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US officials made it clear earlier this week (via an anonymous leak) that the US wouldn't hesitate to counter the PBOC's decision to pump more liquidity into the Chinese financial system - a decision that, incidentally, also helped push the yuan even closer to policy makers' "red-line" level of 7 yuan to the dollar - by returning China to the Treasury Department list of currency manipulators, a decision that would make Beijing eligible for further sanctions (and presumably justify a round of competitive devaluations that could escalate into a global currency war).

But if Chinese officials didn't get the message, Treasury Secretary Steven Mnuchin (who almost certainly approved the "leaks" from "senior officials" inside his department) left little room for uncertainty in an on-the-record interview with the Financial Times, where he warned that the US would be monitoring Chinese policy "very closely" for any signs of competitive devaluations meant to offset the impact of President Trump's tariffs on roughly half of Chinese goods entering the US. 

FX

Mnuchin refused to discuss the Treasury's upcoming currency report, and he didn't specifically reference currency manipulation,  but the implication was clear: If China allows (or even actively encourages) the yuan to sink past its red line, then the US will insist that an agreement against currency manipulation be a part of whatever trade accord is produced (assuming there is one). And assuming no agreement is reached, the US will do what it needs to do to make sure that US tariffs on Chinese goods are maximally effective.

Steven Mnuchin said in an interview with the Financial Times that the Treasury monitored currency issues “very carefully” and noted that the Chinese renminbi had fallen “significantly” during the year, adding that he wanted to discuss the currency with Beijing as part of trade talks.

He acknowledged there were several drivers behind the falls in the renminbi, including the country’s own economic issues.

"As we look at trade issues there is no question that we want to make sure China is not doing competitive devaluations," he said ahead of meetings of the G20, IMF and World Bank in Bali, Indonesia.

To be sure, Mnuchin, who was speaking during an IMF-World Bank meeting in Bali (where no trade discussions are expected to be held even though Mnuchin and China's top trade envoy will both be present - though, of course, that could always change), did clarify that some of the renminbi weakness this year has been the result of domestic economic factors in what sounded like a swipe at China. 

"The renminbi has depreciated significantly during the year. There are various factors for that which we look forward to discussing with them," said Mr Mnuchin. "One of those factors has to do with their own economic issues and what has gone on in the Chinese economy."

Mnuchin also obliquely criticized what Mike Pence referred to as China's "debt diplomacy" when he said that any recipients of IMF bailouts would need to be "transparent" about their debt exposure.

Mnuchin

While Mnuchin's remarks were relatively circumspect, an anonymous official quoted by the  South China Morning Post expanded on his warnings and offered a candid update on the status of trade negotiations. With less than two months to go before the G-20 summit in Buenos Aires, when it comes to the US and China, "nothing has changed."

"Our view is that when they are ready to have meaningful discussions about correcting the trade imbalances and the structural issues we have in the relationship, we’re willing to talk," the official said.

The US is "concerned" with moves in the yuan because it fears that China is turning away from "market-oriented" mechanisms for managing their currency and exerting an increasing level of government control.

"We continue to closely monitor developments in the RMB; we remain concerned about the recent depreciation of the RMB," the official said.

"More broadly, we’re concerned about China’s turn away from more market-oriented policies and continued reliance on non-market mechanisms that impact the macroeconomic and trade environment," he said.

No major trading partners were named to the currency manipulators' list when the Treasury released its last report in April, though China and a handful of other countries were included on a "monitoring list" because they met at least two of the three criteria to be considered currency manipulators.

If this outlook changes, or if China is formally named a currency manipulator, the relationship between the two economic powers could deteriorate further, increasing the risk that these economic skirmishes could spill over into a military conflict.

Trade