Yesterday, I told you a story about Sam’s debt problem to explain what is US Debt Ceiling. The story continues here.

When the debt ceiling is going to be reached, the “poor” and “moody” agency who used to rate Sam’s debt to be the best qualify, now tells you that Sam’s debt is not so good after all.

To your horror, you just find out that this “poor” and “moody” agency used to give the same AAA rating for some CDO debt which was eventually defaulted.

So now is Sam going to default his debt for the first time in the history?

Luckily, because Sam owes money to so many people, he is a very influential person. He even has the power to change the law to raise the ceiling so he can borrow more. In fact, he has already done it many times in the past. Look at the historical chart below.

US Debt Ceiling History

Now you feel much relieved right?

The story continues…

It always does not matter until it matters.

For months, people were talking about Euro Debt Crisis, Suddenly, you heard that US is going to reach its US$14.3 Trillion debt ceiling by 2 Aug. Today’s Straits Times prime news headline is “Markets spooked, gold shines on US debt fears”, “Greenback falls to record low against Singdollar and yen”.

So what is debt ceiling? Why is it so important?

What is Debt Ceiling

The debt ceiling is a US statutory limit on the amount of U.S federal debt held by the public and the government’s own accounts. The debt ceiling became law with the Second Liberty Bond Act of 1917, which helped finance the United States’ entry into World War I.

Imagine that you have a good friend, Sam, who always borrow money from you because occasionally, he has some “cash flow problem” running his business, but he always pay you back on time, with full interest for the past 20 years. Because his credibility is so good, you have lent more and more money to him over the years, but never care how his run his business. Sam was even accredited by some “poor” agency as the best person you can lend money to in this world.

One day, you discovered that Sam’s business was in fact very bad for years. The money which was return to you was borrowed from many other creditors like you.

This is not so bad, after all, as long as he continues to serve his interest and pays you back when the loan matures.

However this morning you read the newspaper, you find out that Sam has borrowed to the maximum loan amount stipulated by law. That means he cannot borrow money from others and pay you any more! he is going to default his debt, which is your money!

Now, do you start to feel worried?

The story continues…