Well, that escalated quickly.

Key points: Global markets are being smashed after a rapid escalation in hostilities between the US and China over trade

Global markets are being smashed after a rapid escalation in hostilities between the US and China over trade The US declared China a 'currency manipulator' after the yuan suddenly fell in response to a new round of US tariffs

The US declared China a 'currency manipulator' after the yuan suddenly fell in response to a new round of US tariffs The immediate impact has seen $90b wiped off the ASX's value in two days and commodity prices, such as iron ore, tumble

Friday's fresh round of US tariffs on Chinese imports quickly morphed into a share market rout, then a Chinese retaliation with a sudden devaluation of the yuan and a ban on agricultural imports.

Almost immediately, there was another round of US retaliation and, you guessed it, soon enough another panicky rush to the exits on share markets around the world.

Even though Australia is not a direct participant in the trade battle, shares here weren't immune to the contagion, shedding around $90 billion in value over the past two days.

The Trump administration has wheeled out its 30-year old blunderbuss, The Omnibus Trade and Competitiveness Act of 1988, to fire off an accusation that China is a "currency manipulator".

Sounds bad, right?

Loading

Well, it certainly raises the temperature uncomfortably.

It also shows neither the US nor China is in any mood to compromise at the moment, but it may still be too soon to go into survivalist mode and stock up on canned food ahead of the trade war going nuclear.

Declaring a nation a "currency manipulator" has a certain severe ring to it.

The next step doesn't. As the US Treasury Department gravely intoned in its media release, "As a result of this determination, Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China's latest actions."

Well, that should do the trick. Bring the International Monetary Fund in on it.

Sudden devaluation undermines US tariffs

The US Treasury argues China has deliberately kept its currency weak for years, using its $US3 trillion-plus foreign reserves war chest.

While few would dispute China's central planners pull the levers on the yuan, most would argue its extraordinary stability is due to the Peoples' Bank of China propping up the currency in the face of massive capital outflows, rather than putting a lid on it.

Nonetheless, the sudden Chinese devaluation overnight, through the benchmark 7 yuan to the $US1 mark was all the evidence President Donald Trump and his Treasury Secretary Steven Mnuchin needed to prosecute their case.

"In recent days, China has taken concrete steps to devalue its currency," Mr Mnuchin's statement read.

"The context of these actions and the implausibility of China's market stability rationale confirm that the purpose of China's currency devaluation is to gain an unfair competitive advantage in international trade."

Bank of America Merrill Lynch currency strategist Adarsh Sinha said the message from China's central bank is clear — "the 7 level is not sacrosanct".

"The risk of escalating trade tensions, coupled with China's more limited recourse to retaliatory tariffs to engage in tit-for-tat responses to the US's tariff announcements, meant that yuan depreciation was the most likely policy weapon to offset US trade tariff escalation," Mr Sinha said.

"It should be evident that the currency manipulator tag would be meaningless when the US administration is threatening tariffs on all Chinese imports.

"China is likely to manage its foreign exchange policy as it sees fit, especially if it sees no near-term prospect for negotiation."

Rabobank's Michael Every points out the last time the US checked out China's currency manipulating status just a few months ago it didn't tick all three of the necessary boxes.

"Large bilateral trade surplus — tick; current account surplus as percentage of GDP — no tick; persistent intervention to weaken the currency — no tick," Mr Every said.

"Yet now the yuan is finally moving lower in line with its real fundamentals, it is labelled a manipulator. The irony!

The enduring strength of the Greenback is towards the top of Mr Trump's extensive list of grievances, as it challenges the competitiveness of manufacturers and farmers.

He has even floated the idea of a bit of currency manipulation himself, although the $US50 billion or so stashed away in the US Exchange Stabilisation Fund wouldn't go far in a fully weaponised currency war.

ASX, commodities tumble

The most obvious and immediate impact on Australia is the erosion of wealth stored in equity markets.

Around $90 billion in value has been vaporised from the ASX in just two days.

That may well accelerate as bad economic news now equates to bad market news, rather than the previously sunnier disposition of bad news leading to more rate cuts, leading to higher prices for risky assets such as shares.

Escala Partners chief investment officer Giselle Roux says the equity market's capitulation is entirely predicable.

"There's a confluence of issues and whole host of uncertainty; Trump, China, the Middle East, Brexit — they have been around for a while, but when something happens [like the new tariffs and and Chinese devaluation] it preys on the market's mind and confidence," she said.

"This could be seen as akin to the destabilisation of the Greek banks that lead to a messy meltdown [in 2010]. Trump and China, at the moment, is a reasonable parallel.

"The best people can expect now is a subdued performance [from the market], however the downside risks are far greater."

The growing hostility between the world's two biggest economies has long been one of the Reserve Bank's big worries for the Australian economy and it has constantly warned that the "risks to the global economy are tilted to the downside".

Those risks have tilted even more sharply in the past few days, and that is not good for an open, trade-dependent economy like Australia.

Iron ore prices immediately tumbled below $US100 a tonne for the first time since June.

Profitability in Chinese steel mills is back to being marginal and an escalation in the trade war will only make things worse.

What now?

CBA commodities analyst Tobin Gorey said, while China's currency move in particular is being interpreted as "digging in", it is not clear that China really has any choice.

"China's central bank, with a now weaker outlook for economic growth and a now greater chance of lowering interest rates, is perhaps more simply conceding that it cannot any longer hold the yuan below seven to the dollar," Mr Gorey said.

"This view suggests a weakening yuan is a trade dispute victim more than a weapon. The fall in the yuan though has, for now, stoked major worries for the Chinese and world economy.

"Vietnam War-like analogies about quagmires and lack of a clear plan for exit are starting to emerge."

The question is how deep is the quagmire.

Escala's Giselle Roux said China has little interest the yuan fall too far.

"It's not in China's interest to let it rip, given all the domestic pain it would cause and the problems in servicing its debt."

As the yuan ticked down again in morning trade, Rabobank's Michael Every is not so sure the devaluation is over.

"That obviously opens the door to the nightmare scenario of a downwards spiral in Chinese foreign exchange and simultaneous upwards spiral in US tariffs — which I have long flagged as all too possible under the Cold War scenario," Mr Every said.

"What will markets do? Crash. Equities are slumping. They will slump more. Bond yields are tumbling. They will tumble far more."

Oddly enough, the Chinese are doing US consumers a favour and taking some pain out of the higher cost of imported goods caused by the tariffs.

On RBC figures the 11 per cent slide in the yuan dating back to the start of the trade war rumblings last year has offset around 80 per cent of the impact of the tariffs.

"Thus, viewing the currency devaluation as a retaliation for the latest Trump tariff escalation seems wrong," RBC's chief economist Tom Porcelli said..

"It is more akin to an effort to try and offset the impact of tariffs on US consumers of Chinese goods, so as to protect market share."

It is all rather circular.

So how long will this steady increase in temperature run? Probably quite some time.

The hope is it will just simmer. Boiling over will be another level of pain altogether.