Along the sun-splashed square below, December's pilgrims were poking through the neighboring shops for carved olive-wood creche figures while church bells pealed a noon chorus.

In his second-floor office just above this holy city's central square, Mayor Elias Freij stood over an unfurled map of the greater Jerusalem area splattered with colored blobs--large yellow ones for the new Jewish settlements in what was once Arab land, small red dots for the remaining Arab townships and cities, green shading for future settlement areas and striped sections denoting agricultural lands where no new building is permitted.

"You just have to look at this to see why we are desperate," said the mayor, one of the most moderate Arab voices on the West Bank that Israel captured in the 1967 war. "We are being surrounded on every side, overwhelmed. Every time we turn around there is a new Jewish settlement going up around us. We are being forced into enclaves."

Despite a sense of pride at the PLO's resistance to Israeli firepower during the 74-day siege of Beirut this summer, there is a feeling of despair among the 1.2 million Palestinians on the West Bank that time may already be passing them by.

Here on the West Bank, the principal Palestinian homeland envisioned in a series of Middle East peace plans, there is a sense that the summer's events in Beirut have complicated the search for a solution -- and possibly even foreclosed it.

On the one hand, the war in Lebanon has inflamed the Palestinian nationalism that the Israeli government of Prime Minister Menachem Begin has sought to extinguish. The war -- which was launched to finish the Palestine Liberation Organization as a political as well as military movement -- has united the Palestinians under Israeli rule in support of PLO Chairman Yasser Arafat's political leadership as never before.

At the same time, the grim images of Israel's military power, coupled with the bitter realization that the rest of the Arab world stood by in impotence through the Palestinians' ordeal in the ruins of Beirut, have left a mood of anguished despondency among the people of the West Bank about their future and their identity as Palestinians.

"This summer, seeing our Palestinian fighters holding out in Beirut so long gave us a new sense of pride and identity as a people," said 73-year-old Rashad Shawaa, the elected mayor of Gaza until the Israeli authorities deposed him last spring for alleged PLO sympathies. "But we have also been swept by a mood of desperation. The people are losing hope because they do not think there is a power in the world interested in pressing for the respect of their basic rights."

The conflicting pulls of those two distinct emotions in the occupied territories do not bode well for the diplomats' hopes that somehow the trauma of the Beirut summer may have produced the conditions that might, at long last, lead to a negotiated settlement of the Palestinian problem.

While the mood of desperation has heightened a sense that a negotiated settlement must be made, the reinforced support that the PLO has won here has made almost impossible any negotiation that does not involve it.

"That the PLO has become unquestionably the official representative of the people here, there is absolutely no doubt," admits Freij, the Christian mayor of Bethlehem. A man often attacked by more militant West Bank Arabs for his insistence on a Palestinian initiative to open talks with the Israelis, Freij acknowledges that after Beirut "no one here would dare step in to negotiate with Israel in defiance of the PLO unless he was out of his mind."

Freij should know. A month ago, after he had been to Amman and met with King Hussein, he gathered a group of moderate Palestinian notables, including Gaza's Rashad Shawaa and the acting mayor of Hebron, Mustafa Natche, and proposed that they begin a petition campaign among the Palestinians of the occupied territories to add a local voice to the deliberations revolving around President Reagan's Sept. 1 peace initiative. The text of the petition agreed to by the participants at the meeting specifically urged "mutual recognition between the PLO, our legitimate representative, and Israel because we consider that the two parties constitute an integral part of the peace process."

Even before the petitions could be put into circulation, the initiative came under heavy criticism from other local leaders, who insisted that the only proper channels for the drafters' views existed within the PLO and that only it should speak for Palestinians in the occupied territories. Though Freij claims to have collected 200 signatures, he appears to be the only one of the drafters to have even taken the petition out of the drawer. "We thought that to press the issue would create divisions among us we do not need," said Gaza's Shawaa. "So we dropped it."

That sense of the need to maintain unity in the ranks speaks of the PLO's increased power here on the West Bank. Not long ago, there were ambiguous feelings about the PLO leaders in exile: most had come from the Palestinian exodus of 1948, leaving towns and villages of what now is Israel proper, and their interests were thought to be somewhat different from those of the Palestinians on the West Bank and in Gaza, who only came under Israeli occupation in 1967.

"The solidarity of the people with the PLO has been tremendously increased since the beginning of the war in Lebanon," notes Dr. Gaby Baramki, acting president of Bir Zeit University, one of the three institutions of higher education on the West Bank. "We believe we cannot have more than one leadership, and that is the PLO."

The general insistence that only the PLO can speak for these people in any future peace talks does not exclude a wide range of views over the compromises that should be made to get some sort of settlement before what one Bethlehem businessman calls Israel's "galloping annexation" precludes any realistic prospects for ending the 15-year occupation here.

Faced daily with the reality of the occupation--the deposing and exile of their elected leaders, the censorship of their press, the expropriation of their land, the arrests of their children -- the Palestinians of the West Bank have always been more open to compromises that would end Israel's sway here than have the leaders of the PLO abroad, who experience the occupation in the abstract. The renewed nationalism of the West Bank Palestinians and their strengthened loyalty to the PLO have not altered their hopes for finding a political settlement, though they appear to have lessened what were already the slimmest of possibilities.

On one side of the debate about the future are men such as Bassam Shakar, the mayor of Nablus, who, like Shawaa in Gaza, was deposed last March by the Israelis on unsubstantiated charges that he was a representative of the PLO in the occupied territories.

Shakar lost both his legs in a 1980 car bomb blast widely believed to have been set off by extremist Jewish settlers. He holds to the view, expressed in the plan advanced at the Arab summit at Fez, Morocco, in September that there can be no settlement that does not provide for an independent Palestinian state on the West Bank and Gaza under the leadership of the PLO.

On the other extreme are the men of the "village leagues" that Israeli Defense Minister Ariel Sharon has sought to build up to supplant the traditional leadership of more independent elected municipal officials like Freij and Shakar. The "village league" men, such as Hebron's Mohammed Doudin, talk openly of accepting the limited Israeli interpretation of local "autonomy" ambiguously offered in the 1979 Camp David accords that made peace between Israel and Egypt.

In between those views there is a wide range of interest, if rapidly fading hopes, in at least parts of the provisions of President Reagan's Sept. 1 peace initiative. Reagan's rejection of Israel's right to annex the occupied Arab territories it captured in 1967 and his call for an immediate freeze on the accelerating construction of Jewish settlements in the West Bank territories were widely cheered by the Palestinians--even though the Reagan plan precluded any independent Palestinian state, offering only the alternative of being joined to King Hussein's Jordan, which had administered the West Bank until the 1967 war.

"The Reagan plan does not meet all of our needs, but it meets some of them -- specifically the freezing of the settlements," economist Ibrahim Matar of Jerusalem said. "If we don't find a solution soon that will halt the spread of these settlements it will mean we will be a people without a land: we will be the new Armenians."

Matar insists that time is the critical element on the side of the Israelis and that they are stalling on negotiations because they know it.

"For us the importance of the Reagan plan's call for a settlements freeze offers a light at the end of the tunnel," Matar said. "It would mean that at the very least people would not be taking the land from under our feet. If we knew that, we could have hope for Palestine even if it took five years to negotiate the next step."

To a visitor returning to the occupied territories for the first time since Begin came to power in 1977 and opened the floodgates of Jewish colonization in the conquered Arab lands, it is easy to see why there is such growing desperation about the future here.

Driving up through the Judean hills from Jericho to Jerusalem, one is struck by how much the once soft landscape of barren, undulating hills has changed in recent years. Once naked hilltops have suddenly been crowned with white concrete housing complexes that, shimmering in the late afternoon light, recall the crusader forts that might well have inspired their locations. But these are no longer the primitive pioneer outposts that Israel first justified under the needs of security; these are massive bedroom suburbs luring a new breed of settlers commuting from jobs in Israel's overcrowded cities.

Among even the most moderate Palestinians who have watched these communities rise and start to surround their villages and towns, there is a sense of violation and rage over their seeming impotence to halt what is happening.

"We are being hemmed in, pinned down, enveloped," said a Ramallah doctor. "Of course we want to see negotiations that will somehow give us back our land, our sense of self-respect. But we cannot compromise our right to be our own masters. We can never accept any formula that does not reverse -- not just freeze -- this effort to turn our communities into Bantustans like Begin's friends in South Africa have done with their black majorities."

There is now a Jewish population of about 25,000 in the occupied territories, with 110 settlements already in existence or under construction. To grasp the meaning of these figures in political terms, one has only to look at the problems created last spring when the Begin government forced the dismantling of Israeli settlements in the Sinai before returning the last sliver of that territory to Egypt under the terms of the Camp David peace accords.

To bring back only 800 Sinai settlers cost the government $533 million in compensation and set off such an emotional firestorm that the government itself was briefly threatened.

"When there are 100,000 settlers in the West Bank, the task of reversal will be both an economic and a political impossibility," said Meron Benvenisti, a former deputy mayor of Jerusalem who is completing an exhaustive study of the whole settlements program. "Really, there is very little, if any, time left."

Yasser Arafat, in interviews, insists that he is a "pragmatist," still willing to trust the Americans if only they will prove that they are able to act in the Middle East, not just talk.

It is in President Reagan's ability to convince--or pressure--Begin to halt his relentless colonization of Arab lands that any hope for an Arab breakthrough in the Middle East today lies. The evidence that Begin will not be swayed to freeze the settlements program is at the root of today's heavy mood of pessimism.

"The sad, terrible thing is that nothing changed in the Arab world as a result of events this summer," said an influential Palestinian editor in Beirut, asking that he not be quoted by name. "We Palestinians have neither won nor lost. We have just been left where we have always been, caught between the Israelis, who have cast us out of our homes, and the Arabs, who still refuse to take us into theirs. Peace, if there is ever going to be peace for our people, is still a long, long way away."