US debt crisis - an easy explanation

The long term implications of the debt debacle in the United States involves understanding a lot of "d" words.

The US government runs a budget deficit because each year it spends more than it raises in tax revenue. To fund this deficit, it must go into debt. Simply put - like an owner of a credit card who cannot make a monthly payment and is asking for a raise of the maximum debt of the credit card so that they can use that credit card to make the monthly payment.

Congress imposes a limit on how much the government can borrow. If Congress had refused to increase the debt ceiling, the US government would have not been able pay its bills and would most likely default on its interest payments on debt. This would provoke a downgrade of the nation's AAA credit rating by rating agencies, which would almost certainly lead to a loss of business confidence and potentially a double-dip recession in the US.

US National spending:

U.S. income: $ 2,170,000,000,000
Federal budget: $ 3,820,000,000,000
New debt: $ 1,650,000,000,000
National debt: $ 14,271,000,000,000

For many decades, the safest place for investors to park their money has been US Treasury bonds. Bonds are just contracts which stipulate that, in return for an investor's money, a borrower, such as the US government will pay a rate of return each year - a "yield" - and eventually give the original sum of money back at some agreed point in the future.

Investors have valued the stability offered by these US Treasury bonds. Defaulting on these payments could have seen investors losing faith in the US markets, withdrawing their funds or refusing to lend the US anything but at exorbitant rates. Businesses the world over would be starved of funds to do the things they want to do, including employing the workers they need to do it. Economies would shrink, unemployment would skyrocket.

To resolve this predicament, the solution was for the US to raise their debt ceiling, however this cannot go on forever and will need to stop. So, in a last minute "political peacock carnival," the U.S. President signed the bill for the U.S. debt crisis to came to an end.

What is the immediate effect of the deal?

It grants a $400bn increase in the government's debt ceiling to stave off the threat of default, with an additional $500bn increase available from February to be effective on the president's authority. From the start of the government's 2012 fiscal year on 1 October, savings of $21bn are to be made through limits on spending. After that, caps on federal spending are to save an estimated $917bn over 10 years by slowing the speed of increases. Further cuts are to be identified by a bipartisan "super committee".

Rating agencies Moody's and Fitch announced that the United States would maintain their AAA sovereign credit rating, but the possibility of altering still exists in the future.

What this all means to you

To panic during times of market volatility is the worst thing you can do as one cannot time the market. The reality is that it's during turbulent economic times when the most money is made. Silke Financial Services is firmly of the view that when the share prices of good sustainable companies with good earnings drop, it presents astute fund managers with a golden opportunity to buy these shares at discounted values, which in the long-term can only benefit the investor. Apart from good dividend growth, there is no other way to achieve inflation-beating growth. So in the end, we like 'wobbly' markets as it provides opportunities for investment growth over the medium to longer term.

It is essential to always align your investments with your time horizons

• For long-term goals we consider long-term, growth-oriented investments like general equity unit trusts. With this long-term view there is no need to 'time the market' and take profits at exceptionally high market levels. The longer your investment time horizon the greater you can afford exposure to equity funds. Don't make the mistake of disinvesting if you are a long-term investor. While risk sounds like something to avoid, there can be an upside - greater risk may offer the opportunity for greater rewards over the long term.
• Balanced Funds are actively managed and ideal for time horizons of 5 to 7 years and generally have lower equity exposure compared to funds with full equity exposure.
• Your short-term goals call for investments that are more conservative, and more accessible. For example, if you're investing to save for a deposit on a home, you'll want quick and easy access to your funds and you will not want to take on any major risk.

Silke Financial Services offers advice on funds at all levels of risk. We research the market in order to find the most appropriate funds at all risk levels. But don't make the mistake of disinvesting if you are a long-term investor.

To all our Muslim families, we at Silke Financial Services wish you a blessed Ramadan and a festive Eid-ul-Fitr.