Here's What You Need to Know: The U.S. is set to reach its "debt ceiling" on July 31.

On June 23, Treasury Secretary and former Federal Reserve Chair Janet Yellen urged Congress to extend what is commonly referred to as the debt ceiling. She warned that, if the deadline remained in place and was not met, the U.S. would default on its debt, and described the result of such a default as “absolutely catastrophic.”

In testimony to the Senate Appropriations Committee, Yellen argued that “defaulting on the national debt should be regarded as unthinkable,” underlining that the United States had never before defaulted on its obligations.

The U.S. national debt has now exceeded $28 trillion, owing in large part to massive deficit spending by the Trump and Biden administrations in response to the COVID-19 pandemic.

Government debt is largely issued through the sale of U.S. government bonds, which promise a low but reliable rate of return over an extended timeframe. On July 31, the United States is set to reach its “debt ceiling”; to issue more bonds (and hence more debt), it needs to pay down a portion of its existing debt first. Alternatively, the government could raise the debt ceiling, which does not increase spending but forces the government to make a larger repayment at a future date.

However, if the United States indicates that it is not prepared to pay its debts by July 31, it will “default” on them. Yellen suggested that the action of defaulting “would precipitate a financial crisis”; as the U.S. dollar is the world’s reserve currency, the effect of a default would significantly affect the world economy. The U.S. credit rating would decrease, affecting the government’s ability to sell bonds and borrow money in the future and leading to cash shortages. Yellen also noted that, if a default occurred, it would significantly complicate the recovery efforts from the COVID-19 pandemic, which has cost millions of Americans their livelihoods and savings.

Fortunately, Yellen’s words were well-received on Capitol Hill. Despite partisan disagreement in Congress, both parties have indicated an openness to raising the debt ceiling – although many Republicans have suggested that they would only approve a measure to do so if it came with spending cuts.

For their part, Democrats have reacted to such proposals with hostility, noting House and Senate Republicans’ willingness to spend without consequences during the Trump presidency. Some have also recalled a 2011 conflict between House Republicans and President Obama, which resulted in a minor stock market crash and the first-ever downgrade to U.S. credit.

This article first appeared earlier this month.

Image: Reuters