As the Obama administration's early August debt-deadline continues to approach, it has become near impossible to ignore all the coverage and chatter about the looming U.S. debt crisis. Headlines have been dominated by the constantly shifting story, while those with interests in the stock market have been nervously monitoring their assets.
Doomsayers have called it potentially one of the largest financial crises in history, while lawmakers have insisted the American government, with the "too big to fail" mentality, will not default. But amidst all the financial and political talk, the very basics of the issue can often be lost.
To understand what the debt crisis means, it's important to understand where the problem actually started. The debt crisis in the U.S. certainly didn't happen overnight. Technically the American government has held some sort of public debt since its inception in the late 1700s. The American government has been building up this significant debt since before 1980 and the Ronald Reagan years. Deficit spending from several American wars overseas combined with numerous economic downturns have all contributed to the growing debt.
Since then several extra expenditures like the Gulf War, nation-wide tax cuts and the wars in Afghanistan and Iraq have helped push the American government further into debt. With the debt now approaching $14.3 trillion, the Americans have reached what is known as their "debt ceiling." In other words, the government has pushed its debt as far as current legislation will allow.
So what does all this mean?
Most pressingly, the American government is in danger of running out of money, meaning they will no longer be able to pay their social obligations. This includes funding for government-sponsored programs like Medicare, Social Services and the U.S. defence services.
There is debate about when this will actually happen. The Obama administration says they'll run out of money by Aug. 3, while other estimates peg the date closer to Aug. 10. Essentially, when these dates come to pass, the American treasury will no longer have the money to pay its bills without borrowing more cash.
If the Republicans and Democrats are unable to come to terms and borrow more money, this situation means the Americans will have to default on their payments, damaging their "AAA" credit rating in international markets. It also means interest rates are likely to rise nationwide as a byproduct. A secondary effect will be on the international markets, where losses and financial uncertainty in the U.S. have the potential to spread globally.
Essentially this situation can be compared to maxing a credit card. You can only borrow so much before you're cut off, unless of course, you apply to have your credit limit increased. Sticking with this example, if you fail to pay your bill in time, you are likely to face interest and a weakened credit rating.The Obama administration and American people now find themselves facing a similar dilemma, only on a much larger and more intricate scale.
So who does the American government borrow all this cash from?
The money comes from all over, including a significant amount from the American people, who own debt through pension plans, the Social Security Trust Fund, Treasury securities and mutual funds. Much of the debt is also held by public companies and institutions. A significant portion of the money has been borrowed from foreign countries around the world like Japan and Brazil.
China is also a major holder of American debt, along with some of the world's richest oil-exporting companies who also hold cash or security positions in U.S. debt. Some of the debt is also held within the federal reserve system, which includes both long and short-term Treasury bills and collateral for U.S. cash.
So what's next?
This is not the first time the U.S. has had to increase their debt ceiling. As a matter of fact, Congress has raised or...
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