The US government is on pace to run a record $1.5 trillion deficit this year. Everyone agrees that such a huge deficit is not good for US. S&P lowered the long-term outlook for US government to “Negative” from “Stable”, as it feels that there is a 30% chance that S&P may have to downgrade the rating on the debt in next two years.
What this means is that, if the political parties cannot agree and take action on reducing the debt, there is a strong chance that US Treasury bonds will not be the safest investment as it is today. This could severely impact the US dominance over the world and some experts claim that US may be classified as “third world country”.
The Treasury indicates that the government will run over the deficit ceiling before May 16th (which is when the ceiling expires). If it’s allowed to expire and the deficit runs over, an unprecedented event would pan out: US government would be in default (since US government would be legally prohibited from incurring any debt). Geithner indicates that by taking various accounting measures, the default could be avoided for couple of months, but eventual consequences could be severe. Besides the currency losing value, increasing interest rates (due to risk of default), Government cannot spend money on any agencies (as the priority could be to serve the debt first) and government could shutdown.
You might think, what’s the big deal this time? The government can simply raise the ceiling to avoid that embarrassing situation, and yes, the government has done that 74 times since 1962 (ten times in last decade). However, in this “age of austerity” and with the power divided within the senate and representatives, it is unlikely that Republicans will authorize an increase in the ceiling without significant Democratic concessions. Republicans blame the Democrats for being reckless in increasing the debt ceiling last few times. A majority of polled Americans also oppose raising the ceiling.