Few Taiwanese politicians have a stronger pedigree in the ruling Kuomintang, or Nationalist Party, than Chen Li-an, 58. Chen's father served as vice-president under Generalissimo Chiang Kai-shek after the KMT's 1949 retreat from mainland China. Following in his father's footsteps, the younger Chen quickly rose through the ranks of key government posts.

But on Aug. 17, just two days after China launched a new round of military exercises in waters north of Taiwan, Chen shocked his compatriots by announcing he would defect from the KMT and oppose its candidate, President Lee Teng-hui, in elections next March. Sitting in his Taipei office in front of a statue of the Buddhist goddess of mercy, Chen says he made his bold move in part because Lee's triumphant visit to the U.S. in June has backfired, drawing Chinese wrath. "The military demonstrations make all of us think how we can avoid making mistakes we all will regret," he says.

CROSSFIRE. Chen's defection is just one of the shock waves China is sending through Taiwan, which Beijing regards as a renegade province (table). Since the People's Liberation Army announced in July that it would begin firing missiles near Taiwan, the local stock market has plunged 12%. The New Taiwan dollar has hit a four-year low of 27.45 against the greenback. Economic growth forecasts have been scaled back half a percentage point, to 6.5%. "No measures to upgrade the Taiwan economy can proceed under the present circumstances," says John Nelson, head of investment research for Jardine Fleming Taiwan Securities Ltd.

China's exercises, involving naval and air units and live artillery drills just 95 miles from Taiwan, are a problem for more than just the island's 21 million people. Japan and Southeast Asia already have been jarred by China's underground explosion of a nuclear device this summer and by its expanding claims in the South China Sea. Former U.S. Ambassador to China James R. Lilley says Beijing's action will cause "an escalation in the arms race all over Asia."

The Chinese saber-rattling also spells trouble for U.S. policymakers. Though Boeing, Ford, Lockheed Martin, AT&T, and other U.S. companies are proceeding with new sales or deals, the Clinton Administration is caught in a bipartisan crossfire over managing relations with the Chinese. That has left it zigzagging between conciliation and confrontation. For now, the Administration takes a sanguine view of events in the Taiwan Straits. Officials in Washington say there is no prospect that China will actually blockade or invade Taiwan.

GROWING SPLIT. But in Beijing, Western analysts say the Chinese are preparing for months of steadily intensifying military pressure against Taiwan. That's partly because Communist Party boss Jiang Zemin and other leaders are rallying around the cause of reunifying with Taiwan as part of their maneuvering to succeed paramount leader Deng Xiaoping. An immediate goal is to influence voting in Taiwan's presidential elections next March. The Chinese suspect that Lee and other Taiwan-born politicians are leading the island away from eventual reunification and will formally assert its independence. As Taiwan basks in affluence, the cause of greater international recognition is increasingly popular among voters and cuts across both generational and political party lines.

Beijing-based diplomats expect the Chinese to keep ratcheting up the pressure to dissuade voters from supporting Lee and to put the brakes on a budding independence movement. "They'll continue with exercises until at least March, and maybe have a big one right before the election," says one Western military attache. This could anger Taiwan's powerful supporters in Congress, inflaming Washington's perennial China debate. "We have a moral obligation not to abandon Taiwan," says Washington hard-liner Frank J. Gaffney Jr., director of the Center for Security Policy. "We have a strategic interest in not acquiescing to Beijing's expansionist impulses."

By manipulating Taiwan's politics, China hopes to expand a key fissure inside the KMT between politicians with family roots on the mainland and their Taiwan-born colleagues. The mainlander contingent worries that Lee's attempts to rejoin the U.N. and gain international recognition mean that he secretly supports taidu, or complete independence for Taiwan. Lee, who just weeks ago seemed a shoo-in to win the March election, now faces deepening opposition as a result of the growing split. While he still leads in opinion polls, his numbers fell from 45% to 37% after Chen's bombshell announcement.

There are also huge business stakes in the face-off between China and Taiwan. Taiwanese companies have invested more than $20 billion in China, and they increasingly fear Beijing will take those investments hostage. Applications for major investment projects on the mainland have dropped 40% in a month.

Taiwan executives are looking for ways to persuade Beijing to soften its military tactics. On Aug. 14, two of Taiwan's Cabinet ministers met with several of Taiwan's most powerful business leaders to find ways of jump-starting a dialogue with Beijing. "We still have leverage with our investments," says Parris Chang, a legislator with the Democratic Progressive Party, the leading opposition party and a major advocate of independence.

But the leverage may not work. Because of the nationalist mood in Beijing, the Chinese seem willing to accept economic hardships resulting from a pullback by Taiwanese investors. "China is saying they're willing to bite that bullet, to lose investment along the coast," a Western diplomat in Beijing says. "They're saying that Taiwan is an overriding issue of sovereignty."

GOOD BUY. A surprising number of foreign investors in Taiwan argue that the crisis will simply pass. To them, the panic among local, mostly individual investors has made the Taiwan stock market an attractive buy. On Aug. 21, Salomon Brothers Inc.'s weekly research report advised investors to triple their Taiwan equity holdings, from 2% to 6% of their Asian portfolios. "Most people are looking at this as a short-term phenomenon," says Timothy Greaton, fund manager for Credit Lyonnais International Asset Management Hong Kong Ltd. In mid-August, he beefed up the Taiwan percentage of his Greater China Fund from 15% to 20%.

But most of Taiwan's residents aren't so confident. By trying to influence the elections in Taiwan, Beijing is playing a dangerous game. "Once Communist China starts, I don't think they'll stop," says Jaw Shau-kong, a mainlander politician who also has defected from the KMT to become secretary-general of the rival New Party.

Clearly, the problem isn't going away. Taiwan's growing assertiveness and China's increased willingness to use military means to intimidate the island appear to be long-term trends fundamentally at odds with each other. The dangers of accidents or miscalculations can only grow. If the voices of independence in Taiwan make big gains, the U.S. and East Asia could get caught up in a new and potentially dangerous stage of confrontation across the Taiwan Straits.


-- Creating a crisis within the ruling Kuomintang over policy toward China

-- Forcing the government to reconsider its high-profile campaign to win broader international recognition

-- Contributing to a 12% decline in Taiwan's stock market

-- Creating new tensions regarding Taiwan's investments on the mainland, forcing Taiwan companies to shift investments to Vietnam, the Philippines, and Indonesia

-- Preventing the establishment of direct air and shipping links between Taiwan and China


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