The miller says that he saw "the two of them" naked by the waterfall in the valley. He also saw the red-beaked ravens, which seemed disturbed. The miller went to see what disturbed the birds and came upon the "interpreter" (Luo) and the Little Seamstress having sex in the deep part of the natural pool. He says he felt ashamed. He'd never seen anyone have sex while swimming, and he was very aware that because he's old, he'll never experience sex like that.
By bringing in another person's first-person perspective, the narrator reasserts the importance of storytelling. It's implied that the narrator is listening or transcribing the miller's story, and the narrator specifically is confronted with a downside of growing up: no longer being virile. Because of this, this passage shows the beginning, middle, and end of maturity.
Luo and the Little Seamstress swam out of the water, and the Seamstress fashioned a loincloth of leaves. Luo lounged in the sun while the Little Seamstress climbed the rocks around the pool. She climbed up to a tall rock and the miller secretly admired her body. The ravens returned and settled around her, but she brushed them aside and dove into the pool. The miller thought that he recognized Luo, and he finally realized later that he was the interpreter who accompanied the narrator to visit the mill.
The miller's tale shows that even when Luo and the Little Seamstress are together, the Little Seamstress is beginning to also seek independence, as she dives without Luo. The diving hearkens back to Jean-Christophe, as it seems to be something she does for herself to fulfill her own needs and desires.
The miller tells the narrator that it's lucky for Luo that it was he who saw Luo and the Little Seamstress, as the miller has never reported anyone to the Public Security Office. He insists that if anyone else had seen them, they'd be in major trouble.
This is a somewhat unsettling end to the miller's tale, despite his assurance that he won't report the Little Seamstress and Luo. The discovery that the two are doing something wrong in the eyes of the law creates a sense of foreboding.