What is the US debt ceiling and how would a default affect the global economy?

Disastrous scenario of US unable to fulfil payment obligations would have profound effects around the world

Failure to reach a deal in time could have disastrous effects across the entire global financial system. Reuters

With a potential debt default days away, the White House and Republicans remain locked in negotiations.

Failure to reach a deal in time could have disastrous effects across the entire global financial system.

President Joe Biden said he and House Speaker Kevin McCarthy still remain at odds over the budget, which has caused negotiations to stall.

The brinkmanship is already having effects on the economy, with credit agency Fitch putting America's AAA rating on negative credit watch.

"A default could cause widespread suffering as Americans lose the income that they need to get by. And the resulting income shock could lead to a recession that destroys many American jobs and businesses," Treasury Secretary Janet Yellen said.

Here is what you need to know:

What is the debt ceiling?

The debt ceiling – also known as the debt limit – is the total amount of debt the Treasury Department can borrow to meet its financial obligations.

Among those obligations are Social Security payments, interest on the national debt, tax refunds, military salaries and more.

The US hit its current debt limit of $31 trillion in January. The Treasury at the time announced it would take extraordinary measures to fulfil the government's obligations.

Lifting the debt ceiling does not authorise new spending, but rather allows the US to spend on programmes that had already been approved by previous administrations and sessions of Congress.

When is the 'X Date'?

The X Date is the day the US will be unable to fulfil its financial obligations.

Ms Yellen, who previously said was "impossible to predict the certainty" the exact date on which that will happen, has given the White House and Congress a "hard deadline" of June 1 to raise the ceiling.

The Treasury Secretary now says "the odds of reaching June 15, while being able to pay all of our bills, is quite low”.

What happens if the US defaults on its debt?

In a word: catastrophe.

The US government would be unable to direct payments to members of the military or people who rely on Social Security. Interest rates would soar, leading to increased payments on mortgages, car loans and credit cards.

It would almost certainly tip the US into a recession, with high unemployment. Even in the short term, a default would cease one tenth of US economic activity and cost two million positions, separate analyses from Goldman Sachs and Moody's show.

White House economists estimated that a default would cost eight million jobs and the stock market would plunge 45 per cent.

The US credit rating would also most likely be downgraded.

The global economy, too, would suffer in the event of a US debt default.

A separate Moody's report found that emerging economies will suffer from the stalled negotiations, with commodity exporters in the Middle East, Africa and Latin America suffering the most due to tightening credit conditions.

A default wound also undermine the strength of the US dollar. Sixty per cent of the world's foreign reserves are in the American currency, but investors could lose confidence in Treasury securities.

With the US dollar weakened in this scenario, it would open the door for another currency to challenge it as the world's reserve.

Should the nation's currency weaken, it would make payments more expensive for low-income countries struggling with debt.

Global trading would also decline in the event of a recession as consumers look to limit the amount of goods they purchase, hurting economies that rely on exports.

Fragile economies would also be at risk of falling into a recession.