Is China ready to be a real force in the world?
The Chinese government can do whatever it wants, it has been doing so for many many years. So the obvious reaction to Google's letter would be to let Google leave. But that would be 'business as usual', and quite frankly boring and the blatantly stupid move.
What if China played its hand wisely?
If China sat down with Google, facilitating the situation and making some small concessions (i.e. to help track down the hackers, or facilitate in stopping the hacks from taking place). This would be a brilliant strategic move on China's part.
It will show the world, more importantly the prominent companies of the mature economies, that China is willing to facilitate to their needs (to a certain degree). But these concessions are made in such a way, that the Chinese government still maintains its tight control, but simply eases on its 'shadow control'. (Control typically not seen via the media outlets and the general public, but we were all given a peek at via the Google Letter.)
This should be China's play here. If they are as smart as I keep reading about, this is what they will do, if not more.
There is a win/win scenario here, I just hope egos do not prevent the best scenario from happening.