EDIT: I'm probably not going to do the follow-up to this anymore considering it's all over and the motivation is gone.
Disclaimer: I do not profess to be an expert on the topic of the debt ceiling, however I have been able to spend the time to read quite a bit about it and the debate surrounding it. This is just an attempt to de-mystify some aspects of it.
With all the talk about the debt ceiling these days, it's easy to get confused. The deadline for raising the limit has been changed multiple times and both parties have seemed to swap their positions a couple of times. This is without even mentioning that the debt ceiling is a completely arbitrary limit that is unique to the United States. There has also been a lot of apocalyptic talk about the idea of not raising it, without anyone seeming to go too much into specifics. I'm going to try to sort all these out, and make this as simple as I can.
Until 1917 Congress had to approve each specific increase to the debt individually. At that point, because of the US involvement in WWI, Congress created 'caps' to different types of debt to make it easier to fund the war. Starting in 1939 Congress eliminated the need for separate caps, creating the debt ceiling we have today. The limit was originally only $45 billion dollars, however over the years it has been raised over 100 times, including 7 times during President Bush's time in office. The current ceiling is set at $14.25 trillion dollars. This is a completely arbitrary limit which is why we have been able to raise it so many times, and can still in the future.
The current deadline for raising the limit has changed multiple times essentially because of procrastination by congress and credit rating companies giving the US the benefit of the doubt. The original deadline was calculated to be the end of March. It was then moved because we hadn't hit the ceiling yet. We actually hit the ceiling in May, though the Treasury was able to cease certain 'low priority' spending to make room for paying other bills. It was around this time that the deadline of August 2nd was made, and they have kept to that deadline since. The 2nd is the day when the Treasury will start having to play triage with our spending, deciding which of our interest payments, social security, medicare/medicaid, and defense spending to stop paying. Ceasing payment on any one of these things will have immediate and possibly devastating effects that I will get to in a moment. Recognizing the implications of passing that day without having a deal, the credit rating agencies have made it known that if we don't have a deal by then, they will lower the credit rating of US debt.
If the credit rating of US debt is lowered the effects will likely be intense and far spread. This is because of the current rating the US debt holds, and the historic attitudes surrounding the debt. The US has never before defaulted on its debt, leading to it being considered the most secure investment there is. It's considered so secure that it is often referred to as the 'risk-less rate of return'. Because of this almost all other forms of debt are tied to the US debt. When the interest rate on the US debt rises, so do interest rates on almost everything else. This has the potential to severely effect the ability to borrow for everyone. It also has global implications. Brazilian loans are tied to US debt, and a default here would negatively impact those loans. China, who holds $1.5 trillion of US debt would be catastrophically impacted should the US default, potentially losing the entire value of that debt.
All of that isn't even mentioning that the entire cause of the latest recession was the realization that sub-prime mortgage backed securities were not as safe as had been assumed. This lead to a reassessment of portfolios that took the economy in a downward spiral. A downgrade in the rating of US debt could lead to the same type of reassessment that was around the sub-prime mortgage backed securities. Given the ubiquity of US debt, due to its image as completely secure, the subsequent upheaval in the market could lead to not only a recession, but potentially a full fledged depression.
Let's recap at this point. The debt limit is an arbitrary limit currently set at $14.25 trillion. It has been raised over 100 times without much incident. August 2nd is a real deadline that has real consequences if it is not met. Up through this point US debt has been considered the safest investment, leading to it's widespread use. Almost all interest rates are tied to US debt. If the US defaults, its interest rate will rise, causing all interest rates to rise, reducing the ability to borrow. There are global consequences as most countries own US debt that could potentially become worthless if we default. Taking into account similarities in the sub-prime mortgage caused recession and the current crisis, it is not unreasonable to assume that a default would cause another recession or possibly even a depression.
I'll leave it at this for now and will try to follow up with an analysis of the political aspects of the debt limit debate in the next couple of days. Hopefully I won't have to if a deal is reached, though I remain pessimistic at this point. If you have any questions/corrections at this point I'd be glad to respond.
For more reading:
Wikipedia - United States Debt
Washington Post - Beyond a Default: Catastrophic Calculations
