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Trump Administration Floats Sale of Arms, Jets to Taiwan

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In a move that could strain already fragile China-US ties, the Trump administration floated the potential sale of fighter jets to Taiwan. In an $8 billion deal, Lockheed Martin (LMT) plans to sell 66 F-16 fighters to Taiwan. The deal is now sent to the US Congress for approval.

Apart from the jets, the deal would also include nine spare GE (GE) engines for the F-110 jet. Although most other similar F-16 jets use Pratt and Whitney engines, Taiwan opted to go with these GE engines.

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In a separate $2.2 billion deal, the US State Department cleared the sale of 108 General Dynamics (GD) tanks and Raytheon (RTN) Stinger missiles to Taiwan yesterday. China was quick to retaliate by threatening sanctions of these companies. China may also threaten Lockheed Martin and GE with sanctions. GE is already facing pressure the markets regarding its long-term care insurance programs. These potential sanctions could dent the company, as it derives significant revenues from China.

Mainland China and Taiwan: It’s complicated

Both Taiwan and Mainland China refer to their respective countries as China. Formed on the mainland in 1912, Taiwan refers to itself as the Republic of China (or ROC), and the mainland calls itself the People’s Republic of China (or PROC). After World War II, civil war broke out on the mainland, and the ROC government moved to Taiwan.

Led by Mao Zedong, the Communist Party of China formed the PROC in 1949. The ROC believes that the PROC is illegally occupying the mainland. However, the PROC believes that it is the legitimate China and doesn’t consider Taiwan a separate country. As a result, the PROC considers the potential arms sale to Taiwan by the US as a threat to its sovereignty.

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Why is the US selling arms to Taiwan?

Nineteen countries recognize Taiwan as a country from the PROC. The United States recognized Taiwan as a separate country until 1979, when it shifted its diplomatic recognition to the PROC.

Although the US doesn’t recognize Taiwan as China, it maintains a relationship with the region governed by the 1979 Taiwan Relations Act (or TRA). The act effectively gives Taiwan sub-sovereign status and mandates that any defense-related decision about Taiwan must be approved by Congress.

Previous US administrations have sold arms to Taiwan while operating within the scope of the TRA. However, this $8 billion sale is significant.

Why now?

As the US and China are engaged in a bitter trade war, both sides have used a variety of tactics to gain an edge in the trade dispute. Trump has used tariffs as a negotiating tool while China has flexed its muscles, using rare earth minerals, the devaluation of the Chinese yuan, and the stock of Treasuries as cards in this global game.

Approving the sale of arms and jets to Taiwan during the trade war could be Trump’s way of negotiating. However, this tactic risks prolonging the trade war.

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Could this tactic backfire?

Both the US and China have been impacted by the ongoing trade war. The manufacturing PMI (purchasing managers’ index), considered to be a leading economic indicator, is flirting with the contraction threshold in both economies.

The US manufacturing PMI came at 50.4 in July, just over the contraction threshold. China’s manufacturing sector remained in contraction mode in July with a PMI reading of 49.9. A PMI of 50 is the border between contraction and expansion.

The global economy is also hurting from the trade war between two of its largest economies. The S&P 500 (SPY) has retreated from its all-time high with JPMorgan Chase and others sounding market crash warnings in the current quarter.

Although its economy is visibly hurting from the trade war, China has shown resilience against Trump’s tariff threats. Last week, Trump was forced to delay tariffs on some Chinese goods while abolishing tariffs on others. Now, the 10% tariffs on cellphones, certain electronics, and consumer items have been postponed until December 15.

Trump has already warned that China’s crackdown in Hong Kong could diminish the prospects of a trade deal. In our view, angering China by making such a massive defense deal with Taiwan at this time could only exacerbate the trade war.

Could this turn into a military conflict?

At a time when China’s economy is slowing and protests in Hong Kong are catching the world’s attention, the possibility of full-fledged military conflict in Taiwan seems low. China risks being cornered by doing so. However, China’s borderline belligerence in the region could keep the world on its toes.

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