I hope things don't go any further than they have, but I have a bad feeling they will. China would be smart not to raise tensions further though, if this does deteriorate then the west will stop buying their crap and their economy will dive. If they do attack Japan though, it will turn into WWIII, as the US will be dragged in through their treaty, Australia through theirs and the rest of the world through general wanting to secure Oil/Natural Gas.
As others have stated though, China's military is rapidly modernizing but it is still far behind the US. Japan does have a military (well Self-Defence forces, but it is a military in all but name) with a Navy that is more than capable of defending Japan from China. But the big thing is China's Nuclear Weapon capability, there have been reports lately that they could have 1000+ more missiles than they've actually reported, much more advanced ones capable of striking the US. If Japan really needed to, it could have nukes in months, though, so that shouldn't be much comfort to China, seeing as Japan has a growing pile of Plutonium without a use with it's reactors shut down.
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