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How the Debt Ceiling Works

        Money | Economic Concepts

What Happens If Congress Doesn't Raise the Debt Ceiling?

To understand what would happen if the U.S. Congress didn't raise the debt ceiling, let's go back to the credit card analogy. If you borrow the maximum $10,000 allowed by your credit card, you will need to do everything in your power to avoid going into default, which would ruin your credit rating. You can try to drastically cut your personal spending, get a second or third job to increase revenue, or borrow the money from someplace else, probably at a higher interest rate.

If Congress decides not to raise the debt ceiling, the federal government runs the same risk of going into default and damaging its credit rating. Up until now, the world has treated the U.S. Treasury like an international piggy bank, the safest place to invest money during an era of global economic uncertainty. When a foreign government needs cash, it can simply redeem a few million dollars in U.S. Treasury bonds.

But what if the Treasury doesn't have enough money to back its bonds? At worst, it could default on some of its debts, which could send global markets into a panic. But even if the government avoids a full default, it could lose its AAA credit rating. That means that creditors could demand higher interest rates. When the base interest rate on Treasury bonds goes up, other interest rates are likely to follow, like those attached to home mortgages or business loans [source: Davidson]. Higher rates would discourage investment, creating a huge drag on economic growth in the U.S.

Also, if Congress opted not to raise the debt ceiling, it would be forced to live within a budget. That would likely mean deep, across-the-board spending cuts and massive scale downs of popular programs like Social Security and Medicare. It would also likely mean raising taxes significantly.

Until those spending cuts and tax hikes took effect, the Treasury would have to decide which bills to pay first with its dwindling funds: interest on the national debt or Social Security payments? Tax refunds or Medicare reimbursements? All of these scenarios would likely trigger a massive political backlash from voters in both parties.

That's our brief explanation of how the debt ceiling has evolved from a convenient instrument for managing government borrowing into a political powder keg. For lots more information on the national debt, personal budgeting and credit cards, check out the related links on the next page.


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