The Downing Street Years, 1979-1990

by Margaret Thatcher

House prices were rising sharply. MO was still growing too fast — outside its target range. The forecasts of inflation were constantly being revised upwards, though they still turned out to be too low. For example, in the September 1988 monthly Treasury Monetary Assessment inflation in March 1989 was forecast at 5.4 per cent. In October’s note the forecast was 7 per cent. (In fact it turned out to be 7.9 per cent.) So as 1988 drew to a close — and although unemployment was down and growth and incomes were well up — there was trouble ahead.

  It is on the face of it extraordinary that at such a time — November 1988 — Nigel should have sent me a paper proposing an independent Bank of England. My reaction was dismissive. Here we were wrestling with the consequences of his diversion from our tried and tested strategy which had worked so well in the first Parliament; and now we were expected to turn our policy upside down again. I did not believe, as Nigel argued, that it would boost the credibility of the fight against inflation. In fact, as I minuted, ‘it would be seen as an abdication by the Chancellor when he is at his most vulnerable.’ I added that ‘it would be an admission of a failure of resolve on our part.’ I also doubted whether we had people of the right calibre to run such an institution. As I told Nigel when he came in to discuss his paper, I had thought in the late 1970s about having an independent central bank but had come down against it. I considered it more appropriate for federal states. But in any case there could be no question of setting up such a bank now. Inflation would have had to be well down — to say 2 per cent — for two or three years before it could be contemplated.

  In fact, I do not believe that changing well-tried institutional arrangements generally provides solutions to underlying political problems — and the control of inflation is ultimately a political problem. It can be kept down if you have the will to do so, as the Germans do because of their bitter experience of hyperinflation. We too could have kept it down if we had pursued a sufficiently tight monetary policy — without an independent central bank. What perhaps I should have taken more notice of, however, was that this proposal of Nigel’s showed his attitude to the economic difficulties now clearly visible on the horizon. He wanted to pass the responsibility for them to something — or someone — else.

  The year 1989 — Nigel’s last as Chancellor — was a time of increasing political difficulty for me. It was the tenth anniversary of my becoming Prime Minister — an anniversary which I insisted should be kept as low-key as possible but which was inevitably the occasion for unflattering reviews in the press designed to leave the reader with the strong feeling that ten years of me was quite enough. It was also a time of very high interest rates — 13 per cent in January, 14 per cent from May and 15 per cent from October — and with inflation still rising and the forecast figures apparently inexorably rising too. The trade figures continued to be bad, especially July’s, which undermined confidence and weakened the pound. Alan Walters’s view was that there was now too tight a monetary squeeze which would push the economy into a serious recession. In particular, he strongly advised against raising interest rates to 15 per cent, as Nigel wanted in response to a rise in interest rates in Germany. Alan was right. But I went along with Nigel’s judgement and up went interest rates again. It is perhaps sufficient comment on the later allegation that I was undermining the Chancellor’s position by not dismissing Alan Walters, that I backed Nigel against Alan’s advice and against my own instincts just days before Nigel walked out.

  THE DELORS REPORT ON EMU

  Apart from the conduct of monetary policy, there were two economic issues of substance which concerned us during this period. On the first — the ERM — Nigel and I were sharply at odds. On the second — European Economic and Monetary Union (EMU) — we were in complete agreement.

  As a result of the Hanover European Council in June 1988 a Committee of European Community central bank heads — serving in a personal capacity — had been set up under the chairmanship of Jacques Delors to report on EMU.[98] Nigel and I hoped that together Robin Leigh-Pemberton, Governor of the Bank of England, and Karl Otto Pöhl, President of the Bundesbank, would prevent the emergence of a report which would give momentum to EMU. Herr Pöhl we considered strongly hostile to any serious loss of monetary autonomy for the Bundesbank and Robin Leigh-Pemberton was in no doubt about the strength of our views — and indeed those (at this stage) of the great majority of the Parliamentary Conservative Party and of the House of Commons. Our line was that the report should be limited to a descriptive not a prescriptive document. But we hoped that paragraphs would be inserted which would make it clear that EMU was in no way necessary to the completion of the Single Market and which would enlarge upon the full implications of EMU for the transfer of power and authority from national institutions to a central bureaucracy.

  Nigel and I had met the Governor on the evening of Wednesday 14 December 1988 and urged him to make all these points in the discussions on the text which ensued. We saw the Governor again on the afternoon of Wednesday 15 February. What we had seen of the draft report seemed thoroughly unsatisfactory, along lines known to be favoured by M. Delors who was clearly making the running. Nigel and I wanted the Governor to circulate his own document; but when this appeared it was something of a mouse. Most damaging of all was that Herr Pöhl’s known opposition to the Delors approach simply was not expressed.

  Whatever the Governor may have done proved ineffective. When the Delors Report finally appeared in April 1989 it confirmed our worst fears. From the beginning there had been discussion of a ‘three-stage’ approach, which might at least have allowed us to slow the pace and refuse to ‘advance’ further than the first or second stage. But the report now insisted that by embarking on the first stage the Community committed itself irrevocably to the eventual achievement of full economic and monetary union. There was a requirement for a new treaty and for work on it to start immediately. There was also plenty of material in the treaty about regional and social policy — costly, Delorsian socialism on a continental scale. None of these was acceptable to me.

  THE AMBUSH BEFORE MADRID

  Whatever problems the Delors Report raised, it won few friends at home. However, Nigel and then Geoffrey used it to reopen the argument about the ERM. Nigel argued at our meeting on the afternoon of Wednesday 3 May that we should now enter the ERM. I replied that the overriding priority must be to get down the rate of inflation and it would be quite wrong to adopt the objective of exchange rate stability. This is what we had done when we had been trying to shadow the deutschmark, and it had compromised our battle against inflation. I did not believe that the Delors Report on EMU altered the balance of argument on the ERM. On the contrary, we should certainly not be drawn further into a European system that would almost certainly change following the Delors Report. I did not accept the premise that it was necessary to join the ERM in order to prevent developments in the Community which we did not like. I thought that the idea of setting a target date for joining some time in the future would be particularly damaging. Nigel disagreed. But I said that I did not want the issue of UK membership of the ERM to be raised at this stage.

  This did not mean that I was giving no thought to it. Indeed, a few days later Alan Walters sent me a paper entitled ‘When the time will be ripe’, spelling out the conditions which must be met before we would join. He suggested that all the constituent countries must have abolished all foreign exchange controls and the legal machinery through which they were imposed. All domestic banking systems and financial and capital markets must be deregulated and open to competitive entry from EC countries. Any institution, corporation, partnership or individual must be free to enter any banking or financial business, subject only to minimum prudential conditions.

  These were bold suggestions. On the one hand, they would certainly give our position a much more positive aspect. The moves against corporatism in France, Germany and Italy would be valuable in their own right. Whether the ERM could for long stand the removal of all these controls, which helpe
d give it a false stability, was to be seen. The difficulty of Alan’s approach, of course, was that it did not remove the fundamental objections which both he and I had to the system of semi-fixed exchange rates which the ERM constituted. But in the end I knew that Alan’s ingenious suggestion might be the only way in which I could resist the pressure from Nigel, Geoffrey and the European Community for early entry.

  Leon Brittan — now Vice-President of the European Commission — came to see me soon afterwards to try to persuade me of the benefits of ERM membership. He argued that it would give us an important say in the next steps of economic and monetary co-operation. Indeed, he said that it would enable Britain to dictate the pace and course of further progress in this area. He had apparently been reinforced in this view by a remark made to him by M. Delors over dinner to the effect that ‘if she joins, she wins.’ I was not, however, overimpressed by the European Commission President’s table-talk. I said that I did not believe that those who wanted to advance along the route mapped out by the Delors Committee on EMU would be deterred from pressing ahead by British membership of the ERM. And so, of course, it proved.

  My relations with Nigel went through another difficult patch in May when an interview I gave to the World Service came indiscreetly close to admitting that the reason why our inflation rate had increased was because we had been shadowing the deutschmark. This, of course, was true, but it was a departure from the convenient answer that it was because we cut interest rates in the wake of the ‘Black Monday’ Stock Market crash and held them down too long that inflation had begun to rise. Nigel was at a European Finance ministers’ meeting in Spain and became very upset. So I authorized a line for the press which reverted to the less accurate but more mutually acceptable explanation. But I did at this time ask the Treasury to provide me with a paper giving their explanation as to why inflation had risen. I was subsequently interested to learn that Nigel had asked that the first draft of this paper, which had focused almost exclusively on the shadowing of the ERM, should be revised to extend the analysis to cover the earlier 1985–6 period as well.[99] Not surprisingly under these circumstances, I found the finished product less sharp and persuasive than some other Treasury papers.

  There was worse to come. On Wednesday 14 June 1989, just twelve days before the European Council in Madrid, Geoffrey Howe and Nigel Lawson mounted an ambush. Geoffrey, I soon learnt, was the moving force. They sent me a joint minute arguing that in order to strike an acceptable compromise on the Delors EMU proposals — agreeing to Stage 1 but with no commitment to Stages 2 and 3 or an Inter-Governmental Conference (IGC) — I should say that I would accept a ‘non-legally binding reference’ to sterling joining the ERM by the end of 1992, provided that certain conditions were fulfilled by then. The alternative was — as usual — ‘isolation’. It was a typical Foreign Office paper which Nigel Lawson in his better days would have scornfully eviscerated.

  I had myself, since reading Alan’s earlier paper on the conditions for entry into the ERM, been giving a great deal of thought to this subject. It was not clear to me whether spelling out these conditions at this stage would help deflect the other Community countries and the Commission from the course towards EMU on which they seemed set. I was not convinced about the alleged political advantages. I was deeply concerned about the consequences of setting a specified date for the currency markets. However, I saw Nigel and Geoffrey on the evening of Tuesday 20 June to discuss their minute and its contents. At the end I said that I would reflect further on the way in which this issue should be handled at Madrid. I remained sceptical whether a concession on membership of the ERM would really achieve our agreed aim of blocking an IGC and Stages 2 and 3 of Delors. But this could only be judged on the spot at Madrid. In any event I remained very wary of setting a date for sterling’s membership.

  I had not liked this way of proceeding — by joint minutes, pressure and cabals. But I was more than angry about what happened next. I received a further joint minute. In this Nigel and Geoffrey said that just spelling out in greater detail the conditions which would have to be fulfilled before we joined — widening these to include for example Single Market measures — would be ‘counterproductive’. There must be a date. And they wanted another meeting before Madrid.

  I read their minute on Saturday morning at Chequers and almost immediately received a telephone call from my office to ask about the time for a meeting. This was extremely inconvenient. On Sunday afternoon I was due in Madrid. But they could not be deterred. I could have seen them late on Saturday night or early on Sunday morning at No. 10. They chose the latter.

  I knew that Geoffrey had put Nigel up to this. He had been in a great state about the European election campaign which had not gone well for us. I knew that he had always thought that he might one day become Leader of the Conservative Party and Prime Minister — an ambition which became more passionate as it was slipping away from him. He considered himself — with some justice — as an important contributor to our past successes. This quiet, gentle, but deeply ambitious man — with whom my relations had become progressively worse as my exasperation at his insatiable appetite for compromise led me sometimes to lash out at him in front of others — was now out to make trouble for me if he possibly could. Above all, I suspect, he thought that he had become indispensable — a dangerous illusion for a politician. There is no other explanation for what he now did and put Nigel up to doing.

  Geoffrey and Nigel came to see me at 8.15 on Sunday morning, as arranged. They were shown into my study and sat down facing me on the other side of the fireplace. They had clearly worked out precisely what they were to say. Geoffrey began. He urged that I should speak first at the Madrid Council setting out the conditions on which I would have sterling join and announcing a date for entry into the ERM. He and Nigel even insisted on the precise formula, which I took down: ‘It is our firm intention to join not later than — ’ (a date to be specified). They said that if I did this I would stop the whole Delors process from going to Stages 2 and 3. And if I did not agree to their terms and their formulation they would both resign.

  Whether I could have withstood the loss of both my Foreign Secretary and my Chancellor at the same time in this way I am not sure. But three things jostled together in my mind. First, I was not prepared to be blackmailed into a policy which I felt was wrong. Second, I must keep them on board if I could, at least for the moment. Third, I would never, never allow this to happen again. But this third reflection I pushed for the moment to the back of my mind. I told them that I already had a paragraph spelling out in more detail the conditions under which sterling could enter the ERM and I would be using this in my opening speech. But I refused to give them any undertaking that I would set a date. Indeed, I told them that I could not believe that a Chancellor and a former Chancellor could seriously argue that I should set a date in advance: it would be a field day for the speculators, as they should have known. I said that I would reflect further on what to say at Madrid. They left, Geoffrey looking insufferably smug. And so the nasty little meeting ended.

  I shall explain shortly the rest of what happened at the Madrid Council. Suffice it to say here that on the basis of what Alan had already suggested and with some modification I spelt out what became known as the ‘Madrid conditions’ for sterling’s entry into the ERM. I reaffirmed our intention to join once inflation was down and there was satisfactory implementation of the first phase of the Delors Report, including free movement of capital and abolition of foreign exchange controls. But I did not set a date for entry, nor was I put under any pressure at Madrid to do so.

  I do not believe that spelling out the Madrid conditions significantly modified the pace, let alone the direction, of discussions on the Delors report on EMU. Only someone with a peculiarly naïve view of the world — the sort cultivated by British Euro-enthusiasts but without any equivalent among hard-headed continental Euro-opportunists — could have imagined that it would. In fact, though, the Madrid conditions di
d allow me to rally the Conservative Party around our negotiating position and got us away from the tired and faintly ridiculous formula of ‘when the time was right’. The outcome of Madrid was widely praised back at home. Unfortunately, in a sense the time would never be ‘right’ — because the ERM, particularly now that the Delors objective of EMU had come out into the open, would never be ‘right’. But that was something I could do little about.

  Back home, Cabinet began as usual at 10.30 on Thursday 29 June. Normally, I would sit at my place with my back to the door as Cabinet ministers trooped in. This time, however, I stood in the doorway — waiting. But there were no resignations. The condition that there must be a date for our joining the ERM might never have been mentioned. Nigel Lawson even managed the remark that Madrid had gone rather well, hadn’t it. He certainly had a nerve, I thought: but then Nigel always did. That was one of his engaging characteristics.

  MORE TENSION WITH NIGEL LAWSON

  It was from this time that tension between myself and Nigel Lawson arose over the independent economic advice that I was receiving from Alan Walters. Alan had returned to No. 10 in May 1989. I have already described his contribution to the ‘Madrid conditions’ for ERM entry. While the Treasury, thoroughly alarmed by the inflationary effects of Nigel’s policy of shadowing the ERM, kept urging ever higher interest rates, Alan now drew my attention to the danger that excessively high interest rates might drive the economy into recession.[100] He was, in short, doing precisely what a prime minister’s adviser should. He also had the merit of being right.

  However, during his five-year absence from No. 10, he had been asked to give his views in all sorts of different fora; and Alan’s views were always trenchant. Various reports, articles and lectures containing his thoughts about economic policy issues in general and the ERM in particular kept on surfacing. Partly because these were exploited by the press to point up divisions between Nigel and me and partly because Nigel himself, knowing that he was being blamed for the return of inflation, was becoming hypersensitive, they became a major problem.