Essentially, the US debt ceiling is the maximum amount of money that the federal government is legally allowed to borrow in order to finance its operations. This limit is set by Congress and determines how much debt the government can accumulate.

It started back in 1917, when Congress created the debt limit, also known as the ceiling, to set a cap on the amount of federal debt that the U.S. government can rack up. The debt ceiling has been raised many times over the years to allow the government to continue borrowing money, but there have also been instances where Congress has failed to raise the debt ceiling, which has caused significant problems.

When the debt ceiling is reached, the US Treasury Department is unable to issue any more debt to pay for government programs and services. This means that the government is unable to borrow any additional money to meet its obligations, including payments to Social Security and Medicare beneficiaries, military personnel, and government contractors.

Fast forward to January 2023, and both the national debt and the debt ceiling stands at a whopping $31.4 trillion. Crazy, right? Since 2001, the government has been spending almost a trillion dollars more each year than it brings in from taxes and other revenue (I talk a lot about you can’t keep spending more than you earn, this is a serious problem for regular mums and dads and yet here is the US Govt doing exactly that). To make up for this shortfall, it’s had to keep borrowing money to pay for things that Congress has already approved.

The US debt ceiling problem is a contentious political issue, with some lawmakers arguing that the debt ceiling should be strictly limited in order to control government spending and borrowing (mainly Republican who control the House), while others argue that failing to raise the debt ceiling could have serious consequences for the economy and the country as a whole (mainly Democrats who are in power and also control the Senate). Short term the US would see higher unemployment and higher interest rates something we don’t want to see as inflation and interest rates are already too high.

Why is it a problem for Australia?

Well the simple fact is we follow America in so many ways and if their share market drops or rises we usually follow. The old expression, if America sneezes Australia catches a cold is very apt.

When the US economy is the biggest in the world, around a third bigger than China’s and is more than four times the size of the third largest economy in the world of Japan, the US defaulting would definitely have consequences around the world. So if the US does default, this would for example increase their unemployment and push up interest rates. It would also play a major possible disastrous effect on the US share market. Also nearly 60% of the world’s cash reserves are held in US dollars, and this default would cause a weaker dollar and weaken currencies around the world.

So locally, we have seen how the Reserve Bank has been trying so hard to reduce Inflation well this would just make their job that much harder and have serious consequences for people with mortgages for example.  If we also follow the US sharemarket as we normally do, we have only just started to see recovery signs from our own sharemarket these last few months and so this could have a major effect and undo this recovery.

So to finish off on a positive though, this is not the first time the US have reached their debt ceiling and I think it has been 7 times in last decade. So let’s hope some common sense prevails and the ceiling is either raised or another, but long term solution is you can’t have a Govt spending more than they earn by $1 trillion dollars every year and expect this to last.

Article by Marc Bineham – Money coach, speaker and award-winning author of The Money Sandwich