The U.S. Maxes Out Its Credit Card – Does Collapse Loom?

Another week and another fiscal mess in Washington: This time it’s about our astronomical debt. If you haven’t been keeping up, it’s a pretty intense discussion. So, what is the “debt ceiling” and how does it work?

The best way to think about the “debt ceiling” is seeing it in terms of America’s credit card. Take for example the following illustration: If you own a credit card, most likely you have a credit limit of say, $1000, $3000 or $4000. Well, the U.S.government also has a borrowing limit of about $14 trillion – a heck of a lot of money for any country to owe.

Day of reckoning for America?

With a tremendous amount of recent spending over the years, the U.S.government has finally reached its credit limit, or the inability to borrow.  Since the United Statesspends approximately $120 billion dollars more than it takes in every month, it’s desperate to find that money from some other place. But where? Well, for the most part, the Chinese. They have been buying up U.S.debt at an alarming rate. But none of that would be possible if the debt was not authorized in the first place, hence the debt ceiling.

With a crisis that has been coming to a head for years, no doubt will there be an immediate clash of the ideological titans to get out of this mess. On one ideological side, advocates for deeper spending cuts are trying to force the president to cut entitlement programs like Medicare; and on the other side they are pushing to raise taxes to pay for the whole mess. If there is a compromise, it will have to be met in the middle, which is probably what most Americans would do.

Consider the following brief illustration

If the average American family were caught up in the same “credit” mess one would think that a little of both strategies would be in order. In other words, cut spending, reduce borrowing, and get a second job to bring in more real income.

This may seem reasonable to you and me, but politics is often about winning and creating losers in every deal and since nobody wants to come out looking like a loser, compromise will be hard to reach. This political stalemate creates even more problems in the future. In years past most sessions of congress usually kicked the problem downstream. Well, now, there is very little “stream” left since the debt is so large. In other words, the party is over.

Remember, we have been here before, but what’s the difference with the debt ceiling this time? Well, after the prolonged wars and a stimulus package, the number of dollars has never been bigger.

What’s the danger if we do or if we don’t increase the debt limit?

Ironically, some experts believe that there isn’t going to be much difference unless we take the steps to solve this problem in the long term. This is because the markets, despite how technical and real they are, are actually built on one unquantifiable thing: trust.

The slogan on our dollar, In God We Trust, isn’t too far off. Yes, we may trust in God. But giving up trust in the dollar by those who lend to the U.S.government may be a devastating notion. 

What it means to raise the debt limit

If the U.S.government takes steps to raise the debt limit so that it can keep borrowing more cash, soon the markets will lose confidence that the U.S.government would be able to repay their debt. In other words, let’s say this congress and president does what every other congress has done and kick the burden up the road, markets would calculate that the U.S.would in no way be able to pay up in the future.

On the other hand, if we don’t raise the debt ceiling, the markets would much more quickly lose their confidence (AKA trust) it has in the marketplace, in which case you will find a dramatic increase in the interest rates by which we borrow from.

So, is there room to budge?

President Obama has stated that he will veto anything that does not have a longer term solution to the problem. Well, the bipartisan in the Senate just have the right balance of spending cuts and tax increases to bump up revenue.

The seriousness of the issue has Republicans and Democrats both at odds with themselves. Tea Party activists versus old school Republicans; with the Democrats you have liberals versus social conservatives.

It’s going to be a fight with a lot at stake. You can be sure, that we will be watching what develops.