Why does there have to be a downside?
The US used to be the political and cultural leader of the free world. Where did we go wrong?
Why is the rest of the world laughing at us or looking on in shock?
The rest of the world is not laughing at the US or looking on in shock. While there is some substance to the points you make, I believe the problems and the situation, as you portray them, are exaggerated.
For one thing, the US was never (never ever) the cultural leader of the world, especially not of the free world. That is an impression Americans have gotten possibly from school or more likely from Hollywood, Motown, glossy magazines, etc. America has sometimes led the way in pop culture, but overall, we are definitely not and never were the cultural leader of the free world.
The idea that everyone on Earth sought the American Dream is also a myth, one which we were fed in school and through Hollywood. Immigrants certainly made their way to the US in the millions, but they also sought to fulfil their dreams in Canada, the UK, Australia and Europe.
WWI lasted 4 years and 3 months. The US was only in it for one year and 7 months. It was not until after WWII that the US became a world military leader. It is only since the mid 20th Century that the US has been at the top, so to speak, economically and militarily. So, why Americans believe we have been the greatest nation on Earth for such a long time is beyond reason. But, in school, and certainly through Hollywood, we have been taught, programed if you will, to believe it, and told we created, invented, achieved so much more than any other nation on Earth. It simply isn't true.
Our government is strong and will last: it isn't about to crumble and it is in as good a shape as it ever was. There have always been problems; I don't think the current ones are worse than any others. The Republicans also shut down the government over the budget when Clinton was president. We have always had less than stunning results from our politicians, and the list goes on and on.
I think your post is analogous to the story of Chicken Little: the fact is, the sky is not falling. One of the great weaknesses Americans seem to have is the ability to put things into perspective. And I think needing to believe we are the biggest, the best, the greatest is silly. That's what Mohamed Ali used to say about himself. But even he didn't actually believe it: he did it to build up his steam, to pump himself up before a fight.
I don't think America has 'gone wrong.' I think it is changing and evolving. The British Empire once ruled about half the Earth's surface. Then bit by bit they lost it and became something less than a military and economic strength, but now they are both. From one extreme to the next, they were still in no way a failed nation. I'd like to see the US a less violent nation; I know you would all like a healthier economic climate, and that will come. But expecting to always be the best, and if you aren't you're a failure, that's just foolish.
As far as education, America is a very complex country, very large and very mult-cultural. Actually, literally comparing your education successes and failures to countries like Finland or Japan or Norway is ridiculous. They have far, far smaller homogenous populations: it is much easier to achieve success in education because of that. What America needs to do regarding education is not look to what Finland and other similar countries are doing, but look to what America could be doing. And, I am an extremely firm believer that improvement is not to be found in high scores on standarized testing.