“Blocking foreign investment in U.S. assets where there is no real security threat, while demanding full access to foreign markets, smacks of ‘investment protectionism,’” the Cato Institute, a Libertarian think tank in Washington, D.C., says in a report. “If foreign governments are not allowed a wide range of investment choice in the U.S. they will take their business elsewhere. Without external financing, the U.S. current account deficit would not be sustainable. America would face a deep recession and the U.S. dollar would ultimately lose its status as the key reserve currency.”

If China wants to succeed in a global economy, one would imagine that it needs to establish a transparent legal system based on written and enforceable rules that will protect domestic and foreign investment. In short, China’s future depends on a system similar to the legal foundation of the economies in the U.S. and the West as a whole.

The Cato Institute says sovereign wealth funds now total about $3 trillion, a “tiny sliver of the $190 trillion stock of global financial assets or the $62 trillion managed by private institution investors.”

Democratic Senator Jim Webb of Virginia takes the Trojan horse side of the debate and warns: “While foreign governments may invest money in our country to make a profit, they may also do so in order to further their foreign policy ambitions, to acquire national security assets, or to purchase a stake in strategic industries.”

The U.S. economy is bedeviled by a low savings rate and an exploding fiscal deficit. Don’t bet on presidential candidates John McCain or Barack Obama to reduce the size or cost of government.

Concern about sovereign wealth funds may degenerate into protectionism wrapped in national security. No one suggests vigilance should take a holiday, but killing foreign investment would gut the U.S. economy and erode the individual freedom that has built the American Dream. Major American companies, including Caterpillar (CAT), Coca-Cola (KO) and Boeing (BA) earn significant revenue overseas.

One might ask: Why does everyone underestimate the shrewd Yankee trader who outsmarted a top Japanese company on the sale of Rockefeller Center?

Abu Dhabi Investment Council, take note.