Debt Limit Simplified (I Hope)

People tell me I have a knack for explaining things so they're understandable. Maybe I can help make recent events clearer.

For the last couple months, the mainstream and financial media talked about the potential collapse of the US as we know it unless Congress raised the debt limit, yada, yada, bankrupt, default, yada, yada.

Let's break down the three key concepts

Internal Debt Limit
External Debt Limit
Default

to a level we all understand, Joe Sixpack's family: Dad, mom, and 2.5 children.

Let's say this family (the gubmint) has excellent credit (aaa+), watches its bills, always pays on time.

Because they watch their money and want to avoid trouble, they've agreed among themselves to not borrow any more than $100,000. This is their Internal Debt Limit, and is the same "debt limit" Congress has to deal with.

The family can see that because of a seasonal layoff, they're spending money faster than it's coming in, and owe $95,000. Within another two months, they'll owe their agreed $100,000 limit. This is like the gubmint hitting their limit 8/2.

So the family agrees that things will improve, and they can afford to continue to pay on time (gubmint version--we can print more money) if they owe up to $120,000, so they agree to raise the Internal Debt Limit, just as the gubmint did, and we all knew they would. No big deal, just the family agreeing to a budget.

Since the family has excellent credit (can print money everyone accepts), they simply accept the next $20,000 home equity or cc offer that looks good, and they're set for another 8 months, at which time they have to address the new debt limit (and hopefully, will be back to where they're paying debt down again).

Now what about External Debt Limit? Simply, this has got nothing to do with the Internal Debt Limit, tho commentators acted like it did.

External Debt Limit is the debt limit imposed upon the family from outside. It's like the credit limit on a card. If our family wanted to raise their Internal Debt Limit to $120,000 but had bad credit, they would be stopped at $100,000 by the External Debt Limit, or could only get more credit by paying much higher interest rates.

The gubmint version of this is creditors (mainly foreign gubmints like China, or big investors) simply refuse to buy new bond issues, or will only buy at much higher returns (interest). This will happen when buyers get fed up with the foolishness in DC, but is unrelated to the debt ceiling nonsense.

Default is another concept. On the family level, you don't pay the cc minimum or mortgage when it's due. On the gubmint level, they don't pay interest or principle on bonds. If the gubmint didn't raise the debt level, they could not borrow new money to meet those payments. Of course, there is money coming in all the time, and they would cut back wherever possible to avoid default.

Both family and gubmint want to avoid default, because it can mean foreclosure or only being able to borrow at much higher interest rates.

hth.