What you need to know about the debt-ceiling crisis

Debt talks are down to the wire. Do this with your money, now.

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Debt talks are down to the wire.  Do this with your money now, says The Motley Fool.

Apple now has more cash than the U.S. Treasury. As of Wednesday last week, the U.S. government had an operating balance of $73.7 billion. Apple has $76 billion in the bank.

Laugh at that, feel free to shed a tear, and now here's the latest on the debt-ceiling debacle.

U.S. on the financial brink, says Bloomberg.

Gold falls 1 percent as U.S. close to debt deal, says Reuters.

Senate chaplain's prayers convey crisis, says The Washington Post.

U.S. debt talks have come down to the wire. As of writing, the debt-ceiling deadline clock has ticked down to 1 day, 15 hours, 18 minutes and 54 seconds.


What is the debt ceiling? It's a self-imposed limit on the U.S. Treasury's ability to borrow. Reaching the debt ceiling does not mean the U.S. is bankrupt. This is a purely self-inflicted crisis.

Importantly, raising the debt ceiling is not merely about making room for future spending. It's about Congress deciding whether it wants to pay for the laws Congress has already passed and is committed to. The ceiling has been raised 87 times since 1945, almost always without fanfare.

What happens to the government if the ceiling isn't raised? The Treasury says it will run out of cash on Tuesday. Others think higher-than-expected tax receipts could extend that by a few days. President Obama has indicated he's open to extending the debt ceiling for a few days if more time is needed to hammer out a last-minute deal.

If the Treasury does indeed run out of cash, someone won't get paid. Whether that ends up being bondholders who are owed interest — meaning defaulting on their debt — is unknown.

Money flows into the Treasury in lumpy amounts that can fluctuate wildly from month to month. It isn't a lack of annual revenue, but a cash-flow problem, that could cause the Treasury to default.

Bottom line: No one really knows what will happen. We've never before faced this problem.

The trillion dollar question

What happens to markets if the ceiling isn't raised? That's the trillion-dollar question. In an actual default, there would undoubtedly be some degree of panic, particularly in the banking sector (think September 2008).

Banks and money-market funds that rely on Treasury bonds as bedrock assets would be thrown into disarray. The financial system is held together by confidence. Losing it is not something you want to play with.

But the odds of default are low. More likely is a credit downgrade from one of the major rating agencies if a deal to raise the debt ceiling doesn't also significantly cut future deficits.

This would probably push the nation's credit score from AAA (perfect) to AA (still good). All major rating agencies have the U.S. on "negative" credit watch, meaning a downgrade could happen in the near future. Historically, countries are downgraded 56% of the time they find themselves on negative watch.

No catastrophe

A downgrade wouldn't be catastrophic, but it shouldn't be taken lightly. In general, an AA-rated nation pays more to borrow money than an AAA-rated nation — interest rates are higher by 0.7%, on average. A rise of that magnitude could hammer the stock market and increase the cost of mortgages, credit cards, and other forms of borrowing.

A 0.7% rise in interest rates would add $100 billion a year to federal borrowing costs and could slow economic growth by around 1% a year. As a rule of thumb, that could cost roughly 1 million jobs.

Don't panic – this too will pass

What should you do with your money? Probably nothing. There's never a good time to panic, and decisions made during emotional upheavals are usually regrettable.

Come Wednesday morning, if the debt-ceiling isn't lifted, are companies like Rio Tinto (ASX: RIO), Fortescue Metals (ASX: FMG), Crown (ASX: CWN), Orica (ASX: ORI), Campbell Brothers (ASX: CPB) and Treasury Wine Estates (ASX: TWE) going to suddenly be worth substantially less than they are today?

If you were happy with your portfolio last week, you should be happy with it next week. This, too, will pass.

More reading:

Free report: Read this before the market crashes

Motley Fool staff and contractors may have positions in any stocks mentioned above, and this can change at any time. More is revealed in The Motley Fool's disclosure policy.

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