CAMBRIDGE: There is a reasonable chance that the U.S. economy is living through a speculative bubble of the same kind that has burst for so many other economies this past decade - Japan, Korea, Mexico, to name a few. These financial bubbles were all powered by an underlying myth of economic invisibility. The Japanese thought they had it ten years ago. Hard to believe, but many serious analysts thought Japan was on the verge of conquering the world economy at that time . . . that is, just before the Japanese stock market fell by more than 50 percent. Then Mexico thought that its new free trade arrangements with the U.S. would lead to a surge in economic growth . . . just months before the economy collapsed in the worst crisis in a generation.

Many in the U.S. now think that the U.S. economy is unstoppable, that the Internet revolution underway in the United States is the greatest thing since the industrial revolution itself. Such hyperbole, and the surging U.S. stock market based on these super-bullish views, should immediately give us pause. Is hubris at work here, as it was in earlier bubbles? If the U.S. stock market surge were indeed to end, or to reverse itself, what would be the consequences for the rest of the world?

The U.S. is surely powered by two real strengths - great flexibility of its market system, and great prowess in developing new technologies. The recent U.S. boom is heavily based on enormous investments of U.S. companies in the new information technologies. With its special mix of markets and innovation, the U.S. economy is indeed remaking itself with amazing speed. But financial bubbles are often founded on true economic strengths. A bubble occurs when those very real strengths suddenly take on exaggerated, even mythic, proportions in the eyes of investors, who are then prepared to throw vast amounts of money into the stock market without attention to realistic prospects for future earnings.

Consider my favorite case of the week. Amazon, a pioneer of internet retailing - first with books, and now with just about anything - announced that it had lost $138 million in the second quarter of 1999, though its sales revenues tripled to $314 million. Investors were mesmerized by the rise in sales volumes, and gave no heed to the continuing losses of the company . . . losses that reflect the small retail margins in highly competitive U.S. retail markets. The company's announcement was followed by a further surge of some 4 percent in its stock market price! The company has yet to turn a profit, and the book value of its underlying assets are around $650 million. Nonetheless, Amazon is now valued in the stock market at $19 billion, making it one of the largest 300 companies in the world in terms of market value!

What this suggests is that the U.S. stock market has taken leave of its senses. Yes, there are theories galore to prove that the market pricing is just right. Maybe Amazon will finally be able to turn its large customer base into large profits, but that remains to be proved. But what if the financial markets are simply wrong, as they have been so much of the time in the world in the past 10 years? What if the euphoria is followed by collapse?

One thing is for sure: U.S. consumers would stop their current buying spree, and this would slow the U.S. economy. But would the U.S. go into recession, much less depression? Perhaps briefly, but probably not deeply. With inflation low, a relatively healthy banking sector, and a budget in surplus, the U.S. Government would probably have the flexibility of monetary and fiscal policy to achieve a relatively soft landing. Some investors would surely go bankrupt, but unless things get even more wild than now, the U.S. financial sector would probably survive intact even with a fairly significant stock market correction. Still, this is the time for bank regulators in the U.S. to keep a close watch on bank portfolios, just to make sure that the current euphoria does not turn into a mountain of reckless bank lending.

Would the rest of the world suffer deeply from a U.S. stock market correction, for example by experiencing a drop in export sales to a slowing U.S. market? Probably that effect would also be fairly modest. On the one hand, European, Asian, Latin America, and African economies would have a smaller market in the U.S., but on the other hand, those economies would probably have an easier time attracting capital to their own economies, since less global capital would be flowing to the U.S. economy. Slower export earnings could therefore be offset by rising domestic investment spending, especially if these economies lowered their interest rates in the event of a U.S. slowdown.

In short, the U.S. economy may well be in a financial bubble. Millions of Americans who now consider themselves investment geniuses could well end up rather disappointed if and when the bubble bursts. Even though American pride and consumer spending would be dented, the damage to the world economy would probably not be huge. Governments should have the tools - especially monetary policy - to limit the damage, if they use those tools correctly.