China's economy has humbled many smart people in recent years.

It has defied those arguing it would slow, those predicting a hard landing, those saying its currency would surge and those concerned that social unrest would shake Asia's second-biggest economy to its core.

Yet no one has been more outmaneuvered by China than the world's two biggest economic powers: the US and Japan.

As Japanese Prime Minister Shinzo Abe and US President George W. Bush meet in Washington later this week, both leaders may think markets give a hoot. Abe and Bush may hope that by solidifying ties, investors will somehow feel the global marketplace is a safer, more prosperous place.

Together, the US and Japan produce economic output of $17.8 trillion, while China produces just $2.6 trillion. That means investors and policy makers the world over should be comforted that the US and Japan have arguably never been closer. Yet even independently, both economies should have tremendous sway over smaller, developing ones.

Not China. If officials in Washington and Tokyo have learned anything in the last few years, it's that China won't be pressured into changes or concessions it doesn't feel ready for. While the examples include everything from democracy to human rights to piracy, the clearest demonstration of China's resolve to go at its own pace is the yuan.

If anyone should understand that, it's Henry Paulson. In June 2006, Paulson shocked Wall Street when he left Goldman Sachs Group Inc. to join the Bush administration. "What is he thinking?" was a common question as Paulson joined a lame-duck, scandal-plagued White House. Paulson's stature and decades-long experience with China, many believed, would serve the US well.

Almost one year later, Paulson has been even less successful than his predecessor, John Snow, in getting China to boost the yuan. Nor has he prodded China to open an economy that grew 11.1 percent in the first quarter from a year earlier.

Granted, Paulson hasn't had much time in the job. Yet it was always the case that he needed to act fast to win concessions from China to placate US lawmakers threatening tariffs. Just like Snow, Paulson has been outmaneuvered by China on the yuan and on winning friends in Asia. So has Japan.

Say what you want about China's leaders -- they are scoring huge points in Asia. China is producing rapid growth in a region that used to rely on Japan as its economic engine. It also has been on a charm offensive to allay fears that its cheap labor and military ambitions are reasons for concern.

Charm Offensive

While this latter point is highly debatable, what's not is that China is winning the public-relations charm game in Asia. That could be seen during Premier Wen Jiabao's trip to Japan earlier this month, when he stressed China's desire for better relations between the two nations.

The upshot of China's growth and its charm offensive is that its economy is now more important to Asians than Japan's, even if Japan's is bigger. Increasingly, investors are reading from the same script.

Within Asia, the international community continues to reference the universe of stocks it deals with as "Asia ex-Japan." Mark Matthews, Singapore-based chief Asia strategist at Merrill Lynch & Co., wonders if it's time to start referring to "Asia ex-China."

"Our predilection is that the term `Asia ex-Japan' is now dated and irrelevant," Matthews wrote in an April 24 note to clients. "Ask yourself this question: When was the last time you looked at the Nikkei or the Topix for direction? Really, today, the Asian markets are taking their cues from China."

It's a good point, and one officials in Tokyo aren't considering urgently enough. Traveling around Asia, one senses little interest in Japan's recovery from 15 years of negligible growth. Japan is far too big to be irrelevant, and yet traders in Hong Kong, London and New York now react less to Japan's economic or stock trends than to China's.

The US economy is far bigger and its health matters more to Asia. Even so, China has skillfully used the last six years to win more friends in Asia than officials in Washington realize. Distracted by its war on terror and invasion of Iraq, the Bush White House paid little attention to the world's fastest-growing region. That neglect served China well.

That's not to say it's wise for Asia to embrace China as the new economic or political power yet. It's a developing economy with conflicting needs to slow growth to avoid inflation, and to expand rapidly to create jobs.

China also must beat the system, so to speak. No industrializing nation has avoided major financial problems. The combination of untold numbers of bad loans, stock bubbles, limited transparency and worsening pollution should concern investors.

It's food for thought as Abe meets with Bush this week. One can only hope both leaders digest it.

Courtesy of Bloomberg