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The economies of the United States and Japan are treading the recovery path; there is no need to worry, as there once was, about a free fall. This sanguine outlook for the world’s two largest economies is now clouded increasingly by falling U.S. stock prices. What’s worrying is an apparent shift in investor behavior, with dire implications for international capital flows.

The rout on Wall Street, which stems in part from high-profile corporate scandals, highlights the potential vulnerability of an economy hooked on a stock market boom. Japan’s problem is a glut of money created by years of rock-bottom interest rates. In the absence of real demand, that surplus money appears to be going nowhere. Investors are losing confidence, unsure of where to put their money.

America’s Achilles’ heel is well known: its gargantuan appetite for consumption that is creating enormous deficits in the balance of international payments. The result is a chronic shortage of money. To keep the stock market going, a lot of money must be attracted from around the world. If the flow is disrupted, the economy will suffer. The current-account deficit, at $400 billion a year, is reaching disturbing proportions. America is living on debt, paying far more money than it earns offshore. Now, however, the fund influx is dwindling. In the first quarter of this year, inward portfolio investment dropped by 40 percent, or $93 billion, from a year earlier. Foreign investors are fleeing the U.S. market.

A crisis of confidence is all too apparent. One big reason is the spate of accounting irregularities that began with Enron. The latest in the series, the scandal at WorldCom, has dealt another blow to investor confidence. Under scrutiny is the very strategy of American corporations’ lifting their earnings on the back of rising stocks. Trust in investment bankers and other analysts has also plummeted because they have failed to see through their clients’ plots to manipulate profits.

American consumers, not consummate savers like Japanese, are feeling the effects of the stock market jitters. The boom in mutual funds, which has attracted personal savings as never before, is cooling off. With the Dow Jones industrial average hovering around a low of 9,000 points, individual investors are also retreating to the sidelines. The possibility is that downward pressures on stock prices might continue for some time. The prevailing view is that many stocks are still overvalued compared with corporate earnings.

It is also possible that weakness in the stock market might take the steam out of consumer spending and business investment, key engines of growth. What’s more, the federal budget deficit is growing rapidly as a result of the tax cuts and spending measures announced by President George W. Bush’s administration after Sept. 11. Now the nightmare of “twin deficits” — trade and budget deficits — is back.

America’s grim economic prospects are casting a shadow over Japan’s economic future as well. The present sense of buoyancy, confirmed by the latest Bank of Japan “tankan” survey of business sentiment, is supported chiefly by expectations that exports to the U.S. will continue to expand. With the U.S. market on the skids, this export-led recovery scenario will likely go awry.

In this kind of situation, Japan’s surplus money appears to be losing outlets. Holding government bonds may not be as safe as it has been, given the successive credit downgrades by international rating agencies. Banks, still burdened with large amounts of bad loans, are loath to reverse their careful lending policies. Thus the credit crunch continues even as easy money piles up.

During the past decade and before, Japan’s superfluous funds flowed into the U.S. stock market, playing a part in pushing the Dow Jones index above the 10,000-point mark. There was a stock bubble in the brewing, but many market players were taking it in stride. At the end of the 1980s, Japan’s stock market was also going over the top, but few people cared, believing the boom would continue forever.

The retreat on Wall Street is a serious concern not only to the U.S. but to Japan and other nations as well. But policymakers on both sides of the Pacific appear to lack a sense of crisis. Apparently they believe that the decline of confidence in the stock market and its impact on the real economy are temporary and limited.

Experience shows amply that a cavalier attitude on the part of government officials can only fan investor nervousness. If there is a lesson U.S. officials can learn from Tokyo, it is that failure to take drastic action to clean up the postbubble mess will spell more trouble. America’s stock market plunge is a warning that the successful handling of the post-Sept. 11 crisis is in itself no assurance of a full-dress economic recovery.

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