Image: Uncle Sam © Peter Gridley, Photographer

Unless President Barack Obama and the Republicans can come to an agreement by Aug. 2, the United States will hit its debt ceiling for the first time since the limit was created in 1917. The nation will no longer be able to borrow. Because we spend more than we bring in, the government will be forced to choose among paying creditors, purchasing things like bullets for Afghanistan and honoring financial promises made to seniors.

Well, not right away. A $30 billion slug of debt will need to be repaid, like a credit card bill, on Aug. 4. That's probably manageable, given the $100 billion in cash the Treasury should be sitting on by then. But another $30 billion is due on Aug. 11. Then, a whopping $1.17 trillion comes due on Aug. 15. That's the real day of reckoning.

No one really knows what would happen if the country couldn't pay, just as no one really knew what would happen if a large, systemically important investment bank like Lehman Brothers collapsed. But make no mistake: This would be much, much worse.

The other hard reality is that there's no easy fix that will save investors from what lies beyond the debt-ceiling debate: an epic wealth transfer as the government, in effect, raids the savings of its citizens to cut the public debt. That's what happened in the wake of World War II. And it's about to happen again.

Image: Anthony Mirhaydari

Anthony Mirhaydari

Later in the column, I'll tell you how to avoid being suckered. First, a look at how this debt issue reaches your nest egg.

Avoiding the crash

Already, with stocks off recent highs, it's clear investors are nervous. Consumer sentiment has returned to recessionary lows. Bond traders are buying up protection against a U.S. default. And the rating agencies are sounding the alarm, with Standard & Poor's threatening to cut America's pristine AAA credit rating if the debt ceiling isn't raised and accompanied by at least $4 trillion in budget cuts over the next 10 years.

Without getting into the nitty-gritty of repurchase transactions, capital reserves and collateral obligations, just know that American debt, in conjunction with the U.S. dollar, is the oxygen that fuels the global financial system.

That's not hyperbole. It's a remnant of the pre-Depression gold standard and the post-World War II Bretton Woods currency exchange standard. It is also a reflection of our global dominance, militarily, culturally and economically. Ours is the "risk-free" financial standard to which all other assets are compared.

This position has been a wonderful privilege that we've happily abused to finance oversized homes, oversized SUVs and oversized credit balances on our personal account -- and too much spending without enough taxation as a nation. But there's a catch. We're expected to act like grown-ups and pay our debt on time. Always. No exceptions.

Many politicians, led by the intransigent Tea Partyers in Congress, seem OK with violating that covenant and sucking the oxygen out of the economic system. But we'd all suffocate.

Thankfully, this doomsday scenario seems less likely at the moment.

News reports earlier this week said House Speaker John Boehner, R-Ohio, and the president are once again working toward a meaningful deal to cut the deficit as part of a debt limit increase. A "Plan B" idea is moving forward in the Senate based on the work of Minority Leader Mitch McConnell, R-Ky. Plan B would see Congress give the president unilateral authority to raise the debt limit -- handing him ownership of the debt-limit issue heading into the 2012 election. And yet another plan, from the Senate's bipartisan "Gang of 6" that would cut roughly $4 trillion from the deficit, surfaced as I wrote this on Tuesday.

The burden we bear

Here's the thing: Even if the debt ceiling is raised in time and a budget deal struck, the long-term problem won't be solved. The debt load is expected to become larger than the economy this year for only the second time in the nation's history. And until the budget deficit turns into a surplus, as it did ever-so-briefly in the late 1990s under President Bill Clinton, the debt pile will just keep growing.

The main problem is that much of the budget distress is caused by the lousy state of the economy and the fact that we're coming out of the worst financial crisis since the 1930s. Credit busts tend to result in banking crises that turn into government debt crises. That's happening now, which explains why the annual federal deficit is nearly equal to 10% of the economy -- a level that's been seen only during the Civil War, World War I and World War II.

Yep, the fallout from the housing bust was nearly as bad as the aftermaths of those big events.

The "cyclical" portion of the deficit (worth something like 3.5% of GDP, according to Moody's) should fade as growth reaccelerates. I talked about this back in February ("Pulling the plug on the economy?" ). I talked about the signs of strength in the economy in June ("The economy is recovering -- really"). And I talked about two big ways policymakers could kick-start more vigorous growth two weeks ago ("2 keys to a real economic recovery").

But the other portion, the "structural deficit," is much harder to deal with. As I discussed in a recent blog post, runaway health care costs are a big part of this. Doing nothing isn't an option: Researchers at the Bank for International Settlements project that on our current path, U.S. debt will grow to more than 400% of GDP by 2040.

Republicans oppose meaningful tax increases to solve any of this. Democrats want to protect entitlements, including Social Security and Medicare, as well as the pay and benefits offered to public sector unions. The public is somewhere in between, favoring tax hikes on the wealthy and corporations and defense spending cuts, based on recent polling.

But people don't seem ready for the necessary sacrifices. And with the economy so weak and vulnerable, the country might not be able to handle deep austerity.

For more on what is needed, be sure to review the National Commission on Fiscal Responsibility and Reform's final report from December here (.pdf file).