The US Debt Ceiling: What Are the Dangers?

Last week its more than likely that you have seen at least one article about the US Debt ceiling crisis, but what does it all mean? Do you need to be worried? Also, what actions are currently in place to avoid an economic disaster?

The United States debt ceiling is a set limit on the amount of debt that the US government can issue. US accumulates debt by issuing Treasury bills, notes, bonds, and US saving bonds. The United States operates on a national deficit year on year, spending more money than it brings in. The current debt ceiling limit of the US is at $31.4tn.

If the US does not raise the debt ceiling before it is reached the potential repercussions could include a downgrade of US Treasury securities by credit agencies, in turn increasing borrowing costs for businesses and individuals, as well as a drop in confidence in the eyes of investors. If you were to tally up these potential outcomes it would trigger an immediate recession in the US which could gradually trickle down to economies around the globe.

The fear of potential default would increase market volatility, meaning sudden fluctuations in stock prices, currency exchange rates, and commodity prices. Throughout history US Treasury bonds were and are considered some of the safest investments one can make, if a default was to happen investors would lose confidence in US government’s ability to manage its finances.

Higher borrowing costs would also be imminent as the risk perception associated with a potential default or credit rating downgrade would prompt lenders to ask for higher interest rates to hedge against increased risks.

Cash flow issues could also easily cause disruptions in supply chains, as US would be forced to cut spending immediately, in turn delaying payments to contractors and suppliers.

In extreme scenarios, if the debt ceiling is not raised in time, a default on US government obligations would have severe consequences for global financial markets once again causing a world-wide economic recession.

To end on a brighter note, it seems that Washington has reached a potential deal to raise the debt ceiling and cut government spending, but it is not yet passed. We can only hope that the agreement will come to fruition before 5^th of June, which is the presumed date that the US Treasury runs out of money.