What is the US debt ceiling and why does it matter?

View from the dealing floor.

Chris Tripp works on IG’s dealing floor in London. For more information about financial spread betting and CFDs visit: www.ig.com/uk

‘Obamacare’– titled the Patient Protection and Affordable Care Act, is a piece of legislation which was written into US law back in 2010. It is currently in the centre of a US government stand-off which has led to a two-week-long shut down and the threat of the US reaching its debt ceiling. Without a resolution seeming close, the debt ceiling is expected to be met on October 17 leaving the US Government with around $30 billion to pay daily liabilities in excess of $60 billion.

Obamacare was partially introduced last week with exchanges being launched allowing US Citizens to compare and buy health insurance deals online. One exchange in New York reported 30 million hits in just 48 hours. Other features of Obamacare include tax rises, insurance companies being banned from rejecting healthcare to individuals based on previous health conditions and eligibility for Medicaid being extended to provide healthcare for individuals on low incomes.

The recent stand-off has come to light with Republicans deeply disagreeing with the policies outlined in Obamacare, with some states successfully taking it through the Supreme Court. The Republicans believe that the introduction of these policies will increase taxes by over $520 million and increase US government debt by around $500 million.

The biggest question being asked by investors is ‘What if the US government reaches the debt ceiling without a resolution in place?’ The US’s biggest foreign creditors, China and Japan have already expressed their fears, as any default on their bond holdings could have detrimental impacts to financial markets globally. The US dollar is regarded as the world’s reserve currency, however a default could jeopardize this status as these bond holders shift their assets and cause a subsequent rise in interest rates.

If a default were to occur you would expect to see a widespread sell-off in financial markets globally. Takatoshi Ito, the head of an expert panel advising Japan’s Government Pension Investment Fund, has said that ‘a default would be worse than the blow to the global economy from the collapse of Lehman Brothers in 2008’. In November 2008 the Dow reached a low of around 7507.

It won’t only be the Dow impacted by a default; you would expect most major indices to decline and likely to see the dollar tumbling across the board. The impact speaks for itself, and while a lot of analysts and investors are banking on a deal being reached before the deadline, the potential is there for the stalemate to lead to no deal being reached and disarray in the financial markets.

For the time being, it is safe to say that all eyes are firmly fixed across the pond.

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