The US Treasury Department's clock is ticking as China finally reached its limit after the currency of the second largest economy "so easily fell into the abyss" on Monday. The Treasury decided to tap into an extra lever in the trade confrontation by labelling China as a currency manipulator. This has not happened since the Clinton administration, despite plenty of clear signs, such as lack of free capital flow or existence of a proxy for the free foreign exchange market - offshore renminbi. But, what are the consequences and penalties for PRC?

According to the Treasury, the head of department, Stephen Mnuchin, determined on Monday that China is a currency manipulator. Further to this, it plans to develop measures, together with the IMF, to eliminate the unfair competitive advantage created by the country's recent actions. Just a couple of weeks ago, the Treasury refused to designate China as a currency manipulator as the country met only one criteria of violation. “Concrete actions in recent days” that is, sharp CNY depreciation starting from August 1, while preserving ample gold and foreign exchange reserves, according to the Treasury, suggests that the renminbi sagged artificially. I guess the Treasury implicitly suggests that having ample foreign exchange reserves obliges country to defend its currency during the rise of a pressure but, the PBOC let the Yuan depreciate and this was precisely the trigger. The extent to which the Treasury was impartial making accusations against China remains pretty controversial for me.

In addition, the Ministry of Finance believes that PBOC “openly acknowledges” the fact of controlling the exchange rate, citing as an example, the following statement published by the Chinese Central Bank on Monday: “[PBOC] has accumulated rich experience and policy tools and will continue to innovate and enrich the control toolbox and take necessary and targeted measures against the positive feedback behavior that may occur in the foreign exchange market.”

Devaluing of a national currency is seen as a form of protectionism since it punishes importers and encourages exporters. In the context of the trade confrontation between the US and China, the renminbi devaluation is regarded as a way of “revenge” of China. However, setting the reference rate by the Chinese Central Bank on Tuesday at a stronger-than-expected level for the renminbi indicates a cautious use of the instrument, that is, full-scale realization of revenge does not occur.

American law offers three criteria for determining currency manipulators among trading partners: material trade deficit in trade with the rest of the world, significant trade deficit with the United States and constant unilateral intervention in the dollar exchange rate against the national currency of the country. If China is recognized as a currency manipulator, as it was in 1994, the US government can completely exclude Chinese suppliers from the government tender market. So-called countervailing duties may also be provided for those goods which producers could benefit from cheaper Yuan. There is also a possibility that Trump will use “national emergency” loophole to order the Treasury directly intervene dollar exchange rate, that is, engage in full-scale currency war.

But, targeted duties remain the most likely option of the penalty. With current level of tariffs imposed on China, this will hardly bring more deterioration to the soured relations between the two countries.