Extraordinarily enough, I only learned that Nigel had been shadowing the deutschmark when I was interviewed by journalists from the Financial Times on Friday 20 November 1987. They asked me why we were shadowing the deutschmark at 3 to the pound. I vigorously denied it. But the chart they brought with them bore out what they said. The implications of this were, of course, very serious at several levels. First, Nigel had pursued a personal economic policy without reference to the rest of the Government. How could I possibly trust him again? Second, our heavy intervention in the exchange markets might well have inflationary consequences. Third, perhaps I had allowed interest rates to be taken too low in order that Nigel’s undisclosed policy of keeping the pound below DM3 should continue.
I brought together as much information as I could about what had been happening to sterling and the extent of intervention. Then I tackled Nigel. At our meeting on Tuesday 8 December I expressed very strong concern about the size of the intervention needed to hold sterling below DM3. Nigel argued that the intervention had been ‘sterilized’ by the usual market operations and that it would not lead to inflation. I understood sterilization to mean that the Bank sold Treasury bills and gilts to ensure that the intervention funds did not affect short-term interest rates. But the large inflow of capital, even if sterilized in this sense, had its own effect, on the one hand in increasing monetary growth and on the other in putting additional downward pressure on market interest rates. This was an environment where Nigel superficially could justify lower base rates than domestic pressures warranted. As a result, inflation was stoked up.
In the early months of 1988 my relations with Nigel worsened. It seemed to me contradictory to raise interest rates – as we did by half a percentage point in February – while at the same time intervening to hold down sterling. But, equally, I knew that once I exerted my authority to forbid intervention on this scale it would be at the cost of my already damaged working relationship with Nigel. He had boxed himself into a situation where his own standing as Chancellor would be weakened if the pound went above DM3.
By the beginning of March, however, I had no option. On 2 and 3 March 1988 over £1 billion of intervention took place. The Bank of England was deeply anxious about the policy. So, I knew, were senior Treasury officials.
I had the matter out with Nigel at two meetings on Friday 4 March. I again complained about the level of exchange rate intervention. For his part, Nigel said it would be sterilized. But he did accept that intervention at the present rate could not continue indefinitely. I asked him to consult the Bank of England and report back later that day on whether the DM3 ‘cap’ should be removed and, if so, when. When he returned he accepted that if on Monday there was still strong demand for sterling the rate should be allowed to go above DM3. He was keen to have some further intervention to break the speed at which the exchange rate might rise. I expressed my concern about this and said that my strong preference would be to allow time for the rate to find its own level without any intervention. But I was prepared to go along with some limited intervention if necessary. The pound accordingly rose through the DM3 limit.
Immediately, the Opposition and the media sought to make capital out of divisions between Nigel and me. I set out the policy accurately and the thinking behind it in the House of Commons on Thursday 10 March at Prime Minister’s Questions:
My Rt Hon. Friend the Chancellor and I are absolutely agreed that the paramount objective is to keep inflation down. The Chancellor never said that aiming for greater exchange rate stability meant total immobility. Adjustments are needed, as we learnt when we had a Bretton Woods system, as those in the EMS have learnt that they must have revaluation and devaluation from time to time. There is no way in which one can buck the market.
This last remark however provoked a flurry of press comment to which truth was no defence. The trouble was that it appeared to contrast with Nigel’s continuing public statements that he did not want to see the exchange rate appreciate further.
The question arises whether at some point now or later I should have sacked Nigel. I would have been fully justified in doing so. He had pursued a policy without my knowledge or consent and he continued to adopt a different approach from that which he knew I wanted. On the other hand, he was widely – and rightly – credited with helping us win the 1987 election. He had complete intellectual mastery of his brief. He had the strong support of Conservative backbenchers and much of the Conservative press who had convinced themselves that I was in the wrong. Whatever had happened, I felt that if Nigel and I – supported by the rest of the Cabinet – pulled together we could avert or at least overcome the consequences of past mistakes and get the economy back on course for the next general election.
But this was not to be. Whatever I said in the House in answer to questions about interest rates and the exchange rate was given a construction to suggest that either I was not endorsing Nigel’s views or that I was protesting too much my adherence to them. In these situations you just cannot win. Nigel was extremely upset over my remarks at Prime Minister’s Questions on Thursday 12 May. Though I warmly supported him and his public statements I had not repeated Nigel’s view that further exchange rate appreciation would be ‘unsustainable’.
Geoffrey Howe was now also making mischief. From this time on it became clear to me that Nigel and he were in cahoots, and that of the two Geoffrey was the more ill-disposed to me personally. Earlier – in March – Geoffrey had made a speech in Zurich which was widely taken as siding with Nigel against me on the question of the exchange rate. Then on Friday 13 May he quite gratuitously slipped into his speech to the Scottish Party Conference in Perth the remark, apropos of our commitment to join the ERM ‘when the time is right’, that: ‘We cannot forever go on adding that qualification to the underlying commitment.’ This led the press to widen the perceived rift between me and Nigel over the ERM once more. I was not best pleased. When Geoffrey imprudently telephoned me the morning after his speech to ask for a meeting at which he and the Chancellor should come to see me later in the day to ‘settle the semi-public dispute’, I told him that I would be seeing Nigel later in the day to discuss the markets – which Geoffrey’s own remarks had unsettled. But I was not seeing them together. I told him three times – since he persisted in his attempt to contrive a meeting at which he and Nigel could get their way – that the best thing he could do now was to keep quiet. We were not going into the ERM at present and that was that.
I spent Sunday at Chequers working on a speech I was to deliver to the General Assembly of the Church of Scotland: there was some mirth when my speech writers and I were discovered down on our knees in an appropriate posture, though drawing on the resources of Sellotape rather than the Holy Spirit. But, following the news reports during the day, I was also aware of just how damaging the constant media reports of splits and disagreements on the exchange rate were becoming.
Nigel arranged to see me on the Monday. He wanted to agree a detailed formulation for use by me in the House to describe our policy. I had been told by the Treasury in advance of the meeting that Nigel wanted a further interest rate cut. For my part, I had become appalled at the size of our intervention in the money markets which was clearly still failing to hold sterling at the level Nigel wanted and which, in spite of assurances from Nigel, I feared might prove inflationary. But I had got part of what I wanted – which would ideally have been a pound which found its own level in the markets – in that sterling had been allowed to rise to DM3.18. So I was not unhappy to have the suggested interest rate cut I knew he wanted. I was also aware that the speculators were beginning to consider sterling a one-way bet and that allowing them to burn their fingers a little would do no end of good.
Above all, however, this reduction of the interest rate on Tuesday 17 May by half a point to 7.5 per cent was the price of tolerable relations with my Chancellor, who believed that his whole standing was at stake if the pound appreciated outside any ‘band’ to which he might have se
mi-publicly consigned it. If I had refused both intervention and an interest rate cut and sterling had drifted up to find its proper level there was little doubt in my mind that Nigel would have resigned – and done so at a time when both the majority of the Parliamentary Party and the press supported his line rather than mine. Yet the economic price of accepting this political constraint now seems to me to have been too high. For the whole of this period the interest rate was too low. It should have been a good deal higher, whatever the effect on the level of sterling – or the level of the Chancellor’s blood pressure.
I also agreed to use in the House a detailed endorsement of the line which Nigel and I had agreed at our Monday meeting on the place of the exchange rate as an element in economic policy. I had to go further than I would have liked, saying:
We have taken interest rates down three times in the last two months. That was clearly intended to affect the exchange rate. We use the available levers, both interest rates and intervention as seems right in the circumstances and … it would be a great mistake for any speculator to think at any time that sterling was a one-way bet.
In fact from June 1988 onwards interest rates rose steadily.
Nigel insisted on raising them only half a per cent at a time. I would have preferred something sharper to convince the markets how seriously we took the latest indicator that the economy was growing too fast and that monetary policy had been too lax – namely the balance of payments figures. Nigel took a more laid-back view of these than I did. He thought that the current account balance of payments deficit, which was growing ever larger, was more important as an indicator that other things were going wrong than in its own right. But the deficit worried me because it confirmed that as a nation we were living beyond our means – as well as suggesting that higher inflation was on the way.
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 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.’
The year 1989 – Nigel’s last as Chancellor – was a time of increasing political difficulty for me. It was also a time of very high interest rates – 13 per cent in January, 15 per cent from October – and with inflation still rising and the forecast figures apparently inexorably rising too. 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.
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 – 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. Nigel and I hoped that together Robin Leigh-Pemberton, Governor of the Bank of England, and Karl Otto Pohl, President of the Bundesbank, would prevent the emergence of a report which would give momentum to EMU. Herr Pohl 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 Pohl’s known opposition to the Delors approach simply was not expressed.
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.
Nigel and then Geoffrey used the Delors Report to reopen the argument about the ERM. But 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 that it was necessary to join the ERM in order to prevent developments in the Community which we did not like.
This did not mean that I was giving no thought to it. 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. 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 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.
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 1985–86 period as well.* 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 learned, 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 – 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.
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.
Margaret Thatcher: The Autobiography Page 83
