Google's threat to quit China over censorship and hacking intensified Sino-U.S. frictions on Wednesday as Washington said it had serious concerns and demanded an explanation from Beijing.

China has not made any significant comment since Google, the world's top search engine, said it will not abide by censorship and may shut its Chinese-language google.cn website because of attacks from China on human rights activists using its Gmail service and on dozens of companies, including Adobe Systems.

Google's action should be a wake-up call to everyone involved in China's economy -- U.S. businesses, the U.S. administration and the Chinese themselves, said Tony Fratto of the Hamilton Place Strategies consulting firm.

Media freedom groups who had severely criticized Google's previous compliance with Chinese curbs praised the company's decision and called for other firms to follow suit.

A foreign IT company has finally accepted its responsibilities toward Chinese users and is standing up to the Chinese authorities, who keep clamping down more and more on the Internet, said Reporters Without Borders.

However, investors were spooked and U.S. and Chinese analysts warned of turbulent bilateral ties in 2010.

Technology business analysts noted in reports issued on Wednesday that Google draws $300-600 million in revenue from China -- less than 5 percent of its sales. But they voiced concerns about Google's future prospects in that huge market.

Friction over the Internet, part of a long-running dispute over human rights, appears likely to stoke U.S.-China tensions. Analysts predicted clashes on climate change, China's crackdown on dissidents, Iran's nuclear ambitions and other issues.

President Barack Obama's administration, which in 2009 strived to embrace China as a partner in tackling global issues, has angered China by approving arms sales to Taiwan and by slapping tariffs on Chinese tires and steel products.

Obama is also expected to meet with the Dalai Lama of Tibet, a world religious figure whom China reviles and accuses of leading a Tibetan separatist drive. Obama avoided meeting the exiled Tibetan leader last year to pave the way for a summit with Chinese President Hu Jintao in November.

Writing before the Google decision, The Eurasia Group consultancy said looming economic friction made U.S.-China relations the top global risk of 2010.

In the future, we'll look back at that summit as the peak of the relationship, and we'll see significant deterioration in U.S.-Chinese relations in the coming year, the group wrote.

CYBER SECURITY LEGISLATION

White House spokesman Robert Gibbs sidestepped questions about the possible impact on U.S.-China relations and said Washington awaited an explanation from China on the attacks.

The president and this administration have beliefs about freedom of the Internet, he said.

Chinese authorities were seeking more information on Google's statement, the Xinhua news agency reported, citing an unnamed official from China's State Council Information Office, the government arm of the country's propaganda system.

Admiral Robert Willard, head of the U.S. Pacific Command, told a congressional hearing that U.S. military and government networks and computer systems continue to be the target of intrusions that appear to have originated from China.

While most cyber-attacks focus on prying out data, the skills being demonstrated would also apply to wartime computer network attacks, he said.

Sen. Joe Lieberman, chairman of the Senate Homeland Security and Governmental Affairs Committee, said he was drafting legislation to strengthen U.S. cyber security.

Google's experience should be a lesson to us all to confront this ever growing problem aggressively and with all available means, he said in a statement.

China has said it does not sponsor hacking.

Pressing China for an explanation, U.S. Secretary of State Hillary Clinton said: The ability to operate with confidence in cyberspace is critical in a modern society and economy.

With China the largest lender to the United States, holding $800 billion in Treasury bills, Internet tensions will make steering this vast, fast-evolving relationship all the more tricky, especially with the U.S. Congress in an election year.

China has been taking a harder line, said Shi Yinhong, an expert on relations with the United States at Renmin University in Beijing. The next few months are going to see some turbulence in China-U.S. relations. We may see some tactical concessions from China, but the general trend isn't toward compromise.

Chinese industry analysts said the issue had snowballed beyond Google.

If this becomes heavily politicized, and there are signs that it is, and people in the Chinese government say, 'This is good. It serves you right, and we won't bow our heads to the United States,' then there'll be no way out, said Xie Wen, a former executive in China for Yahoo and other big Internet companies, who is now an industry commentator.

The impact on China's image will gradually also affect the enthusiasm of investors, he added. It's not the pure economic losses -- a billion or so -- it's the deteriorating environment.

TENSIONS OVER INTERNET

China's policy of filtering and restricting access to Web sites has been a frequent source of tension with the United States and tech companies, such as Google and Yahoo Inc.

Google's announcement suggested the recent intrusions were more than isolated hacker attacks.

These attacks and the surveillance they have uncovered -- combined with the attempts over the past year to further limit free speech on the Web -- have led us to conclude that we should review the feasibility of our business operations in China, Google's chief legal officer David Drummond said in a statement posted on the company's blog.

Some 20 other companies also were attacked by unknown assailants based in China, said Google.

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For a related TIMELINE Graphic, see:

http://graphics.thomsonreuters.com/0110/CN_GGL0110.gif

For a Graphic on China market share, see:

http://graphics.thomsonreuters.com/119/CN_BAIDUG1109.gif

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Google's potential withdrawal from China shocked investors and analysts, who fear the web search leader's strategic plans may be threatened.

For investors this is clearly a negative, Broadpoint AmTech analyst Benjamin Schachter said in a research note. The obvious concern is that China's growth has been solid and its market potential is enormous.

Such concerns pushed investors toward Chinese search engine Baidu Inc, which leads Google in China's search market with more than 60 percent share. Shares of Baidu jumped 12 percent to $432 in early trading, while Google shares slipped 2 percent to $579.

Obama, during a visit to China in November, told an online town hall that he was a big supporter of non-censorship.

After the Google announcement, searches on its google.cn search engine turned up images and sites previously blocked, including pictures from the 1989 crackdown on pro-democracy protests in Beijing. Other searches remained restricted, carrying messages warning users that some content was blocked.

China's ruling Communist Party, wary of the Internet becoming an uncontrolled forum for the country's 360 million Internet users, is unlikely to allow Google to avoid repercussions.

If google.cn, launched in 2006, shuts down, Beijing could seek to restrict access to Google's main search engine, which can also do searches in Chinese, although China's firewall of filters blocks many users from opening up the results.

The general tendency over the past year has been to accuse foreigners of having a Cold War mentality and being anti-China, said Rebecca MacKinnon, an expert on the Chinese Internet at the Open Society Institute.

How exactly they are going to react to this, I cannot anticipate, but it's likely that it will not be pretty.

(Additional reporting by Lucy Hornby, Jeemy Pelofsky, Paul Henderson, John Poirier, Gabriel Madway, Jim Finkle, Ian Sherr, Braden Reddall, Clare Baldwin, Matt Spetalnick, Franklin Paul and Alexei Oreskovic; Editing by Alan Elsner)

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