobless recovery. In other words, get used to going nowhere for a while.

REPORTER ASSOCIATE Noshua Watson FEEDBACK abernasek@fortunemail.com