One of the odd things about Mrs Thatcher’s first government is that she and her allies are often portrayed as slaves to a meticulously crafted ideological blueprint. In reality, they spent so much time arguing about the implications of their ideas that it is a wonder they managed to get anything else done. Here was a perfect example. In effect, Howe was implementing an old-fashioned monetary squeeze, using high interest rates to wring inflation out of the economy. But although Mrs Thatcher backed him publicly, she was not happy about it. Every time Howe gloomily announced that they needed to put interest rates up, she winced and looked for reasons not to do it. She is supposed to have gone around telling people: ‘There is no alternative.’ Yet, as Howe recalled, she was ‘ever on the lookout’ for an alternative. In essence, she liked the idea of getting inflation down, hated the thought of doing it with high rates, and was convinced that someone, somewhere, must have invented a less painful way. As Lawson sardonically put it, ‘there was no more assiduous seeker for gimmicks which would supposedly give us tight money without high interest rates than Margaret Thatcher’.46
In the early years of her administration, the gimmick that caught her attention was Monetary Base Control. The gist of this was that instead of relying on interest rates, the government should seek to control the money supply directly, by setting strict targets for the banks’ reserves with the Bank of England. Some of the most influential monetarist academics, notably the sainted Milton Friedman, were all for it, as was Mrs Thatcher’s favourite City insider, the stockbroker Gordon Pepper. But Howe and Lawson were dead against it, while Gordon Richardson pointed out that there was no guarantee Monetary Base Control would ‘make it any easier to avoid high interest rates’. For the time being, therefore, the Bank of England fobbed her off with a promise to look into it more closely. But she never gave up on Monetary Base Control. Whenever there was a bad set of inflation figures, or whenever Howe asked her to approve another interest-rate rise, it was not long before she brought out the dreaded three words.47
In the meantime, Howe had become convinced that he had no choice but to drive down inflation with the blunt instruments of high interest rates and deep spending cuts. On 6 July he circulated an exceedingly gloomy paper to his Cabinet colleagues. The economic position, he said, was awful, and unless Britain was to sink into terminal decline, ‘there is an urgent need to bring about major improvements in inflation, productivity and competitiveness’. And since he could only hike up interest rates so high before stifling any chance of recovery, the only solution was to cut spending and slash the deficit. Ideally, he was looking for cuts of about £6½ billion, which would ‘entail accepting a loss of output and employment in the short-term. How severe these losses will be, and how long they will last, will depend partly on how quickly our policies change the climate of expectations in which price and pay decisions are made.’ But it would be ‘unrealistic’ to expect a real recovery before 1983, which meant they were in for a ‘very difficult time’.48
Chancellors demanding spending cuts are never popular with their colleagues. In fact, Howe’s proposed cuts were only cuts in the future programmes prepared by the Callaghan government, not existing programmes. In real terms, spending was still going up, as it did every year during the Thatcher premiership.fn5 Even so, as early as 11 July the Cabinet Secretary, Sir John Hunt, warned Mrs Thatcher that some of her ministers were ‘becoming alarmed’ by her Chancellor’s proposed tactics. Characteristically, she decided to attack them head-on, opening the next day’s Cabinet meeting with a ringing declaration that they had to swallow Howe’s cuts whether they liked it or not. Going through ‘this vale of tears’, the Chancellor added, was the ‘last chance of restoring sanity’. But his position did not go unchallenged. In a sign of things to come, Jim Prior spoke up for his fellow moderates, insisting that cuts on this scale would mean ‘massive redundancies’. Britain, he said, was heading for a ‘severe depression’, and they were in danger of making it worse. But Howe dug in his heels. In what was to become a familiar Thatcherite formula, he and Biffen told their colleagues that this would be a ‘crucial test of our determination to stick to our announced policies’. And in the end they got their way, the Cabinet eventually agreeing to £6 billion in cuts at the end of October 1979.49
By now some of the defining themes of the next few years had become apparent. Already there were hints of tension between Number 10 and the Treasury, though they were as nothing compared with the divide between hawks and doves in the Cabinet. Already key government figures were disagreeing about the right ways to measure and control the money supply. And already the upbeat tone of the Conservatives’ election campaign – ‘Don’t just hope for a better life. Vote for one’ – was giving way to a mood of relentless pessimism.
When Nigel Lawson got back from holiday at the end of August, he sent Howe a long note about the way they were selling their plan. ‘There is no way in which we can avoid being attacked, whatever we do,’ Lawson wrote, so ‘we must be guided by the reflection that it is better to be attacked for the right policies than the wrong ones, and concentrate on getting our own message across.’ For this he recommended using ‘primitive’ language, not the jargon of academic monetarism. They were right to talk about ‘the absolute disaster that would follow any change of course’. But they should not forget why people had voted for them in the first place:
The [other] note that really must be struck, along with the other two, is the note of confidence and above all of hope; the message that there is indeed light at the end of the tunnel. This is absolutely vital, not least if we are to maintain a reasonable degree of business confidence over the difficult 18 months that lie ahead. But it goes wider than that. Churchill may have told the British people that he had nothing to offer them but blood, sweat, toil and tears, but that wasn’t strictly true. There was something else he offered them: the promise of victory – and that was why they followed him.
Mrs Thatcher would have loved the comparison.50
Summer faded into autumn, and the mood darkened by the day. On 12 October the Chancellor sent Mrs Thatcher his grimmest warning yet. The outlook was even ‘more pessimistic’ than he had foreseen a few months earlier. GDP was likely to fall faster than expected; price inflation was likely to be much worse; consumer spending was likely to be lower; and thanks to the high pound, Britain’s trading prospects were bleaker than ever. Worse news followed. On 31 October the Confederation of British Industry (CBI) reported that business confidence was lower than at any point in the organization’s history, with its 1,800 member companies blaming the high pound, rampant inflation and massive pay settlements. Five days later, Howe told Mrs Thatcher that the Treasury was now predicting unemployment of about 1.25 million in 1979–80 and 1.6 million in 1980–81. So much, then, for putting Britain back to work. And as events were to prove, even these figures were wildly optimistic.51
By now Howe had taken one of the most momentous decisions of his chancellorship: indeed, one of the most important decisions of the entire period. In the summer of 1979, Britain still had the strictest foreign exchange controls in the industrialized world. Imposed during the Second World War, they had been maintained by the Attlee government to stop capital flooding out of the country. For decades afterwards, they seemed to be set in stone, thanks to the anxiety about the balance of payments and state of the pound. To the left, exchange controls were a guarantee that firms would invest their money at home, providing British jobs for British workers. So even as other governments got rid of their controls, British firms still found it hard to invest money overseas, British tourists could take no more than £50 abroad and ordinary people were still not allowed to buy gold. Even in the City, the outlook remained resolutely parochial. Of almost £100 billion invested by British insurance firms, pension funds, investment trusts and unit trusts in 1979, less than £8 billion was invested abroad. London, one stockbroker told the City’s historian David Kynaston, ‘was still a little island’.52
By
the turn of the decade, however, there was a growing sense that exchange controls had become an intolerable obstacle to competition and innovation. ‘National borders’, the head of the American firm Citibank told a conference in London in June 1979, ‘are no longer defensible against the invasion of knowledge, ideas or financial data.’ In its way, this was an excellent motto for the age of globalization. And the timing was perfect. Callaghan had considered abolishing exchange controls but thought it too risky. The Bank of England, however, thought there would never be a better time to do it, because North Sea oil and the high interest rates meant there was little danger of people taking their money out of London. So in his first Budget, Howe had relaxed some of the restrictions on firms investing abroad and people travelling overseas. But on 4 October, Lawson persuaded him to go further. They should get rid of the lot, Lawson said: not slowly, not gradually, but all at once. This would be the definitive signal that instead of sheltering behind protectionist borders, Britain ‘would now live and die in the real world economy’.53
This was, by any standards, an astonishingly daring step. Despite backing abolition in principle, the Bank of England was wary of moving so quickly. Some of the Cabinet were nervous, too, though the only minister to speak against it was Michael Heseltine, who warned that people would ‘buy villas in the south of France’ instead of investing in British industry. Most strikingly, Mrs Thatcher, as was her wont, was very worried about such a radical departure. In one early discussion she declared that it would be a ‘mistake to relax the controls further until the Government’s market philosophy was being seen to work’, because the uncertainty might send capital flooding out of the country. In the end, though, Howe’s and Lawson’s joint efforts did the trick. ‘On your own head be it, Geoffrey, if anything goes wrong,’ she said. He decided she was joking. Even so, he recalled, it was the ‘only economic decision of my life that caused me to lose a night’s sleep’.54
When, on 23 October, Howe announced his decision, it took the Commons completely unawares. The Labour left, who saw exchange controls as an essential step towards building socialism in one country, were appalled. The backbench firebrand Bob Cryer claimed that abolition represented a ‘classic betrayal of the workers of this country by a Tory Government who are the lickspittles of the capitalist sector’, while Tony Benn gloomily recorded that ‘international capitalism has defeated democracy’. The Observer’s economics editor, William Keegan, even predicted that controls would be back by 1985. But the right were delighted, and most of the papers were pleased to see the government dismantling the barriers of the 1940s. Now at last, said that bible of rapacious capitalism, the Guardian, people were free to ‘buy gold bars by the truckload; or to walk through the Customs clutching armfuls of pound notes; or to speculate to our heart’s content on any currency or stock exchange which will let us’.55
Although it is rarely mentioned as one of the landmarks of the Thatcher years, the abolition of exchange controls was immensely important – and not just for the financial sector. Lawson thought that ‘without it, the City would have been hard put to remain a world-class financial centre’, and he was probably right. Now the City’s outlook became genuinely global: with millions flowing in and out of London every day, it became increasingly integrated with markets abroad, especially New York, which brought new opportunities, new risks and new temptations. Even before the ‘Big Bang’ of 1986, the days of the City as a ‘little island’ were over. And the end of exchange controls also sent a potent symbolic message. Only three years earlier, some of Callaghan’s ministers had seriously talked about adopting import controls and a siege economy. Even now the Labour left were committed to building the New Jerusalem behind a protectionist trade wall. But for all her patriotic rhetoric, Mrs Thatcher wanted to see Britain in the vanguard of liberal globalization, rather than skulking behind protectionist barricades.56
Later, the end of controls came to seem inevitable, part of a worldwide movement driven by financial innovation and information technology. But a different Prime Minister might have made different choices. In France, President François Mitterrand, desperate to stop capital fleeing the country, actually tightened exchange controls before abandoning his socialist experiment in the second half of the 1980s. But Mrs Thatcher thought Britain had shrunk from global change for too long. ‘For forty years the commercial sector of our economy has operated from within the Bastille of exchange control,’ she told the Lord Mayor’s Banquet in November 1979. ‘Now the prison doors have been thrown open. Once again Britain is prepared to face the world on the same terms as other major Western nations.’57
In the short term, though, there was an obvious problem. As in so many areas of economic policy in the early 1980s, it sometimes seemed that as soon as Howe fixed one part of the machine, steam burst out somewhere else. In this case, scrapping exchange controls made it much harder for the government to manage the money supply, because British firms were now able to borrow in other currencies. In very simple terms, the more freely capital could flow in and out of the country, the harder it was to control.58
On 5 November, just two weeks after his ground-breaking announcement, Howe warned Mrs Thatcher that the latest figures were ‘worse than disappointing’, with government borrowing up by £1 billion and bank lending at a record £1.2 billion. As a result, inflation was very unlikely to come down by the end of 1980. Mrs Thatcher was outraged, but there was worse. With the money supply out of control, investors were refusing to buy government debt, known as ‘gilts’. Instead, they preferred to wait until interest rates went up, which the markets now considered inevitable. The only option, Howe said gloomily, was to give them what they wanted and raise rates by at least 2 per cent. Once again Mrs Thatcher was horrified. She had been looking forward to bringing interest rates down to relieve the pressure on her beloved middle-class homeowners – and here was her Chancellor wanting to put them up! No, she said. Two days later, Howe was back, pointing out that gilts were not moving at all. No again. Higher interest rates would cause her serious ‘political problems’. What about trying Monetary Base Control? At this, Howe said patiently that ‘he too was most unhappy … but he did not think there was any alternative’.59
In the end, Howe the tortoise wore her down. On the morning of 15 November, the Chancellor told the Cabinet that he was raising interest rates by 3 per cent to 17 per cent, the most punitive increase in history. He was trying to keep things as ‘un-unpleasant’ as possible, but this was the only way the government could end the orgy of borrowing and get investors to buy gilts again. Many of the faces around the table were white with horror. Speaking for the dissenters, Jim Prior said he was ‘disappointed and shocked’ by news that would wreak terrible damage on business confidence. But despite her doubts, Mrs Thatcher threw her weight behind her Chancellor. Interest rates were only so high, she said, because they had all been too slow to trim their budgets. ‘It wouldn’t be 17 per cent if we got our expenditure down.’60
In this lovely Beatrix Potter-inspired cartoon (Daily Telegraph, 14 November 1979), Nicholas Garland captures the growing alarm among the Tory faithful at the state of the economy.
By now the glow of election victory had long since faded. It was lucky for Mrs Thatcher that the next day’s front pages were dominated by the revelation that Sir Anthony Blunt, the former Surveyor of the Queen’s Pictures, had been the Fourth Man in the Cambridge spy ring. Even so, the Express thought it ‘the bleakest hour’ since she had come to power, while the Mirror called it a ‘vicious new credit squeeze’ that would punish ‘commuters, housewives, homeowners and council tenants, ratepayers and small businessmen’ for the incompetence of the ‘Scrooge Tories’.
Even on the Tory benches, the mood was very anxious. The spy revelations, thought Alan Clark, had been a ‘lucky break for Geoffrey because the whole Blunt affair diverted attention from the really alarming manner in which our economy seems to be conducted’. A week later, The Times reported ‘growing concern among some Co
nservative MPs’ that the government was doing terrible damage to British industry. ‘The picture’, wrote the paper’s economics editor, David Blake, on 23 November, ‘is an appallingly stark one.’61
He was right. In Whitehall everything seemed to be going wrong at once. By mid-December, inflation had reached 17½ per cent, with most experts predicting that it would hit 20 per cent by the following summer. ‘The difficulties we face are greater than we had any reason to expect,’ Howe told his colleagues on 10 December. Not only was inflation rising more quickly than he had feared, but borrowing was currently projected to hit around £13 billion by 1982, which would be a colossal blow to international confidence. The only solution, he thought, was to slash £1 billion immediately and another £2 billion a year later. Ten days later, The Times declared that ‘no Government since the war’ had been confronted with such a ‘dangerous and bleak’ prospect so soon after taking office, and suggested that Mrs Thatcher ‘appeal to the larger interest of the nation, for the sake of its survival, against the destructive self-interest of particular groups’. But Wilson, Heath and Callaghan had been banging that particular drum since the mid-1960s. It had not done them a blind bit of good.62
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