Kevin Rudd's arrival in China on his first posting as a junior diplomat was very different. "China in the mid-1980s was not easy," he told the Herald when he was the shadow minister for foreign affairs. "We had a ground-floor apartment. It was invaded by rats from the piles of garbage outside. So I had to sit on the edge of the bed with a club waiting for the rats to come out. Therese sensibly took our baby daughter to an eighth-floor apartment till the problem was fixed. So we liked China, but it was tinged with a basic realism." Rudd soon knew a great deal about China, and he knew what he didn't like. Knowing China does not necessarily mean to love it. Rudd's China expertise proved to be a political asset for Labor at the 2007 election. In fact, Rudd's Mandarin moment ranked with his drunken outing to a New York strip club in winning favour with the Australian public. The first poll taken after the news broke in August 2007 of Rudd's celebrated visit to Scores was a Newspoll that found his approval rating had jumped by a solid 6 percentage points to 66 per cent.

The next month he opened his mouth at a Sydney lunch feting China's President Hu Jintao and fluent Mandarin Chinese flowed out. Australians watching the TV news were impressed. The first poll taken after this was a Nielsen sampling that discovered a bounce of 8 percentage points in Rudd's approval rating to 67 per cent. "While we should always be cautious about attributing movements to a single event, Kevin Rudd's speaking in Mandarin at APEC also seems to have been a big hit with voters," the Nielsen poll director, John Stirton, remarked at the time. These two events - an unorthodox double whammy of lechery and linguistics - took Rudd's popularity to a level without precedent for an Opposition leader in the 35 years of the Nielsen poll. So how is that, today, Rudd is behaving as if his Sino skills are an embarrassment? And how could his timing be so bad, exactly as China emerges as an indispensable world power and Australia faces a test with the biggest foreign investment proposal China has ever made? Howard, after a searing first-year fiasco with China over Taiwan, recovered to conduct a strong relationship with China for the rest of his prime ministership.

Howard's formula was simple: concentrate on trade. Everything else - the sensitive issues of Taiwan, Tibet, defence, human rights, democracy, Falun Gong - was shut out. The result? A trouble-free relationship and $25 billion worth of LNG contracts for Australia. Rudd, by contrast, has arrived in a Manchu muddle. Four events came together in the past week. Rudd conducted in secrecy a meeting with Li Changchun, the Chinese Politbureau member responsible for propaganda, while the Chinese publicised it. The Chinese Communist Party was conducting itself with greater transparency than was the Australian Prime Minister. Then Rudd's Defence Minister, Joel Fitzgibbon, was alleged to be under covert and illegal investigation by his own department because of suspicions that he was too closely aligned with a Chinese-born Australian businesswoman, Helen Liu. More damaging was the hurt Fitzgibbon inflicted on himself. In breach of the ministerial code of conduct, he had failed to disclose that Ms Liu paid for him to travel to China three times. The Opposition's Joe Hockey tried to cast this as part of a sinister pattern of behaviour - Rudd and several of his ministers had accepted free trips to China over the years.

Then Rudd in London tried to avoid appearing on a TV set sitting next to Beijing's ambassador to London, Madam Fu Yi, even though he'd known her for a decade. Rudd asked instead to sit next to a white man, Britain's Foreign Secretary, David Miliband. It was "fear on the couch", according to China analyst Professor David Goodman, of Sydney University. It just so happened that Rudd in London, continuing a policy that had been pursued by Howard, was lobbying other countries to allow China more voting power in the International Monetary Fund. Malcolm Turnbull had had a very bad week. For the first time, one of the major opinion polls, the Nielsen, found he had entered the political twilight zone where more respondents disapproved of him than approved. Turnbull attacked: he seemed to spend most of his time talking about China. "Now he's not a roving ambassador for the People's Republic of China. He's the Prime Minister of Australia and he has to put our national interest first." Labor's Lindsay Tanner accused the Opposition of racist yellow peril fearmongering. Goodman rated Turnbull's attack effective because of "a beat-up by Coalition-leaning journalists", and Rudd's fearfulness stoked by "the fact that there's still a quiet racism, especially in the Labor Party". But a foreign policy expert and Rudd confidante, Griffith University's Professor Michael Wesley , holds the PM responsible: "They might look like unfortunate coincidences but my view is that accidents tend to happen to people who aren't prepared for them. If you have a clear statement of policy and clear sense of where you're going then you can survive these things.

"But Rudd has been so spooked by the Manchurian candidate syndrome in Australia that he has purposely been uncreative in setting out a China policy," Wesley said. "If there was anything Howard did well in foreign policy it was that he stated his general policies very clearly and he stuck to them. What strikes me about Rudd's policy is there isn't one. He makes it on the run. I think he has to make a major statement on China and the region, founded on a very clear analysis of where China is now and where it is going." And where is that exactly? Kurt Campbell, about to be appointed leading official on East Asia in the Obama Administration's State Department, wrote in a co-authored paper published by the Centre for a New American Security in June last year: "China's ascent has arguably been one of the most rapid and consequential in history, in many ways rivalling or even surpassing the significance of America's rise in stature during the first two decades of the last century." Since those words, China's power has become more obvious. As the vulnerability of the world's biggest debtor, the US, has been exposed by the financial crisis, China's strength as the world's biggest creditor has emerged starkly. And, strikingly, China has not hesitated to assert it. Beijing has developed a strident new activism in investment strategy and diplomacy. In 1989, China's great moderniser, Deng Xiaoping, issued a slogan to guide his country's conduct in the world: "China should bide its time and hide its strength, and do what it can." There's no hiding strength today. With the unfolding financial crisis, China has displayed anger and impatience with the US; it has blamed and threatened the US; and it has actively advanced alternatives to the US-centric world economic system.

"China is adopting a more assertive foreign policy commensurate with its increasing power," says Anne-Marie Brady, a China expert at Canterbury University, New Zealand. "It's flexing its muscles, and it has muscles to flex." Note this: Washington has met every Chinese demand made of the US in this crisis. The next big test for China's foreign investment policy will be Australia. Specifically, it will be the application by China's state-owned Chinalco to take its holding in Rio Tinto to 18 per cent, with bigger stakes in some prize Rio assets. The Federal Government, particularly Treasurer Wayne Swan, is considering the application. Valued at $US19.5 billion ($27.3 billion), the bid is the biggest single foreign direct investment proposal China has mounted. The former treasurer Peter Costello this week gave the Herald six reasons why Swan needs to consider the Chinalco bid "extremely carefully". Costello was the first treasurer to block a foreign takeover under the current foreign investment laws when he denied Shell permission to take control of the giant North West Shelf gas producer Woodside.

"Rio's assets in Australia are a huge strategic resource for Australia," said Costello. "In strategic terms, they are more important than North West Shelf gas. We have plenty of gas deposits and some of the biggest ones have not even come into production yet. "But I don't think many more iron ore deposits on this scale will be opening up." The Federal Government needed to measure six factors, Costello said: "One, the strategic nature of the resource. Two, the market is down. Three, the Australian dollar is weak. Four, the seller is in a position of financial exposure." In other words, Rio is a distressed seller. "Five, the buyer is a state-owned enterprise. Six, the buyer is a state-owned enterprise which will actually be a user of the resource", raising potential conflicts of interest between its role as a customer of the company seeking cheap products and a shareholder seeking maximum return. Costello has no illusions about China's future value to Australia. "China is extremely important. It's an emerging global superpower."

However, "China is entitled to and will pursue its national interest, just as Australia is entitled to pursue its national interest". On the other hand, Australia is a country which, since Federation, has run a current account deficit. It relies on foreigners to finance the deficit which last year was $50 billion, the equivalent of 4 per cent of GDP. As a small, successful, capital-importing, trading economy, it is strongly in Australia's interests to operate an open and rules-based system of trade and investment. Complicating the Chinalco decision is that Swan last week blocked a smaller Chinese takeover bid - the Minmetals offer for OZ Minerals. The explanation? One of the Australian company's mines was near a sensitive defence site, the Woomera weapons testing range.

"Blocking this transaction will have significant consequences," says Stephen Joske, a China analyst at the Economist Intelligence Unit and former Australian Treasury representative in Beijing. "It will add a risk premium to investments, devalue Australian resources assets and raise the risk that China becomes less enthusiastic about the rules and processes of globalisation." Canterbury University's Anne-Marie Brady, whose work has included groundbreaking exposures of the Chinese Communist Party's detailed internal systems for managing foreigners, says of the Chinalco bid: "I think there has to be some caution. For example, in last year's milk poisoning case, which affected 290,000 Chinese kids, one of the reasons the milk company didn't release any information was that it was under party discipline. It was a former state-owned corporation and they were under instructions not to release any negative news in the lead-up to the Olympics. "It's always a problem - it's a party-state economy." Loading China will continue to build impressive skylines in the future, and it will always have rats. Deft statesmanship for foreign governments lies in the art of knowing China's negatives and its positives, and navigating adroitly between them.

Peter Hartcher is the Herald's international editor and John Garnaut is the Herald's China correspondent.