Why federal debt matters to markets

As the world's largest issuer of debt, the United States' decision on the debt limit has an impact on investors at home and around the world.

What is the limit on federal debt? Why is there pressure to raise the debt limit? Who has authority over the debt limit? Why is the debt limit important to financial markets? How have financial markets reacted to the debt drama? What might Congress do next?

What is the limit on federal debt?

A recent document of the U.S. Treasury states: "The debt limit is the total amount of money that the government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments. The debt limit does not authorize new spending commitments. It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past."

In dollar terms, the debt limit is approximately $17 trillion. As the Congressional Budget Office puts it, "On May 19, the limit was reset to reflect cumulative borrowing through May 18; it now stands at $16.699 trillion.

On October 16, 2013, Congress took action to suspend the limit for about four months, until February 2014 giving the Treasury flexibility to pay the government's bills.

Why is there pressure to raise the debt limit?

Government spending continues to exceed revenues, which makes it necessary for the Treasury to borrow money to meet spending commitments. While the federal deficit is lower than in recent years, projections by the Congressional Budget Office show that spending, or outlays, will continue to outpace revenues in coming years.




Who has authority over the debt limit?

Article 1, Section 8 of the U.S. Constitution gives power over the debt to the U.S. Congress: "The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defense and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States; To borrow Money on the credit of the United States...."




Why is the debt limit important to financial markets?

With the world's largest economy, the United States is the largest debt issuer, and it has a long-established reputation for meeting its obligations.

"The United States has never defaulted on its obligations, and the U.S. dollar and Treasury securities are at the center of the international financial system. A default would be unprecedented and has the potential to be catastrophic: Credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 and worse."

Source: U.S. Treasury.


How have financial markets reacted to the debt drama?

The interest rate on short-term T-bills rose sharply in October, even more sharply than it rose in 2011.



What will Congress do?

Key dates for spending and debt