Margaret Thatcher: The Autobiography (107 page)

Even now it is unclear whether my misgivings were justified. Some analysts – notably the perceptive Tim Congdon – would argue that the rise in £M3 now and later did cause inflationary problems. By contrast, Alan Walters reckoned that monetary policy was sufficiently tight, as did the rest of my advisers. The important thing is that when clear evidence appears that things are slipping you take action fast. Certainly, I do not believe that monetary policy in 1985 – or 1986 – was the main cause of the problems we were later to face.

Nigel now returned to the charge on the ERM. I agreed to hold a further seminar at the end of September though by now I was more convinced than ever of the disadvantages of the ERM. I could see no particular reason to allow British monetary policy to be determined largely by the Bundesbank rather than by the British Treasury, unless we had no confidence in our own ability to control inflation. I was extremely sceptical about whether the industrial lobby, which was pressing us so hard to join the ERM, would maintain its enthusiasm once they came to see that it was making their goods uncompetitive. I doubted whether the public would welcome what might turn out to be the huge cost of defending sterling within the ERM – which, indeed, might well prove to be impossible in the run-up to a general election and so be compounded by a forced devaluation. Looking back over the last few years it was clear that sterling had not tracked other European currencies in a stable way. In 1980, sterling rose 20 per cent against the European Currency Unit (ecu). In 1981 it fell by 15 per cent from peak to trough. In 1982 it did the same. In 1983 it rose by as much as 10 per cent. In 1984 it was somewhat more stable. But in 1985 it had risen by more than 10 per cent. To control such movements, we would have needed recourse to huge quantities of international reserves and to a very tough interest rate policy.

There was nothing secret about these facts. But nothing is more obstinate than a fashionable consensus. Nor is it without influence on Cabinet committees. I had no support at the seminar at the end of September.

Nor did my arguments budge Nigel and Geoffrey. There was no point in continuing the discussion. I said that I was not convinced that the balance of argument had shifted in favour of joining.

Until 1987, when Nigel made the exchange rate the overriding objective of policy, there was no fundamental difference between us, although Nigel apparently now thinks I was ‘soft’ on interest rates. Anyone who recalls our decisions from 1979 to 1981 will find that implausible. It would also surprise anyone who considers that one of the main arguments
advanced for joining the ERM, which Nigel so passionately wanted, was that it would lead to
lower
interest rates. And, as I shall show subsequently, there were occasions when I thought that
he
was soft on interest rates and wanted to raise them more quickly. The two of us were equally opposed to inflation but it was my constant refrain that much as I might admire his fiscal reforms, he had made no further progress in getting down the underlying inflation rate.

But we did have rather different starting points. I was always more sensitive to the political implications of interest rate rises – particularly their timing – than was Nigel. Prime Ministers have to be. I was also acutely conscious of what interest rate changes meant for those with mortgages whose prospects – even lives – can be shattered overnight by higher interest rates. My economic policy was also intended to be a social policy. It was a way to a property-owning democracy. And so the needs of home owners must never be forgotten. A low interest rate economy is far healthier than a high interest rate economy.

High real interest rates
*
do ensure that there is a high real reward for saving. But they discourage risk-taking and self-improvement. In the long run, they are a force for stagnation rather than enterprise. For these reasons I was cautious about putting up interest rates unless it was necessary.

Another reason for caution was the difficulty of judging precisely what the monetary and fiscal position was. The Mo figures were volatile from month to month. The other aggregates were worse. In these circumstances, making the right judgement about when and whether to cut or raise interest rates was indeed difficult. So at the meetings I had with Nigel, the Bank and Treasury officials to decide on what must be done I would generally cross-examine those involved, give my own reaction and then – when I was sure all the factors had been considered – go along with what Nigel wanted. There were exceptions. But they were very few.

It was only from March 1987 – though I did not know it at the time – that Nigel began to follow a new policy, different from mine, different
from that to which the Cabinet had agreed, and different from that to which the Government was publicly committed. Its origins lay in the ambitious policy of international exchange rate stabilization. In February Nigel and other Finance ministers agreed on intervention to stabilize the dollar against the deutschmark and the yen by the ‘Louvre Accord’ agreed in Paris. I received reports of the massive intervention this required which made me uneasy.

In July Nigel raised again with me the question of whether sterling should join the ERM. I was not unprepared for this and had earlier talked the subject through with Alan Walters and Brian Griffiths, the head of my Policy Unit who in an earlier incarnation had been Director of the Centre for Banking and International Finance at the City University. I said to Nigel that the Government had built up over the last eight years a well-founded reputation for prudence. By joining the ERM we would in effect be saying that we could not discipline ourselves. ERM membership would reduce the room for manoeuvre on interest rates which would, at times of pressure, be higher than they would be if we were outside. Overall, when things were going smoothly membership of the ERM would add nothing to our economic policy-making, and when things were going badly membership would make things worse. Nigel completely rejected this. He said he would want to discuss it all again with me in the autumn. I said that I would not wish to hold a further discussion on the subject until the New Year.

By now there was some evidence that the economy might be growing at a rate too strong to be sustainable. In August 1987 Nigel proposed a 1 per cent rise in interest rates on the grounds that this was required to defeat inflation by the next election. I accepted the proposal. That was the position when on ‘Black Monday’ (19 October 1987) there was a sharp fall in the Stock Market, precipitated by a fall in Wall Street. These developments were, in retrospect, no more than a market correction of overvalued stocks, made worse by ‘programmed selling’. But they raised the question of whether, far from overheating, we might now be facing a recession.

I was in the United States when I learned about the Stock Market collapse. I dined that evening with some of America’s leading businessmen and they put what had happened in perspective, saying that, contrary to some of the more alarmist reports, we were not about to see a meltdown of the world economy. Still, I thought it best to make assurance doubly sure, and I agreed to Nigel’s request for two successive half
percentage point cuts in interest rates in response to help restore business confidence.

What I did not know was that Nigel was setting interest rates according to the exchange rate so as to keep the pound at or below DM3. It may be asked how he could have pursued this policy since March without it becoming clear to me. But the fact that sterling tracks the deutschmark (or the dollar) over a particular period does not necessarily mean that the pursuit of a particular exchange rate is determining policy. There are so many factors involved in making judgements about interest rates and intervention that it is almost impossible at any particular time to know which factor has been decisive for whoever is in day-to-day charge.

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:

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.