chinaLast summer, following the political circus that was the country's debt-ceiling fight, Standard & Poor's downgraded America's debt one notch from its coveted "AAA" rating to "AA," -- an action that many predicted would surely lead to financial doom.

Nothing of the sort happened.

In fact, what followed was just the opposite: Fearing global instability and even deeper economic troubles in Europe, investors from around the world rushed into U.S. Treasuries, sending yields to record lows, and thus keeping America's cost to borrow at record lows, too.

Now another of the big ratings agencies, Moody's (MCO), is threatening that if the country doesn't address its rising debt by early 2013, it, too, might rescind its own "AAA" rating of U.S. debt, with the implied potential of sending the country's debt costs soaring.

An increase in borrowing costs would indeed be troublesome for the country. But the vastly more scary prospect facing America is the continuing economic slowdown in China.

U.S. of IOU

China is an economic powerhouse; everybody knows this. Its economy is second only in size to America's. China also holds -- and continues to buy -- a significant chunk of America's sovereign debt, which just surpassed the $16 trillion mark. Of that amount, China holds about $1.2 trillion of it, or 7.5%.

That may not sound like a lot, but it makes China America's top foreign creditor. Japan comes in second, with $1.1 trillion. And the next biggest foreign debtor is the U.K., which holds just under $500 billion in U.S. debt. That's a big drop-off.

The point being, the U.S. counts on China to soak up a lot of our debt. And China has always been happy to do so.

America as a Giant Vault

Since liberalizing its economy in the 1990s, China has become the world's factory. As a massive exporter, it has to do something with all the money that's rolling in. And like so many investors around the world, China uses the U.S. as a place to keep its spare cash. Not only is its money safe here, but the country even earns a bit of interest on it.

For investors of all sorts around the world, then, America operates a bit like a bank. But what happens when that bank's biggest and most reliable depositor doesn't need it anymore? What happens when that depositor stops depositing money in the bank?

The U.S. might be facing just such a situation in the not-too-distant future.

China's economy is slowing. The World Bank puts China's 2011 GDP growth rate at 9.1%, down from 10.4% the year before, and down from 14.2% in 2007. Why is this happening? America's economy is growing at an anemic rate right now, and half of Europe is in recession. Demand for Chinese products is down, and it probably will be for some time to come, so of course China's economy is slowing.

Look to Your Own House, America

And as China slows, it will necessarily have less need of the U.S. as a place to stash its money. Consequently, it will slow its buying of Treasuries. And the bond markets could subsequently send the country's cost to borrow soaring to unsustainable levels in the same way they've done with debt-ridden eurozone countries such as Greece, Portugal, Ireland, and Spain.

So the state of U.S. debt definitely matters; its continuing rise must be checked, but not because of Moody's. Who knows; a downgrade by the rating agency could have no effect at all if real market demand sends Treasury yields even lower. Chances are, if it happens at all, it will be a non-event. It's our own house we need to look after now.



John Grgurich is a regular contributor to The Motley Fool. Motley Fool newsletter services have recommended buying shares of Moody's.


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merle the pearle

The manufacturing needs to come back to america, American have more pride when it comes
to manufacturing, if the billion dollar corporation, would just except a smaller profit instead of
wanting it all! thing will work out fine!

September 14 2012 at 9:00 PM Report abuse rate up rate down Reply
sunnyhoney95

I'm sure most people in America would gladly pay a higher interest to rid our country of our indebtness to China. The best thing for America is to increase our own manufactuering base and make our own products and go back to trading with countries that are fair. We need to do business with countries that respect trademarks and patent laws.We need to go back to our trade system that provided a surplus to our economy. Obviously our trade system was successful and while we abandoned it, Germany adopted it and look at their booming economy.

September 14 2012 at 7:44 PM Report abuse +2 rate up rate down Reply
luvmee40

Holy Crap! Really? What next? All of this Arab up rising is the cause of some movie no one has ever seen yet it was the day of 9/11. When is it going to be enough people? How much more do we need to see? Do fear the downgrade? Oh please people get some common sense fast.

September 14 2012 at 7:29 PM Report abuse -2 rate up rate down Reply
ectullis

But fear Obsama most of all.

September 14 2012 at 6:43 PM Report abuse -2 rate up rate down Reply
boowah

More like "fear a Republican Victory" The Gop candidates have said they will punish China for their unfair trade practices, and that in turn may bring on the trade war that we all fear.

September 14 2012 at 6:15 PM Report abuse +1 rate up rate down Reply
2 replies to boowah's comment
luvmee40

You better pray for a republican victory. 4 more years of this we cannot handle. We won't make it

September 14 2012 at 7:30 PM Report abuse -2 rate up rate down Reply
SPQR

A trade war would be great! We would go into depression and then have a real chance to fix things. Some saw the great depression as a bad thing but it propelled us to the top. We are now trying to avoid one. The right choice would have been to arrest every CEO and VP involved in derivatives and bum mortgages and all the other crooks and only save the consumers and let the market save itself. Some of the great achievements in the US arose from the great depression. In this one nothing is happening!!!!! We could have turned banks into parks and wildlife sanctuaries

September 14 2012 at 11:42 PM Report abuse rate up rate down Reply
Matt Dougherty

The only thing about china is egg rolls !

September 14 2012 at 6:10 PM Report abuse rate up rate down Reply
1 reply to Matt Dougherty's comment
SPQR

some of the women are hot but they have high shrieky voices

September 14 2012 at 11:43 PM Report abuse rate up rate down Reply
alfredschrader

The things that made America great; Hard Work and Prosperity are not there. Instead there is vacation after vacation, hundreds of thousands of foreclosed homes, millions of unemployed homeless people wandering the streets,and a ruined credit rating.

September 14 2012 at 5:31 PM Report abuse rate up rate down Reply
2 replies to alfredschrader's comment
luvmee40

And now another billion dollar stimilus that goes straight to the failed banks to buy up homes? Really, are we nuts?

September 14 2012 at 7:31 PM Report abuse -1 rate up rate down Reply
1 reply to luvmee40's comment
TRAVISSIGGLO

Yes we are when we want to pump more money into a failed housing situation, But it looks
like the administration is trying, we went from hope & change, to forward, all the cash, It may
stick somewhere ??

September 14 2012 at 8:14 PM Report abuse rate up rate down
tonybraciolev

Vacation after vacation?

September 14 2012 at 8:36 PM Report abuse +1 rate up rate down Reply
bolomark3

People don't realize that if we don't get somebody else besides Obama in office this nation will cease to exist as we know it today. Obama hasn't approved a budget and doesn't have a plan to do otherwise. If something isn't done by the first of next year or unless we get Romney in office to reverse Obama care the nation will see over 21 new tax increases from Obama Care alone and all previous tax cuts will cease to exist. Also, there has yet to be a budget passed in over 3 years. Obama knows not how to lead or run a country just how to destroy one from the inside out.

September 14 2012 at 5:11 PM Report abuse rate up rate down Reply
1 reply to bolomark3's comment
SPQR

we need those tax cuts to disappear especially for the romney middle class

September 14 2012 at 11:46 PM Report abuse rate up rate down Reply
drmaxchartrand

This is why we need Romney/Ryan more than ever! Obama will run us in the ground if we do it his way!

September 14 2012 at 4:31 PM Report abuse -1 rate up rate down Reply
dcsincc

if we renig have them come get all the cheap crap they exported over here. china will get worse before we do .we have the know how to survive..they are just starting to get to where we have been..they have put the cart in front of the horse' so to speak..

September 14 2012 at 4:18 PM Report abuse +1 rate up rate down Reply