Image: Anthony Mirhaydari

Anthony Mirhaydari

As the kids were gearing up for Halloween just a few weeks ago, everything seemed right in the financial world -- or at least, back on the right track.

Europe had hammered out an against-the-odds agreement to save Greece and bolster its bailout fund. The U.S. economy was revving up again with a solid third-quarter report on the gross domestic product. And central banks around the world were opening the floodgates, washing the financial markets in more cheap cash.

Then it all went wrong. It went wrong because of politicians. It went wrong because of democracy. And it's about to go wrong again if the bipartisan "supercommittee" in Congress fails to agree on at least $1.2 trillion in budget savings over the next 10 years through tax hikes and cuts to popular programs like Medicare and defense spending.

The committee's deadline is Nov. 23 -- a week from now. And hopes are not running high.

It's worth remembering that the economy looked ready to rev up in late June and early July, before the debt and deficit mess in Washington in August. And it looks like the politicians are ready to derail the nascent recovery. Again.

The European example

To put all the political wrangling in context, let's start in Europe.

On Oct. 31, then-Prime Minister George Papandreou of Greece, frustrated by a lack of political support and violent popular protests, shocked the world by announcing he would put the latest bailout plan -- the so-called "Oct. 26 agreement" -- to a binding vote by his people. The measure likely would have failed, in an act of democracy the financial world clearly feared.

Papandreou has since left office, and the shock waves of this move have reverberated through the world economy.

The European bond market has come under fresh attacks, pushing Italian bond yields to unsustainable levels -- a much more serious economic threat than Greece represents. Spanish, Belgian, Austrian and even French borrowing costs over German equivalents have also climbed as doubts grow over the financial health of all these countries. The eurozone's bailout fund, the vehicle that's supposed to put an end to the crisis once and for all, is having trouble raising cash. What was once unspeakable -- the removal of countries like Greece from the European Monetary Union -- is now being discussed in Berlin and Paris.

All this uncertainty and volatility comes with the eurozone rapidly falling into a deep, new recession. Eurozone industrial production dropped 2% in September from August. Worst hit was the capital goods sector. The latest eurozone purchasing managers survey points to a "sharp contraction" in economic output in the current quarter according to Capital Economics.

Recession will only worsen the debt crisis by deepening the deficits of Greece, Italy and others. America could meet a similar fate unless it acts swiftly to enact short-term stimulus and sensible medium-term measures to close the deficit focused, mainly, on out-of-control health care costs.

Politically impossible bills to pay

The reason the fallout was so swift and so severe is that Papandreou's gambit struck right at the point of weakness for the rich world's post-bubble economic reality: After years of living well off of cheap credit, the bill has come due in the form of harsh austerity -- something that's politically unpalatable.

Elected officials, who promised voters the world during the boom times, don't have the guts to do what's necessary now, in a time of tepid, post-crisis growth. Popular protests and fringe political movements, from deadly clashes in Athens to Spain's indignados and the rise of nationalist, euro-skeptic parties in places like Finland and Slovakia, only make it worse.

This is why the governments of both Greece and Italy have been replaced with unelected technocrats tasked with implementing painful spending cuts and tax increases before new elections are held. Free of the demands of democracy, these new leaders can do what elected leaders would not.

And they need to do it quickly. Unless Greece can secure its next batch of European Union/International Monetary Fund bailout cash, it will be bankrupt in a matter of weeks. In Italy, borrowing costs are on the same trajectory that doomed Greece, Ireland and Portugal. And now, the focus of the market's fury is shifting to other "core Europe" countries like Spain and France.

Back in the USA

Similar dynamics are playing out here at home as Democrats and Republicans knock skulls over taxes, spending and the deficit. Their constituents scream for jobs, while groups like Occupy Wall Street, Grover Norquist's Americans for Tax Reform and the Tea Party press hard for competing demands.

The unwillingness to make politically risky choices is why, back in August, when the deal to raise the debt ceiling fell short of what was needed to stabilize the fiscal outlook, Standard & Poor's cut America's AAA credit rating. The market hasn't recovered from that downgrade.

Congress committed to budget savings of less than $1 trillion over 10 years, with an additional $1.2 trillion hopefully coming from the select supercommittee. S&P was looking for something closer to $4 trillion in savings to keep the U.S. rated AAA. The analysts added that the government was losing its ability to manage public finances, due to "America's governance and policymaking becoming less stable, less effective and less predictable." This interparty bickering, which took the country to the verge of a government shutdown and default on its debt, "weakens the government's ability to manage public finances," they suggested.

America faces stark choices, tight deadlines and scary consequences for inaction, too. Yet politicians continue to dance around the inevitable, unable to compromise and unwilling to do the honorable thing: sacrifice their political careers to do what's right for the country.

The US debt picture

Even assuming the supercommittee gets a deal proposed in time for Thanksgiving and it gets passed by Congress for Christmas, America's debt will continue to grow. Analysts at S&P expect that, assuming the Bush tax cuts are extended for the majority of Americans (a stimulus measure that enjoys a modicum of bipartisan support), net government debt would rise from 74% of GDP this year to 85% by 2021. So more spending cuts and higher taxes will still be needed.

But if Congress fails to act, the $1.2 trillion in automatic cuts kick in (hitting defense spending hard), the economy will weaken in the face of Europe's tailspin, S&P would likely cut the U.S. credit rating again (to AA from AA+) as the net debt load swells to 101% of GDP by 2021 and the government reinforces the notion that the country is ungovernable.

That, no doubt, would result in a harrowing repeat of the early August market collapse. A drop in financial wealth, and lost confidence, would push the fragile U.S. economy down into recession with the eurozone. China and the other emerging-market economies couldn't maintain their growth with the world's two largest economies in the ditch.

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With a week to go to the Nov. 23 deadline, things aren't looking good.

Republicans have proposed a $1.2 trillion deal (the bare minimum) made up of $750 billion in spending cuts and $300 billion in new taxes, which come from lowering overall rates but capping deductions and tax credits.

Democrats have rejected this, arguing it would increase the burden on middle-class families. They've put forward a $2 trillion deal with equal shares of cuts and taxes. Republicans claim Democrats are resisting cuts to Medicare -- a shame, because medical spending is the main driver of the long-term budget mess.

News reports are filled with rumors that members of Congress are laying the groundwork for failure as the two parties remain far apart on taxes, Medicare and Social Security. There are efforts to save the Pentagon from the deep automatic cuts that would kick in if no deal is reached. There is also chatter that tough decisions on taxes, including the Bush tax cuts, could be pushed back until after the 2012 presidential election.

In other words, they're trying to kick the can down the road again.

Held in low regard

While our leaders won't face international pressure to abdicate, as we saw in Italy and Greece, the U.S. electorate isn't impressed; it gives Congress a record-low approval rating of 13% right now, according to Gallup. Nor are the Chinese: The Dagong rating agency said this week that it may downgrade the U.S. credit rating again (it cut our rating back in August) on a failure of elected leaders to deal with the deficit. Wall Street isn't impressed, either.

A deadlock in Congress now, one that likely wouldn't be broken until after the 2012 election as divisions harden, would result in a cascade of failures that will continue to pummel stocks, confidence and the economy. Merrill Lynch/Bank of America economist Ethan Harris expects at least one U.S. credit rating downgrade in late November or early December as a result of a failure by the supercommittee to create a "credible" deficit-fighting plan.

Even if the bare minimum $1.2 trillion deal gets passed -- likely with accounting gimmicks such as overly optimistic economic growth projections -- a number of other major decisions loom over the next year that will require hard-to-come-by bipartisan support. These include expirations of the $90 billion payroll tax cut, $40 billion in extended unemployment benefits, tax incentives for business investment and the Bush tax cuts, as well as another decision on the U.S. Treasury's debt ceiling.

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.

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.

More immediately, on the investing front: I've been advising trade-minded subscribers to my newsletter on ways to try to catch the market's ups and down for the last few months -- ups and downs that are set to continue, and require quick action to try to play.

For average investors, it's much tougher, because the market is moving based on politics and macroeconomics rather than anything a particular company does. There are also few attractive alternatives. Treasury yields are in negative territory and are likely to underperform over the long haul. So for now, hang on.

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 and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.