US hits the debt ceiling: What it is and what will happen if it isn’t raised

What is the debt limit and why does it matter?

The debt limit is the total amount of money that the US government is authorized to borrow from the treasury to meet its existing legal obligations, such as military salaries, interests on the national debt, tax refunds, and Social Security and Medicare benefits. As of last Thursday, the US hit its $31.4 debt ceiling, forcing the treasury to take measures to allow the government to keep paying its legal obligations such as its debts, Social Security payments, Medicare and Medicaid billing, and others. This is particularly concerning, given that according to U.S. Treasury Secretary Janet Yelle, the US government is expected to run out of money for its obligations in mid-June, after which the US would be in danger of defaulting on its debt that it currently refinances through treasury money. Therefore, it is imperative that congress raises the debt ceiling, given that federal spending is not only used to finance mandatory programs that people depend on (i.e social security, federal retirement programs) but is also a portion of the overall US economy.

How would a potential default affect financial markets?

The U.S. defaulting on its debt could threaten the value of the U.S. dollar, which has the potential to threaten the value of bonds and equities. Currently the US dollar is known as the world’s reserve currency, thanks to the US government’s reputation of always paying off its debts. Relating to bonds, a default can cause investors to lose confidence in the U.S’s ability to pay its bonds, which has historically been viewed as a safe investment. This can cause some investors to pursue international equities and foreign government bonds, which can have a negative impact on the US economy because of less US investment. Although such a situation has never happened, a similar standoff occurred in 2011 over the debt ceiling, which downgraded the U.S. credit rating for the first time and where there was a huge push to sell off stocks. Because a similar situation has occurred once, it is possible to expect a worse outcome if the US government were to default on its debt. Therefore, both parties in congress should work to raise the debt ceiling to a level where the federal government can pay off its obligations at least until the next appropriations process.