Completely false. It's the first time a US company has been designated a supply chain risk. Now the likes of Boeing can't use them. Health companies with Medicare/Tricare contracts don't know and will hold off until it's fully litigated.
This is not the government saying they're going with a different vendor, it's the government saying everyone has to choose to either have federal contracts or Claude, they can't have both.
The line of reasoning is more like this: if you make and sell safe-cracking tools then it would not be unreasonable for the government to regulate it so only registered locksmiths could buy it. You don't want people profiting from the support of criminal acts.
The government could similarly argue that if a company provides communication as a service, they should be able to provide access to the government given they have a warrant.
If you explicitly create a service to circumvent this then you're trying to profit from and aid those with criminal intent. Silkroad/drug sales and child sexual content are more common, but terrorism would also be on the list.
I disagree with this logic, but those are the well-known, often cited concerns.
There is a trade-off in personal privacy versus police ability to investigate and enforce laws.