Move over Nero: legislators on both sides of the Atlantic seem as if they can hardly summon up the energy to fiddle while their economies burn. In Europe, a chronic lack of co-ordinated action early in the financial crisis means the very survival of the euro is now in serious doubt. In the US, the crisis is potentially more serious: if Republicans and Democrats cannot agree on a deficit reduction plan by the 2 August deadline for raising the debt ceiling, the world's largest economy will be in default.

Perhaps the most astonishing thing, however, is that investors seem to be fiddling just as happily as politicians while this crisis unfolds. Ratings agency Moody's warned on 13 July that it could remove the AAA credit rating on US debt because the talks are running out of time. Yet the S&P 500 share index rose a further 4%, leaving it up by a fifth over the last year, the dollar strengthened against the euro and US Treasuries – or government debt – remained unmoved.

That may be because, for the moment, Europe is the biggest worry as Italy struggles to persuade the world that it is not heading the way of Greece, Ireland and Portugal. It may be because investors think the budget impasse is simply posturing by political rivals as they prepare for a compromise.

That is dangerously complacent. The European mess is undoubtedly serious, but the US economy and its currency are at the heart of global finance. Its $14.3tn of debt is almost equal to its GDP, putting it about 14th in the list of the most indebted countries. Financing the deficit requires the continued confidence among investors – particularly the Chinese, who are still the main buyers of US government debt – that the country can continue to service that debt. So far, that is not in serious doubt. But its economy is still very weak – the housing market remains deep in the mire, the labour market has stalled and consumers are on strike. The costs of programmes like Medicare means that government spending will escalate.

That is why budget cuts are essential. President Obama wants $4bn of cuts and tax increases. The Republicans are refusing to sanction more than $2bn and are steadfastly against any increase in taxes, even on the very rich.

A compromise may yet be found but a half-hearted fudge aimed merely at avoiding default or downgrade, rather than addressing the fun

damental problem that the US is spending too much, should not reassure investors.

Justin Urquhart Stewart, marketing director of Seven Investment Management, says the buoyant stock market partly reflects the fact that corporate profits have been very healthy. But he thinks there could be more difficult times ahead: the outlook for the domestic economy is poor; the Chinese economy, which has been the growth engine for the world is struggling to contain inflation while social unrest is growing and there are serious questions over whether its growth can be sustained; the crisis in Europe will further undermine its economic growth. These are serious even without the prospect of a debt default.

Investors may be pinning their hopes on a third dose of the quantitative easing financial support package – and Federal Reserve chairman Ben Bernanke has hinted that it may be needed. After all, the previous two rounds sent asset prices – particularly commodities and, for a time at least, stock markets – soaring, so perhaps a third round would be equally worthwhile.

Or perhaps not, says Jeremy Batstone-Carr, director of private client research at Charles Stanley. He points out that the last round failed to increase employment and simply fuelled inflation which, while it may be good for asset prices in the short term, is bad in the long-term. Indeed, some analysts think that QE3 would be seen as desperate and so could actually be counterproductive.

"The frightening thing is that it is all in the hands of the politicians," said Urquhart Stewart. Politicians have proved remarkably inept at dealing with the financial crisis so far. Investors would be unwise to bank on them getting it right in the future – and should prepare for stock and bond markets to reflect that.

Urquhart Stewart has increased the cash allocation in Seven's portfolios saying that this is "safest" until the politicians manage to come up with some sensible solution to the US and European problems.