By intervening in the currency markets to weaken the yen, Japan risks rewriting one of the unwritten rules of international finance.
Japan moved forcefully into currency trading Wednesday, selling hundreds of billions of yen against the U.S. dollar to push the high-flying yen lower and provide a boost to its flagging export-driven economy. The move sent the yen down 3 per cent against the greenback.
The decision will have repercussions far beyond currency markets.
Japan was crucial to the U.S.-led consensus among the Group of Seven rich industrial nations in support of freely floating exchange rates. As an Asian power that had resisted manipulating foreign-exchange rates for six years, Japan was proof to China and other emerging markets that an export-oriented economy can function while letting investors and traders determine the value of its currency.
But Japan's currency intervention throws a wrench into the floating-currency consensus. The move puts further strain on efforts to co-ordinate global economic policy within the larger Group of 20 nations, which pledged this summer to work together to try to spread demand evenly around the world.
Critics of the free-market approach to exchange rates welcomed Japan's apparent abandonment of that orthodoxy. "The Bank of Canada should do the same thing," said Erin Weir, an economist at the United Steelworkers union in Toronto, who has argued that officials in Ottawa should intervene to weaken Canada's dollar. "Japan's actions confirm my point that currency devaluation is a viable option."
Japan's break from the G7 position on exchange rates is an echo of the "beggar-thy-neighbour" policies of the Great Depression, where governments actively sought a trade advantage at the expense of other countries, said Desmond Lachman, a former economist at the International Monetary Fund who is now a resident fellow at the American Enterprise Institute for Public Policy Research in Washington.
"The Japanese move makes a lot of sense from the Japanese point of view," Mr. Lachman said on a conference call with reporters. "What it highlights is that we might be moving into a realm where it's not only China, but other countries that will be making these moves."
In a report to clients, economists at Montreal-based brokerage Brockhouse Coopers noted that "in a world where every country appears to want a weak currency that favours exports, the Bank of Japan's intervention will probably not be welcome by most of its trading partners."
Japan's intervention had the look of political expediency.
Prime Minister Naoto Kan, who overcame a challenge to his leadership of the ruling party only a day earlier, spoke to reporters about the decision - a contrast to Japan's approach earlier this decade, when the Bank of Japan was much more circumspect.
In his campaign against Mr. Kan, rival Ichiro Ozawa made an issue of the harm the yen's surge to a 15-year high against the dollar was doing to Japan's export-driven economy.
"The Japanese are desperate to preserve what export drivers of growth they have given their problems with domestic demand," said Wendy Dobson, co-director of the Institute for International Business at the University of Toronto's Rotman School of Management and a former associate deputy minister in Canada's finance department.
Japan's intervention coincided with a two-day hearing by the U.S. House Ways and Means Committee on China's currency policy, a sensitive issue for the Obama administration, which is trying to put pressure on the Chinese government to loosen its tether on the yuan while at the same time keep lawmakers' appetite for retaliation from sparking a trade war.
U.S. Treasury Secretary Timothy Geithner, who is scheduled to testify at the committee Thursday, had no comment on Japan's move, according to his spokeswoman. In Switzerland, Jean-Claude Junker, who chairs meetings of finance ministers from the euro zone, told reporters that "unilateral actions are not the appropriate way to deal with global imbalances," according to a report by Reuters.
The commitment to unfettered exchange rates already was waning because of the financial crisis. The Swiss National Bank intervened heavily to weaken the franc against the euro, and the International Monetary Fund, in a reversal, said emerging market nations could be forgiven for attempting to limit rapid appreciation of their currencies by attempting to slow the inflows of international capital.
"There is a Group of Seven consensus about this, and Japan went along, but that commitment clearly has limits," John Williamson, an expert on exchange rates at the Peterson Institute for International Economics in Washington. "The consensus around unmanaged floating exchange rates is fading slightly," Mr. Williamson said. "The previous bill of goods was oversold."
That might be going too far. Tim Adams, a former undersecretary for international affairs at the U.S. Treasury department, said Japan's justification for intervening was to tame excess volatility, which he said is consistent with G7 policy. "I don't see this as beggar-thy-neighbour, per se," Mr. Adams said. "There's been much less of that than I might have expected to see."
But it does argue that the unity the G20 showed in the immediate aftermath of the financial crisis continues to fray. "We are seeing the shuttering of the international consensus," said Domenico Lombardi, a non-resident senior fellow at the Brookings Institution in Washington. "Each country is now doing what it sees fit for its national circumstances."