A serious conflict arose around the Senkaku Islands off Okinawa. When Japan detained fishing boat captain early Semptember, who was poaching offshore the Islands, China pressured Japan to release him without legal procedure, and detained several Japanese businessmen in China.

I see that the Chinese leadership was in strong strain, because their things are already moving around the coming (in autumun 2012) replacement of the Communist Party Chairman (now Hu Jintao) , thus making the leadership vulnerable to strong nationalist voices among younger generations.
If things will be left on its own, the world will see a very negative consequence.
Below is my view.

1. The Senkaku Islands which China now claims came under Japan's jurisdiction in 1895, when the islands were not under any country's rule. Since then governments in China did not protest to this until 1971, just after a U.N. organ disclosed that the seabed around the islands might contain a huge oil reserve. Therefore, Japan has a comfortably sustainable legal position about its ownership of the islands.

Japan calmly pursued legal procedure for investigation of the Chinese fishing boat captain, who violated the Japanese territorial water and (apparently) intentionally collided into the Japanese maritime security ship during its attempt to escape arrest.
China on its part conducted a Soviet-type propaganda, saying that it is the Japanese side which intentionally collided with the Chinese ship. But the video, which was taken by the Japanese side, proves the opposite.

2. China is interested in these islands not only for its national pride, but also for fishing, and oil and gas which may lie in the seabed of the Japanese EEZ (exclusive economic zone).

3. This time China wanted to justify its fishing, which was being done without consent of the Japanese side. It even detained several Japanese business people in an apparent attempt to pressurize Japan.

4. China has been showing similar forcible acts in South China Sea as well. To break the status quo in East Asia is tantamount to destabilization of the whole region. The access of the U.S. navy to the Indian Ocean and the Middle East will be thus blocked.

5. The West and Japan have been heavily investing in the Chinese economy. We have overdone it.
The Western investment companies will severely suffer, when the bubbly stock and real estate prices will crash. Our (I mean the West and Japan) production in China exacerbates the trade deficit and strips our own people of jobs. What is worse, our investments have strengthened Chinese armament and unleashed their desire to force their will on others.

6. It is a good thing that we keep lively economic relations with China, but it is time to stop the all-out transfer of our industry to China. The ASEAN countries and Africa will be able to take a lion's share in industrial production. The production cost in China is growing and their labor union is as strong as in the U.S.

7. A multinational arrangement (with Chinese participation) may be needed to keep the status quo in East Asia. Otherwise, China will easily deal with each country one by one.