The Debt Ceiling
If you’ve had your eye on the news, both financial and political, you know the current hot issue is the debt ceiling. So what’s the big deal and what does this actually mean?
The U.S. needs cash:
The U.S. needs cash to pay it’s bills, just like anyone else. And the U.S. uses debt (in the form of bonds and treasuries bills, or T-bills) to fund many day to day expenses, like salaries and benefits for its employees. If you think the lines are long at the DMV or other government agency offices, imagine what happens if the U.S. government stops paying cash and only pays IOUs. Seems impossible? Ask any Californian about that possibility. If the U.S. can’t borrow cash, it won’t be able to make payroll (Any Dodgers fans out there???).
Why does the U.S. have to borrow money anyways??
Great question (wait, did I just compliment myself??). Think of the U.S. government like the guy in college that wants to buy an XBOX, but doesn’t get paid until next Friday. He wants that XBOX now. He will have the money, but not for a while (maybe it takes him two paychecks). So he goes to his roomate: You buy the XBOX now for $300, and I’ll give you $310 next Friday. That is debt funding, and that is what the U.S. government is doing. The money (taxes) is coming in, but we don’t have it all right now. This of course is a dangerous game. What if our college guy wants an XBOX, a date with the girl next door AND a new bike. Now we’re talking. he’s really borrowing against the future…but that’s a thought for next time.
So what happens if the U.S. can’t borrow money??
One of two things would happen to cause this: 1. No one agrees to lend the U.S. money or 2. The U.S. government doesn’t raise the debt ceiling (meaning our college kid can only borrow for the XBOX, nothing more). Well, in short…bad things happen at this point.
Payrolls are missed, but that’s a minor problem. The real problem happens when the U.S. doesn’t have the cash to pay interest on its debt (using debt to pay debt??? YEP! – I would not advise this by the way, you don’t have the ability to raise taxes like the government does). Just like any person, the U.S. has a credit rating.
The U.S. has a PERFECT credit rating. The U.S. debt is considered RISK FREE. Meaning, you don’t have to worry, the U.S. will pay you back. now if the U.S. misses payments, just like if you or I miss a car payment, the credit rating takes a hit. This is bad…very bad. A bad credit rating for the U.S. Government means:
- A hit to the economy. How can American companies trust that things are going to go well when the Gov isn’t doing well.
- Higher costs for the U.S. Ever borrowed money for a car? Good credit rating gets you a good interest rate…we don’t want to see what happens when the U.S. gets a bad interest rate…yikes
- High taxes needed to cover expenses
- Government cuts
- Trust me, this is BAD.
Andrew is a corporate finance consultant living in Los Angeles, specializing in distressed and bankrupt consulting. He helps clients review business plans and the general market and decide what steps to take next. He has a masters in finance.
Andrew enjoys running and biking in the San Gabriel mountains, cheering for the San Francisco Giants and eating (but trying not to gain weight).