BOSTON ( TheStreet) -- China is often depicted as a red dragon, owing to the cultural significance of the mythical beast.A large, fire-breathing monster is also how many see China's economy as it gains speed and quickly closes the gap with developed nations. The world's most populous country is quickly learning how to use its immense size. That means tougher competition for many nations, but also a new source of demand that will power other economies in the years to come. China recently surged to third place, behind the U.S. and Japan, on the list of the largest economies based on gross domestic product. China's GDP growth has been exponential. Because per-capita GDP is still only $6,546, trailing the U.S. by almost $40,000, there's room for growth. China is becoming an increasingly important part of the global economy. Manufactures are terrified by the prospect of China growing even bigger, since the country already is a force to be reckoned with, due to its ability to make cheap products. Still, much of China's advantage stems from the fact that the government plays a role in depressing its currency versus the dollar to make its exports even more attractive. While maintaining a currency peg in itself isn't underhanded, China has been slow to adjust its exchange rate, prompting competitors to cry foul. If the currency were allowed to float freely, the Chinese yuan would be bid up, making Chinese goods less appealing and encouraging more interest in American wares. China's cheap currency has stoked inflation as money pours in, pushing up the current account balance. Besides concerns for U.S. manufacturers, China represents an opportunity for American companies seeking to expand their reach. As China accepts more foreign influence and grows wealthier, demand for American products should increase, leading to gains for Apple ( AAPL), Microsoft ( MSFT), Wal-Mart ( WMT) and Johnson & Johnson ( JNJ). Apple's sales to Asia increased from $599 million in 2004 to $3.3 billion in 2009. Similarly, Google's ( GOOG) revenue from what it calls the "rest of the world," i.e. emerging-market countries, increased from 21% of the total in 2004 to 40% last ear. Still, Google has faced censorship controls and threatened to cut ties with the China, underscoring the risks of doing business in the Maoist nation.
Industrial companies such as General Electric ( GE) and United Technologies ( UTX) should also feel increased demand from China as the country builds out its infrastructure to accommodate growth breaking out across the country. In addition to offering opportunities to American companies, China holds a leash on the U.S. economy. China owns about $800 billion in U.S. debt, which isn't indexed to inflation. If the U.S. allows inflation to accelerate, China's investment is whittled away as the money they lent to the U.S. becomes increasingly worthless. If U.S. inflation gets out of hand, major foreign investors including China could sell their holdings or, worse yet, refuse to buy more government issues, forcing down the price of bonds. That would require the U.S. to pay a higher interest rate on borrowed funds, making it more difficult to meet debt obligations and driving up other interest rates, putting a lid on economic growth. As a result, U.S. is becoming more dependent on China to fund its own activities and to provide opportunities to grow internationally. Eventually, it will become impossible for China to hold its currency peg. Until then, the dynamic between the U.S. and China will tighten: Cheap products from China should help Americans stretch their dollars, while enriching a country that will increasingly put pressure on American businesses. China is going onward and upward. Rather than fight it, investors should embrace the Asian nation. American companies stand to be beneficiaries, and Chinese companies look to be promising investments. Hitching a ride on the red dragon could be one of the best ways to improve returns in the next generation. -- Reported by David MacDougall in Boston.