America is on the brink of a potential default, threatening military salaries and social security payments. How did the world's largest economy get here?

Why is America facing a debt crisis?



In short, because it is not allowed to borrow any more money. The US national debt cannot legally exceed a debt ceiling of $14.29 trillion (£8.86tn) – a seemingly huge amount, but one which was reached in May.

So what happens next?



Either the US raises the debt ceiling (and can then issue more debt), or it does not (and is then barred from borrowing to pay its bills – such as social security and the health insurance programme Medicare). With a 2011 deficit of at least $1tn, the stakes are high.

Why doesn't Obama just raise the ceiling?



Because the leader of the world's largest economy does not have the authority. Any changes to the debt ceiling need to be approved by Congress, and this has led to a protracted stalemate between Republicans and Democrats.

Why can't the two sides agree?



Both sides realise that the US debt needs to be brought under control, but have rather different ideas about how to do it. Obama is proposing a 10-year, $4tn package of spending cuts and tax rises – including higher income taxes. The Republican party supports a $2.4tn package of spending cuts, but is not backing the tax rises.

How has America been keeping afloat since May, when the debt ceiling was reached?

By stopping payments to certain federal pension schemes, and by liquidating some of the scheme's assets. Treasury secretary Tim Geithner has pledged that the shortfall will be repaid once the ceiling is raised.

How urgent is the situation?



The US treasury estimates that funds will dry up on 2 August. However, the deadline is actually 22 July – to give time for legislation to be written and approved.

Has the debt ceiling often been raised?



Many, many times. More than 70 times since the mid-1960s, and 10 times in the last decade. It's not been entirely one-way traffic, though, since Congress did vote to lower the limit twice in the 1950s, during America's postwar economic boom.

Without a deal, will the US immediately default on 2 August?



Not according to Ben Bernanke. The Federal Reserve's chairman told Congress on Wednesday that the first response would probably be to cut social security payments, Medicare and military pay.

How are the markets reacting to the deadlock?



Until very recently, the view in the City and on Wall Street was that a deal would be reached in time. However, investors are starting to get edgy. Moody's has warned that a US default is unlikely, but no longer unthinkable, and put America's credit rating on negative watch. On the bond markets, however, US 10-year bonds are trading with a yield, or interest rate, of just 2.9%. The suspicion is that neither side wants to take the blame for pushing the US into a new financial crisis.

What impact would a default have?



Some experts have predicted a major panic. Standard & Poor's has made it clear that it would cut the US rating from AAA (the top) to D (the bottom). That would mean banks would technically be barred from using US debt as collateral with central banks (although these rules could be changed). As Gary Jenkins of Evolution Securities put it: "They wouldn't dare, would they?" Even Bernanke has conceded that failure to lift the US debt ceiling would throw the financial system into tremendous disarray.

Why doesn't the president have unfettered powers to set the debt ceiling himself?



Article 1, section 8 of the United States constitution says only the US Congress has the power to allow America to borrow. Originally, this meant that every loan had to be signed off individually. But in 1917, Congress agreed a limit for the first time. This legislation, called Second Liberty Bond Act, funded America's entry into the first world war. The modern debt ceiling – the limit on all public debt – was created in 1939, set at $45bn.