Debt default damage already unfolding

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Just when will the threat of a U.S. debt default began to inflict damage on the U.S.economy and global financial system?

It's already happening. And until Congress gets over its temper tantrum and lifts the Treasury's borrowing authority, it will get progressively worse.

Imagine if you woke up tomorrow morning and the U.S. government said $20 bills weren't actually worth $20 anymore. Try using one in a New York City cab.

That's essentially what will happen Oct.18 if Congress doesn't agree to lift the debt ceiling and the government defaults. Only the $20 bills will be U.S. Treasury bonds, the global currency used by governments, investment funds, banks, large corporations and anyone else who deals in very large amounts of money.

Like China. The largest foreign holder of U.S. debt is wondering aloud if it's time to move its money elsewhere. With a congressional stalemate forcing the government of the richest country on earth to check behind the cushions for nickels and dimes to pay its debt, China's leaders think it's time "for the befuddled world to start considering building a de-Americanized world," according to the state news agency, Xinhua.

(Read more: No way US would allow debt default? Don't bet on it)

Even without a full-blown, "Thelma and Louise" ride off the default cliff, the damage is already accumulating.

Consumers are as weary of this movie as the Chinese, lowering confidence and making them think twice about spending—just as retailers are stocking shelves for the holidays.

Nervous employers may think twice about hiring. That may already be happening. We don't really know because Congress has also shut down the government, so employment data is not being reported.

The bond market is already shunning short-term U.S. debt, sending interest rates on 30-, 60- or 90-day paper soaring.

The housing market is already seeing the storm roll in.

"The confidence of our buyers and sellers is waning very rapidly," Gary Thomas, president of the National Association of Realtors, told the Senate Banking Committee on Thursday. "We have transactions canceling right now. We have people not being able to get loans. We can't get beyond where we are at. It's going to go backwards very, very fast."

The fallout is already starting to accumulate. Here's what happens if this goes on much longer:

We all know Congress can't be that stupid. We've seen this movie before. They always wait until the last minute.

The problem with this scenario is that no one knows when that "last" minute—or hour, or day—will fall.

The Treasury's best guess is it can make it through Thursday—but no one knows for sure. But without congressional approval to continue selling bonds—as the government has done to manage its finances for the past century—the Treasury will come up short. Soon.

(Read more: Thursday debt deadline a 'soft date,' says Bowles)

As of this past Friday morning, the latest data available, the Treasury opened for business with just $36 billion in cash to continue making payments on the roughly 80 million transactions it processes every month, including interest on $12 trillion in debt. On a busy day, the government owes as much as $60 billion in legal obligations authorized by Congress. So the government is already running on fumes.

Wait: What's this about $20 bills being no good?

Your paper money is still good. For now. Paper money ultimately relies for its value on trust.

The source of Treasury bond's value is a little more specific: it's a legal obligation to pay back the money you loaned the U.S. government.

The current value is based on the interest promised by the Treasury in relation to the risk and rates paid by other investments. Simply put, if the interest payments are suspended, the bond loses value. Since no one knows exactly which bonds may or may not get paid, the entire batch of debt is suspect.

But they're not going to be suspended. There's still enough cash coming in to cover the interest payments. This whole thing is a White House scare tactic.

Let's ignore for a moment the Treasury's multiple, very real concerns about choosing which bills to pay—including technical (the system isn't set up to do so), legal (Treasury has no authority to do so), and political (paying China before making good on Medicare payments, for example).

The larger issue is the wide daily swings in the amount of money flowing in and out of the government's coffers. Lots of money comes in, for example, around quarterly tax deadlines (the last one was Sept. 15.). Big payments go out at the start of each month for Social Security.

The Treasury uses short-term borrowing, among other things, to smooth out this flow of cash. Think of it like overdraft protection on your checking account. If it loses the capacity to borrow, it's only a matter of time before it overdraws its account at the Federal Reserve and misses an interest payment.

So these investors miss a few payments. This is only temporary. Everyone knows they'll get paid eventually.

That may be true, but any "delay"—in itself—will cause major damage. Try telling prospective landlords that you're "pretty sure" you'll "eventually" pay your rent each month and see how many of them are willing to rent you an apartment. Investors feel the same way about their interest payments.

(Read more: The best ways to punish Congress)

That's why any "delay" would almost certainly trigger further downgrades in the U.S. government's debt rating. Just like your own credit score, that rating is maintained by three separate agencies, one of which has already knocked the U.S. off its AAA-rated perch. When your score goes down it costs more to borrow—if you can get a loan at all.

I don't own any U.S. Treasurys. I can still get my $20 from the ATM machine. What do I care if China doesn't get paid?

For starters, because if you ever plan to borrow money, a Treasury default will make it more expensive. Investors who buy lower-rated debt have to pay more because of the higher risk of not getting paid. Since Treasurys are the safest debt, all other borrowing rates are pegged off them. So rates on credit cards, mortgages, car loans, etc. all go up.

The larger problem is that Treasury bonds are the $20 bills of the global financial system. If the cab driver refuses your $20 bill, you can walk. If people stop accepting U.S. Treasurys, the financial system grinds to a halt. That ATM machine might stop dispensing $20 bills.

A Treasury default would gum up the works fairly quickly. Some investment funds are barred from holding anything less than AAA debt. The Federal Reserve cannot accept defaulted securities as collateral. Trillions of dollars of financial contracts known as repurchase agreements, derivatives instruments and other transactions are built on the supposedly sound bedrock of Treasury bonds. It doesn't take much of a tremor to start breaking windows.

The Panic of 2008—and the global crisis—was sparked by the failure of Lehman Brothers to make good on about $500 billion in various obligations. There is roughly $12 trillion—more than 20 times as much—in U.S. Treasury debt lubricating the machinery of the global financial system.

It may not happen exactly at the open of business Friday morning. The government might scrape by until next week sometime. But if it's forced over the brink of default by Congress, the damage would spread within days. And would take years to clean up.

By CNBC's John Schoen. Follow him on Twitter @johnschoen