Following Taiwan's announcement last week that it wanted to establish "special state-to-state" relations with China, Beijing reacted by blasting Taiwan's President Lee Teng-hui as a "sinner," revealing that it had neutron bomb technology and, if the rumors are correct, placing troops in one military district on a heightened state of alert.

Taiwan's stock market reacted by tumbling 506 points on Friday, a 6.4 percent plunge, the biggest drop in nine years and an indication of the power the unpredictable giant in Beijing has over Taiwan's affairs.

So the question in Beijing, Taipei and Washington is: Will China stop there?

"There is intense interest and concern about this situation," said a senior Western diplomat. "We are worried that things could get out of hand."

On the surface, it would appear to be in China's interests to adopt a low-key approach to Lee's move to abandon the "one China" policy, which has been the bedrock for Taiwan-China ties since relations began improving in the 1980s. Lee's move has not been welcomed internationally, and Beijing might benefit by exhibiting self-control, Western officials said. Already Beijing has won diplomatic points for adopting a wait-and-see approach and not immediately canceling the planned October visit of its top negotiator with Taiwan, Wang Daohan, to Taipei.

But the Taiwan issue in China sits at the core of the legitimacy of the Communist government. China views Taiwan as a renegade province and refuses to treat its democratically elected government as an equal in negotiations over Taiwan's future. China's position is that there is one China and its capital is Beijing. China also has attempted to strangle Taiwan diplomatically; it was partly this policy that prompted Lee to act.

China's political and military leadership is also engaged in a significant power struggle. And Lee's sudden about-face could play into the hands of factions pushing for a tougher line in Beijing.

For months now, hard-liners gathering around Li Peng, the former prime minister and most anti-American of China's top leaders, are known to have lobbied for a more aggressive and less pro-Western foreign policy. And China has veered sharply to the left on several other issues, including launching a political crackdown on dissent that is still continuing, scaling back bold economic reforms and suppressing religious activities.

Leftist Chinese scholars and officials close to Li have scored points by accusing President Jiang Zemin and Premier Zhu Rongji of selling out China to the United States--in Zhu's negotiations over China's bid to enter the World Trade Organization and in Jiang's efforts to cultivate close personal ties to President Clinton. And senior military officers have labeled the Ministry of Foreign Affairs the "ministry of selling out the country."

None of these accusations has been made public. And the closest many Westerners can get to the battle is by surfing chat rooms on government-approved Internet sites. But inside the walls of the Communist Party headquarters in Beijing's Zhongnanhai, there is an intense jockeying for power.

One Western official noted that the power struggle has immobilized China's foreign policy. No major decisions or moves are expected until after the Communist Party leadership returns from its annual August pilgrimage to Beidaihe, a seaside town 90 miles from Beijing.

But Chinese hard-liners have already been able to blame two foreign policy defeats this year on weak leadership. During the Kosovo crisis, Chinese views were all but ignored in the West because China is not a world player. And many Chinese firmly believe that NATO attacked China's embassy in Belgrade on May 7 because China is weak. Nostalgia for China's iron-fisted leaders, Mao Zedong and Deng Xiaoping, is rising. "This never would have happened if Mao were here," is heard commonly now in Beijing.

Given this environment, U.S. concern that China could do something rash is high, and sources say that over the coming weeks the Clinton administration will engage Beijing and Taipei in an effort to reduce tensions. The State Department has already announced that its "one China" policy has not changed.

One source said U.S. officials are concerned that Jiang and Zhu might be forced to sacrifice a more moderate foreign policy as part of a deal to allow them to continue economic reforms.

A motivation for the new U.S. policy is a desire to avoid the troubles of 1996, American officials said. Then, U.S. diplomats ignored a simmering problem between Taiwan and China until it erupted in the spring.

Beijing was infuriated by Lee's scheme to obtain an U.S. visa in 1995 and become the first president of Taiwan to visit the United States since Washington dropped diplomatic recognition in 1979.

China lobbed missiles into the ocean near Taiwan's shores. The United States dispatched two aircraft carrier battle groups to the region to calm Taiwan's fears and warn Beijing that it would not tolerate an attack on Taiwan. U.S. officials later acknowledged that China and the United States had come close to war.

"We don't want to go through that again," another Western official said.

CAPTION: An investor shares advice with others at the Taiwan Stock Exchange Wednesday, two days before the market tumbled more than 6 percent.