Read Part 1 of The Times credit crunch series

Read Part 2 of The Times credit crunch series

Read Part 3 of The Times credit crunch series

Read Part 4 of The Times credit crunch series

Read Part 5 of The Times credit crunch series

The West’s big economies have entered 2008 in a state of high anxiety. On both sides of the Atlantic, a dangerous storm front of economic woes has been building since the late summer. Now the fear is that this storm will soon break with ferocity across the developed world, battering national and individual fortunes and confronting industrial countries with their worst downturn since the recessionary squalls at the turn of the decade.

The threatened storm is brewing over an economic landscape strewn with risks – house prices that are plunging in the United States and sliding in Britain, soaring oil prices that finally have breached the $100 mark and an abrupt tightening of banks’ lending conditions for households and companies alike.

Yet the landscape is as clouded by uncertainty as it is fraught with economic danger. The forecasters of the City and Wall Street are sharply divided over the question everyone is asking: just how bad will it get?

Most, if not all, agree that the odds on severe turbulence are significant and rising. Yet hopes persist that the worst of the danger may soon blow over.

Just how the dangers facing the world’s leading economies will play out is, in truth, highly unpredictable. Among the uncertainties, two crucial and closely intertwined questions stand out.

First, will the global credit squeeze that is making it harder and more expensive for individuals and businesses to borrow soon abate? Or will lending conditions grow still more stringent, turning the screws on economic activity and growth?

Second, whether or not the credit squeeze eases off, will the United States succumb to a recession triggered by its housing market slump and the knock-on effects on American consumers?

If the US does slide into a recession in some form, claims that the world’s other rich economies might remain immune are liable to prove rose-tinted. This year China will, for the first time, become the largest single national contributor to worldwide growth. For all that, America still makes the global economic weather: any US recessionary winds will, inevitably, buffet Europe, too.

Whether the credit squeeze now peters out or becomes much more severe is perhaps the most critical issue, but also the hardest to call with any degree of confidence.

From the moment on August 9 when the squeeze took hold, it has seemed to tighten its grip inexorably.

As the world’s big banks have seen losses multiply on high-stakes bets on parcels of sub-prime loans made to poor Americans with dubious credit records, so they have become ever more fearful. With the banks resorting to hoarding cash to protect themselves against scarcity of funds, their own losses and the losses of their rivals - both known and still to emerge – the resulting shortage of capital has driven up interest rates in the money markets to abnormally high levels.

The banks have been forced to take billions in dubious debt securities, previously held off-balance sheet, on to their books, and eventual writedowns on their losses are tipped to rise to between $200 billion and $400 billion. The danger is that these financial stresses will lead them to choke off lending to consumers and businesses. In turn, scarcer access to loans, and dearer terms for those that can be had, could slam the brakes on economic activity and growth.

Until the very end of last year, this threat seemed to grow by the day. A series of efforts by the world’s powerful central banks to rein in money market interest rates for lending between banks delivered scant relief, in a warning sign of the scale of the strains on the system.

Surveys of credit conditions, including one in December by the Bank of England released this week, have confirmed that access to credit for households and companies has become more difficult, and that it could get tougher still.

All is not lost, however. Determined and coordinated moves by central banks at the end of last month have appeared, at last, to curb money market interest rates. In both Britain and America, analysts say that, while lending conditions have tightened, credit-worthy individuals and businesses can still find loans at reasonable rates, while large companies have strong cash reserves. In addition, injections of capital into Wall Street institutions by the so-called sovereign wealth funds of emerging market countries have helped to bolster their finances.

Against this backdrop, there remains a decent chance that the worst of the rough weather of the credit squeeze may lift fairly soon. The difficulty is, no one can be certain. It is equally possible that the yet steeper falls in US house prices expected by some experts, and a rising tide of mortgage defaults by overstretched American sub-prime borrowers, could mean that American banks’ losses mount. That could see the squeeze intensify, with lending severely curbed, piling still more pressure on house prices and triggering a downward spiral that would throttle US growth.

Even if the credit squeeze does abate, many analysts believe that the US housing slump alone will prove sufficient to consign the world’s biggest economy to recession. By November, average US house prices had tumbled by 5 per cent in a year and two thirds of Americans now believe that, if their country has not already fallen into recession, it soon will. Leading economists and some top Wall Street institutions put the odds on a US recession as high as 50-50.

The forces other than the credit squeeze that threaten to push America to this economic tipping point are all too clear. The US Federal Reserve has admitted that it has been caught off-guard by the brutality of the housing market’s plunge. As home values tumble, anxious American consumers witnessing the withering of their wealth grow more reluctant to keep up the high-spending habits, fuelled by rampant borrowing, that for years have made them to main motor of US growth.

Now, with the surging fuel bills caused by record oil prices also eating into Americans’ incomes, a full-scale retreat by consumers whose confidence is wilting would make a drastic economic downswing inevitable.

Once more, however, more positive arguments make it hard to reach a clear prognosis on America’s prospects. The slide in the dollar has fuelled a US export boom that is helping to shore up growth. Both consumer spending and the American jobs market have held up so far, despite housing woes. The US Federal Reserve has bolstered conditions by cutting official interest rates by a full percentage point, and is poised to do still more.

The picture on the uncertainties confronting the global economy remains highly ambiguous, then. What is clear, however, is that the outlook for the United States, Britain and the world looks more shaky than at any time since 2000-01.

Britain may be especially vulnerable if the worst-case scenarios materialise. With its housing market among the most overvalued in the West and now on the slide, with households sitting on a £1.4 trillion mountain of personal debt and with the strong economic growth of recent years heavily dependent on a financial sector now in the front line of the credit squeeze, the UK looks badly exposed to a global downturn.

The scale of the personal debt burden does mean that each cut in interest rates will mean more to Britons’ stretched finances in terms of reduced repayment costs than in the past. But the Bank of England may still struggle to boost demand through cheaper money, as it has in the past, if overextended households are more reluctant to borrow as harder times loom.

With the Treasury’s own finances also mired deep in the red thanks to heavy borrowing by Gordon Brown to fund higher public spending, the Government, too, looks badly boxed in. Annual public borrowing stuck at 3 per cent of GDP leaves scant room for further boosts to spending or tax cuts aimed at buoying growth.

By the summer, we may yet breathe a collective sigh of relief if the storm warnings prove to be a false alarm. For now, though, we can only brace ourselves and hope for the best in what looks certain to be a year of living dangerously for the world economy.

Explore Economics

• Autumn Budget 2007

• Budget 2008

• World Economic Forum

• The Times MPC

Times Recommends

• BA chief waives bonus after T5 fiasco
• Prospects of cheaper loans hit as Libor soars
• Rice price dives as US and Japan set to unlock grain pact