Shortly after the federal government reopened and the debt-ceiling standoff was temporarily resolved, a European friend — an admirer of the U.S. — asked me plaintively, “What is going on over there?” What indeed? I was tempted to say it was just another bout of partisan squabbling that didn’t signify much. In the markets there was no “debt crisis.” The yield on very short-term Treasuries (the ones due to be repaid immediately) spiked. But the benchmark 10- and 30-year issues barely budged, and stocks stayed close to all-time highs. Investors never believed a debt default was a serious possibility, and they were right. Despite all that, we can’t afford to ignore what’s happening in Washington. Political dysfunction now represents the biggest threat to the U.S. economy. However you look at it — short term, medium term, or long term — the gridlock is crimping growth and undermining the country’s prospects. Worst of all, there’s no end in sight.
Let’s start with the fourth quarter. Thanks largely to the shutdown, it looks as if we’ll see yet another period of sub-2.5% growth — the fifth in a row. The direct hit to spending that resulted from salaries being withheld and departments shuttered knocked perhaps 0.3% off GDP. And the perception of paralysis also hurt the private sector. According to a University of Michigan survey, consumer confidence fell by four points in October, and a record number of respondents made negative comments about the government. Business confidence was already weak. Outside of the aircraft industry, orders for capital goods, which should be growing strongly at this stage in the recovery, fell by 1.1% in September.
This latest hit to the economy comes on top of significant tax hikes and spending cuts that resulted from the previous episode in the capital’s follies, the “fiscal cliff.” And the prospects for next year are subject to political uncertainty. While Republican threats to force a debt default are no longer credible, there’s no assurance that, come January, we won’t see another shutdown, or shutdown threat. During the Clinton and Bush years, it was sometimes said that divided government was good for the economy. With no one party in control, neither side could cause much mischief. But this argument was based on an assumption that turned out to be wishful thinking: that the party with veto power on Capitol Hill would act responsibly.
We now have a situation in which Congress is locked into the sequester, which both sides agree is a poorly designed policy, and every year or so — possibly just a few months on the next go-round — the doomsday clock starts ticking down. According to a study by the consulting firm Macroeconomic Advisors, crisis-driven fiscal policy has reduced GDP growth since 2010 by about one percentage point a year: Spending cuts have accounted for two-thirds of the shortfall, and increased uncertainty has been responsible for the rest. Over the long term the costs could be much larger. The sequester is squeezing outlays on education, scientific research, and infrastructure projects, all of which contribute significantly to wealth creation. And if the dysfunction persists, it could undermine the dollar, which would be disastrous.
It is the dollar’s status as the global reserve currency that enables the U.S. government to have its cake and eat it too — running up heavy debts at modest cost. Partly because the greenback has no obvious replacement, investors and foreign governments have, so far, retained their faith in Treasuries. But as Fitch commented in placing them on review for a possible downgrade, “the repeated brinksmanship … dents confidence in the effectiveness of the U.S. government and political institutions.” Should that confidence ebb away, we would be facing sharply higher interest rates, capital flight, and an economic bust every bit as deep as the 2008-09 recession, and possibly worse.
It isn’t going to happen overnight. It might never happen. But in adopting such a nihilistic approach to the basic maxims of sound government, Ted Cruz and his cohort are putting the country on a perilous course.
John Cassidy is a Fortune contributor and a New Yorker staff writer.
This story is from the November 18, 2013 issue of Fortune.