A truce in global currency wars?

Financial markets wobbled this week in response to a more than 7% fall in Japanese stocks in a single day.

But investors seem now to have decided that the ructions in Japan are more a problem for the Japanese prime minister and his radical economic policies than they are problems for the whole world.

If they want something to worry about, those same investors might want to worry about why they have decided the eurozone crisis has been solved - despite having very little hard evidence to back this up (see, for example, the cover of the latest Economist).

But that is another matter.

Before this week, Prime Minister Abe's policies had had a dramatic effect on Japanese stock markets, and on the Japanese exchange rate, which has fallen 20% against the dollar and the euro in the past six months.

When Mr Abe was elected, there were mutterings about how other economies would react to this dramatic effort to boost Japan's competitiveness - at a time when plenty of others are trying to export their way out of trouble as well (see this previous blog entry).

But since then the slide in the yen has produced barely a ripple.

Does that mean that all the talk of global currency wars has been overdone?

Not exactly. But though they have dithered on most things, G20 policy makers do seem to have been able to agree on what counts as an act of international economic hostility, and what is more like friendly fire.

This was brought home to me, recently, at a private seminar on the subject that I chaired at Chatham House.

I can't quote any of the people there directly, but I can say there were some very respected economists around the table, as well as current and former senior officials from both sides of the Atlantic.

Nearly everyone agreed that in a reasonable world, countries should be able to pursue monetary and fiscal policies that are appropriate for their own domestic circumstances without being accused of waging "currency war".

But, of course, some policies have more international consequences than others - especially those which, like Japan's, are expressly designed to boost the country's competitiveness relative to others.

How do you prevent a domestic reflation policy coming off as a 1930s-style attempt to "beggar thy neighbour"?

This has been one big question of the past few years. But you'll be glad to hear that various G20 and G7 meetings have now come up with the following implicit rules of the road:

Rule one is that you get to have your own monetary policy.

But rule two is that you don't get to strengthen that policy with an explicit mention of the exchange rate. It might be an indirect consequence of your monetary policy but you don't get to harden that connection or talk about it.

Of course, this leaves plenty of room for interpretation: what the Fed calls quantitative easing, Brazil's finance minister has often dubbed competitive devaluation.

But the answer that Ben Bernanke would give to Brazil is that a policy undertaken entirely with domestic assets cannot properly be called an act of currency war.

On this view you could say that China and other Asian economies who buy vast quantities of foreign assets to keep down the value of their currencies and maintain their competitive position are currency warriors.

If the Bank of Japan had gone ahead with buying foreign bonds as part of its new reflation policies, that would probably have been considered bad faith as well.

But, if you're not mentioning the currency explicitly or using foreign assets to meet your goals, the international community appears to have decided that aggressively loose monetary policy is OK, even if it has the effect of tanking the exchange rate.

There is a final rule - which is really an exception to the one about not mentioning the exchange rate.

This says that if you are a small and very open country whose exchange rate is clearly overvalued as a result of international events beyond your control, then you're allowed to talk about the currency and take explicit measures to bring it down.

In other words, if you're like Switzerland - you can do something similar to the Swiss.

Does all this mean we will have no more talk of currency wars? I doubt it.

If and when global imbalances start to creep up again, surplus countries with fixed exchange rates policies and massive foreign reserve pots are likely to once again come under pressure to change course.

But the bottom line - for now - is that the world has decided to agree with the Fed chairman Ben Bernanke that the super-loose monetary policies being followed by Japan, the US, the UK and the rest are not zero sum "beggar-thy-neighbour" policies but "enrich-thy-neighbour" policies which, if successful, will leave everyone better off.

Let's hope he's right.