A rudderless ship of state

Here we are, barreling toward the edge, and the two parties are pulling in opposite directions. The two camps couldn't be more divided.

In March, Republicans in the House passed their 2013 budget proposal, dubbed "The Path to Prosperity," combining tax cuts with dramatically lower spending. In it, the free-for-all smorgasbord that is now Medicare would end in 2022 for those born after 1956, to be replaced by a private-insurance-premium-support system. Seniors would be on the hook for the difference between the government vouchers and their insurance premiums.

Other government spending, save Social Security and defense, would also be slashed.

Obama, for his part, unveiled a more middle-of-the-road budget featuring new taxes on those making more than $250,000 a year, extension of payroll tax cuts and unemployment benefits, and cuts in areas such as agricultural subsidies and health care payments.

The contrasts are stark. The Republicans would cut the public debt to 10% of GDP by 2050. Current law, the fiscal cliff, would cut the debt to 42% of GDP. Obama's plan would see debt increase to 124% of GDP. And, the Congressional Budget Office's "alternative fiscal scenario" -- which would see expiring tax cuts extended, Medicare payments to doctors held steady and Bush tax cuts kept -- would put the debt at more than 200% of GDP. I'll dub this the KTC option, for kick the can.

Even the KTC option could be considered overly optimistic.

It assumes that the economy revs up and returns to full employment by 2015 and stays there. In other words, KTC assumes the new recession in Europe and the "hard landing" in China don't translate into a slowdown here. In fact, it assumes no recession through 2022. Given the issues we face -- higher inflation, crimped consumers and a poor job market -- this isn't realistic.

Lower debt is good, obviously -- but not at the expense of growth. The Europeans are beginning to realize this, which explains why Madrid and Rome are beginning to chafe at budget austerity demands out of Berlin. Indeed, Italy announced Tuesday that it will delay by a year its current plan to balance its budget in 2013 as the eurozone tips into a new recession.

Image: Fiscal drag © MSN Money

As a rule of thumb, each percentage point of deficit reduction takes a percentage point off of GDP growth. So the Republican plan would cut growth by 2.6% next year and 2% in 2014; the fiscal cliff would take 3.7% off next year and 1.5% in 2014; Obama would see 1.9% taken off this year and next; and the KTC option would see 1.4% taken off next year and 0.5% in 2014.

Compare that with the near-5% tail wind we enjoyed in 2009 as the stimulus kicked in and stocks rocketed higher.

Entitlement spending is the problem. According to Credit Suisse, spending on Social Security and health care programs will amount to nearly 13% of GDP in 2022 versus an average of 7.3% between 1972 and 2011. All other spending will fall to 7.8% from 11.4%.

My solution is to take the Republicans' desire to insulate the Treasury from incipient health care cost inflation while, mindful of the lessons of the 1937 double-dip and the eurozone's current woes, adopt the Democrats' desire for short-term economic stimulus on things like infrastructure and research-and-development credits.

But I'm not holding my breath that consensus can be found without another confidence-sapping, market-shaking showdown. That would likely encourage Fitch and Moody's to follow S&P's example by calling out the obvious: America just isn't the credit risk it used to be as the elephants and donkeys in Washington bicker, posture and bloviate all while coddling the most important voting bloc of all, senior citizens.

Last November, I warned that the dynamics of democracy will likely prevent any meaningful progress on the structural deficit without a bond market revolt. I think it's worth repeating:

"In the months to come, if the two parties battle as the economy burns, the solution embraced in Italy and Greece -- unelected technocrats -- may look more and more attractive as the deus ex machina to get us out of this mess.

"Greek philosopher Plato warned of this more than 2,400 years ago in ancient Athens, claiming that the absolute freedom of democracy and the freedom of speech and license to do as one wishes can devolve into an unmanageable state. He compares such a place to a dilettante with no discipline; a hedonist with neither order nor necessity nor an appetite for sacrifice and self-control.

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"The country, drunk on the insatiable desire to have no master in any facet of life, becomes intolerant of any whiff of elitism, fiscal responsibility or denial of any earthly desire. Leaders aren't allowed to place the least bit of austerity on their people. To stay in power, they must be pliable and provide plenty of what the people want -- namely, low taxes and lots of government spending.

"Otherwise, they are punished. Think about that when the 2012 elections roll around."

Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.