If the government can't issue new debt, first it must stop paying for things, resulting in furloughs and a tightening or suspension of federal services. This happened in 1995 (before the big government shutdown at the end of the year) when Congress failed to increase the debt ceiling and the government underwent a smaller shutdown -- to slow the drip drip of money out of the Treasury and avoid a default.
"There's always some wiggle room. There's various accounts that the Treasury can play with and able to draw on money so they could almost certainly extend the time past where you would literally run out of funds," said Dean Baker, economist at the Center for Economic and Policy Research.
At some point though, the Treasury will be unable to issue more debt. When that happens, things decay dramatically.
"My guess is you'd probably see some real panic in financial markets. You'd probably see interest rates on U.S. debt go through the roof. Sort of like what happened with Greece earlier in the year when there was concern that Greece would default on the debt," Baker says.
It's a classic hostage situation. And the key question is whether Republicans are willing to hold ranks and exert their leverage longer than Democrats are willing to call their bluff. If neither side blinks, and Congress, led by Republicans, tells the world, "we're not going to pay off our debts," the economic fallout would be dramatic. If Republican demands are unreasonable and Democrats refuse to cave, then Republicans will be forced to decide whether to let the country -- and particularly their wealthy base, and donors on Wall Street -- take a huge hit, or let down the Tea Party, which is practically itching for a shutdown.
So far, Republicans are standing firm.
"I think it will not be without some strings attached if it happens, because they're going to have to seriously address spending and debt," Senate Minority Leader Mitch McConnell told Fox News last week.
Sen. Tom Coburn (R-OK) suggested he'd like to see over $300 billion in spending cuts before he'd end a filibuster on the debt ceiling.
On NBC this weekend, Tea Party leader Jim DeMint (R-SC) joined in on the fun: "No, I won't. Not-- not unless this debt ceiling is combined with some path to balancing our budget: Returning to 2008 spending levels. Repealing Obamacare," DeMint said. "We have got to demonstrate that we have the resolve to cut spending."
The only ray of hope that a dangerous impasse could be avoided came from Speaker-to-be John Boehner, "We're not quite sure when we're going to face this increase in the debt limit, but when we do, we'll be ready to meet our obligations," Boehner told ABC -- though he, too, added it would likely be paired with spending cuts.
Alternatively, Democrats could cave and hand the Republicans big spending cuts during a recession. This vote could come as early as this winter, just after Republicans come to power in the House.