EXPLAINED: What's US debt ceiling & why is it such a big deal?

The US has hit its borrowing limit, also known as the debt ceiling, fueling fears of putting global markets in instability and setting off a budgetary battle in Congress. The looming debt ceiling crisis unsettles investors, as any default will have a major impact on the international financial markets.

So, what exactly is the debt ceiling, or borrowing cap, and why is it such a big deal?

What is a debt ceiling?

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The debt ceiling determines how much money the US government can borrow for its expenses. After the borrowing cap is reached, the Treasury Department is not permitted to raise money for the government by issuing further bills, bonds, or notes. In this situation, the only source of funding for the country is tax revenues. Currently, the cap on the US government borrowing equates to around 120 per cent of the nation's yearly economic output.

Where is the borrowed money used?

US Congress determines the borrowing limit presently set at $31.4 trillion. The Federal government uses borrowed money to help pay for costs included in its budgets, such as social security and Medicare payouts and the salaries of US military and government workers.

How long can the US government survive?

Janet Yellen, the US Treasury Secretary, stated last week that the government could only pay its payments through early June if the debt ceiling is not increased. Yellen said that "extraordinary measures" are now being used to stop the United States from going into default on its financial expenses. However, Yellen's estimate for the "drop-dead date" is earlier than some experts had predicted for the US to exhaust its borrowing limit.

Indeed, many experts believe the US could reach its debt ceiling in the third or fourth quarter. According to Jonathan Cohn, Head of Rates Trading Strategy at Credit Suisse in New York, the debt ceiling may be hit between September and early November. Goldman Sachs expects the US government to run out of money anytime between August and October.

Can the US then raise the debt ceiling?

The borrowing cap has to be raised, so the US government continues to make its payments due and prevent a default. The political situation, though, is not favourable. Republicans run the House of Representatives, while Democrats have a majority in the Senate. Congress is reluctant to raise the debt ceiling because it might provide Republicans with leverage when negotiating spending cuts.

Democrats vs Republicans:

In a conversation with Fox News, newly appointed US House Speaker Kevin McCarthy said one could not just keep increasing the debt ceiling. "Let's sit down and change our behaviour for the good of America. Because what we're going to do is bankrupt this country and these entitlements if we don't change their behaviour today." On the contrary, White House press secretary, Karine Jean-Pierre, said the administration would not be negotiating. If the debt ceiling is to be raised, it should be done without any conditions.

What if the debt ceiling is not raised?

If the US government cannot borrow more money, it will put existing Federal programs at risk. Investors will get jittery if the verbal battle is not resolved and no further action is taken to address the situation. The US dollar may also lose its global appeal if the Federal government defaults on its loan and interest payments. That, in turn, would weaken the greenback, hurt US financial markets and weigh on the economy, including job losses and activity gloom.

2011 political deadlock over the debt ceiling:

The United States was on the verge of default in 2011 due to political deadlock in Washington over the debt ceiling. That crashed US stocks and cost the nation its top-tier AAA credit rating from Standard & Poor. According to a research report from Goldman Sachs, the S&P 500 plummeted 15 per cent during the 2011 crisis, while the stock of those firms with the highest sales exposure to US federal spending fell by a quarter.