So, today we banged our head against the current debt ceiling for the first time.  Think of the country like a tall person who has just moved into an unusually cheap and small basement apartment.  The first bang is the most surprising, but it's not catastrophic.  In fact, it's not likely that any particular head bump will be catastrophic.  Nonetheless, taking up residence in that space is a catastrophe.

Strained analogies aside, Tyler Cowen has some good thoughts on this, particularly number 7:

Do we take market prices seriously? Since Treasury rates are still low, low, low, arguably we can infer that the market does not think the Republican stance is so catastrophic. Paul Krugman does not take a consistent position on the relevance of low rates. They are allowed to indicate that the U.S. government should spend more, but not allowed to indicate that we should diminish the blame to be leveled at Republicans. One cannot have it both ways.
In general, people are not consistent on these issues.  Republicans claim to be worried about borrowing, but they are not willing to consider any tax increases at all, so their actual bargaining position is "slash federal spending by a third, or I will trigger a financial crisis."  Translation: "I care about borrowing, but not as much as low taxes, and aren't you outraged that my opponents, those irresponsible ideologues, are putting their priorities ahead of balancing the budget?"  Meanwhile, Democrats claim that the GOP is irresponsibly risking the nation's credit rating, but of course Democrats could end that risk by agreeing to the GOP's terms; you cannot have a showdown unless both parties are willing to risk death*.  Also, how dare the GOP demagogue this important issue the way Barack Obama did when he was a Senator?

Personally, I think that both our current deficit, and the refusal to raise the debt ceiling, are big problems, and I don't think that we should take low interest rates as a sign that nothing bad is going to happen.  I don't see many people on either side as being serious about deficit reduction.  Rather, I see them as engaged in strategic maneuvering, attempting to lock-in their preferences in such a way that when the deficit finally has to be addressed, the other side's priorities will bear most of the burden of fiscal tightening.  When they have spare time from this exhausting labor, they expend it on trying to work the refs, laying as much of the blame as possible on the other side.  

For example, I guarantee that this post will garner a bunch of people complaining that I am unserious because I have not made it clear that our problems are simply the fault of GOP insanity/excessive spending.

I think this is profoundly stupid and dangerous behavior.  Fiscal crises are--ahem--inherently unpredictable events.  No matter how you assure each other that your awesome new health care plan can't possibly be repealed because everyone's going to be lovin' on it so hard . . . or that no peacetime US government in history has ever collected more than 20.5% of GDP . . . the fact remains that when interest rates are rising and everyone's panicking, the unthinkable frequently happens.  Moreover, the tax hikes and spending cuts that are required in a fiscal crisis tend to be much more draconian than would otherwise be required, because they tend to happen when GDP is depressed and the gap between tax revenue and spending is exceptionally large.  After the economy recovers, if you want taxes lowered or spending raised, you will have a painful, bruising fight to restore those preferences you thought you'd locked in.

Just fr'instance, if a crisis came in the next 12 months, triggered by something crazy like, oh, I don't know, the United States being rendered legally unable to roll over its debts, we would still be almost $300 billion in the hole even if we cut the entire discretionary budget--including eliminating all military activity.  If we zeroed out all means-tested entitlements, we could probably save about $250 billion worth of defense spending, which would require reducing our military (and its activity) by two-thirds.  Instantly.

Contrariwise, if we were forced to balance the budget right now with tax increases, we would need to increase all taxes--capital gains, income, payroll, etc--by 75%.  Obviously, attempting to shift that burden up the income distribution would require even larger hikes on the remaining brackets.

Since both of these outcomes seem ludicrously unlikely, it seems fairly obvious that both sides, if they refuse to compromise and are forced to restructure the budget during a downturn, are going to end up making much larger compromises than they consider acceptable--or than they would have to if they moved at an earlier, more felicitous moment.

The charitable case for all this is outlined by Tyler Cowen: No one in Congress has a mandate to deliver any sort of deal.  Indeed, almost everyone in the House has a mandate to deliver either lower taxes or higher spending.  

The public is like one of those people who calls into Suze Orman with $80,000 in credit card debt and a plan to fix it by rationalizing their paper clip spending:  They don't want to raise taxes, but the only budget they're willing to cut is the trivial sum we spend on foreign aid, which the public stubbornly continues to believe constitutes 25% of the federal budget.  Even more distressingly, I'm told that they persist in this irrationality even if the pollsters provide them with the actual breakdown of the federal budget: they still say that they really want politicians to reduce the deficit, that they don't want taxes increased on anyone except Warren Buffett--and that the only thing they want to cut is foreign aid.

Judging from polls and personal interviews, half the public seems to believe that there is some sort of "common sense" solution, involving no major cuts or tax hikes, which is eluding politicians only because they're a bunch of partisan jerks.  The other half is busily encouraging their politicians to engage in as much partisan jerkitude as possible.  Neither is conducive to actually achieving a solution.  So we have to cut our politicians a little slack; they're acting insane because we're acting insane.

But even the charitable reading isn't too charitable.  Sure, it's hard to cut a hard deal when none of your constituents thinks it's necessary.  On the other hand, if they don't have a mandate to cut any specific deal on the budget, I'm pretty sure they do have a mandate to not dump us into a horrible fiscal crisis in which even more draconian changes will be necessary. And they're ignoring that mandate.

* They could almost certainly get a deal by agreeing to cut spending later in exchange for borrowing now. They don't want to because this would be politically unpopular, and also, they have an ideological commitment to higher spending that looks very much like the GOP's ideological commitment to lower taxes.