Before we dive into how all this could hit your wallet, here's a quick refresher course on the issue. Like every other country on Earth, America borrows money to pay for its services. But legally, there's a limit to how much money the federal government can borrow. Congress holds the purse strings: If more borrowing is needed, they have to approve it. Every time we've bumped up against that ceiling in the past, the legislative branch has simply increased the nation's credit limit.
Our problem right now is that the United States is only a few billion dollars from reaching its $14.294 trillion debt limit, and our elected officials aren't ready pick the simplest choice, the one that past Congresses have made. This time: There's debate. Should they raise the debt ceiling in order to borrow more money? Or do they hold the line and start either defaulting on our debts or stop paying for other government outlays -- military and civil service salaries, for example? Do they cut federal spending, and if so, to which programs? Or do they raise taxes?
Yes, our taxes are tied to the debt ceiling. As long as our country is under its debt limit, it can easily borrow money by selling Treasury bonds. As Stan Collender, a partner at Qorvis Communications, explains, "given that the government currently only raises taxes to cover 60% of what it spends, being able to borrow means that the services people depend on from the government continue." If America hits its debt ceiling, that option would be off the table. In such a scenario, the government would have to raise taxes to fund the shortfall, cut services, reduce its payroll, or do all three.
An Expensive Gamble on Many Levels
But individual Americans also will be directly affected by this when it comes to our own consumer debt. As noted before, America raises money by selling debt in the from of Treasury bonds, the government's version of an IOU. Someone -- you, me, China, my grandma, China, a college endowment, a hedge fund, China (yes, China buys a lot of them) -- purchases a T-bill, and the American government promises to redeem the bond at some later date, paying the buyer back with a bit of interest.
And what might make bond buyers edgy and demanding? The possibility that the government might default -- not pay all of its borrowers back -- which is precisely what could happen if we hit the debt ceiling.
So, America inches toward its debt limit, and bond rates start going up. The interest rates on our car loans, our mortgage loans, our student loans, and our credit cards, to name a few, are tied to bond rates. So if bond rates increase, the interest rates on our personal debt also goes up.
Beware of Falling Dollars
As if increased taxes and higher interest rates isn't bad enough, we could also see an increase in the cost of numerous everyday items, including gas, clothes, electronics, and anything else produced overseas. If the United States starts looking like it can't repay its debts, the value of the American dollar decreases. If the dollar weakens, foreign goods become more expensive.
This is, of course, all speculative at this point.
"We don't know what will happen because this hasn't happened before," says Collender. "But if the debt ceiling isn't raised and the government runs out of cash, at some point the president may decide he has to stop doing certain things, like paying government contractors, for example. That may not sound like such a big deal, but it is if someone in your family, or someone you know, is working for that contractor, or for the supplier of that contractor, or if that contractor is a big employer in your neighborhood or your state."
It also matters because all the parts of our economy are intricately intertwined, like a woven basket where each reed relies upon the next for support. Say the government postpones payments to a contractor. That contractor may decide to hold off on that new ad campaign it had planned to launch. Now, people working in the advertising industry, and maybe the newspapers and television channels that rely on advertising dollars, start to feel the pinch, and so those people decide to start saving more and spending less, in case the economy takes a downturn. Because consumers are now spending less money, stores start seeing a decrease in sales, and respond by reducing employees' hours or even engaging in outright layoffs. And it spirals downward from there.
None of this is very encouraging, which is all the more reason we need to stay alert to how our Congressional representatives handle the debt ceiling issue.
You can learn more about it at the government's TreasuryDirect website, which is surprisingly straightforward and even offers you the opportunity to "make a contribution to reduce the debt." Initially I thought that was funny, as it seems like such a mismatch to ask a single person to toss in a few bucks towards a multitrillion dollar debt. But then I realized it's not such a bad idea. After all, we have to start somewhere.
Loren Berlin is a columnist at DailyFinance.com. She can be reached at loren.berlin (at) teamaol.com. You can follow her on Twitter @LorenBerlin, and become a fan on Facebook.