one of which we would have been proud. Nor did I accept blindly that membership of the ERM was inevitable. One of my first acts as chancellor was to commission a paper on alternative approaches to the exchange rate. I had not gone native at the Foreign Office, as Margaret Thatcher later liked to claim, but I recognised that the pro-ERM tide was strong. Most political opinion favoured entry. So did economic commentators. So did business opinion. A poll of the corporate sector in Financial Weekly revealed that 97 per cent of executives wanted sterling to join the ERM, and 66 per cent did not care at what rate we went in.
As at home, so it was abroad. Both the Foreign Secretary Douglas Hurd and I were repeatedly pressed to join by our European partners. Their pleas echoed concern about the domination of the deutschmark. Bonn and Paris were seen as too close – ‘two threats in a single skin’, as one Italian minister put it to me – and sterling’s entry into the ERM would weaken this domination. More true, however, was the fact that only Britain and France in tandem could counter-balance Germany, and although the French always chatted amicably with the British, they invariably ended up siding with Germany, largely because the Germans so often capitulated to French demands. Nevertheless, the European pressure for entry was there. I gradually warmed to membership because logic was pushing inexorably in that direction.
Meanwhile, the economy was slowing down, and our economic difficulties, together with European disputes and the Poll Tax, were sapping confidence in the government and the Prime Minister. The pound was almost continually under pressure as speculation ebbed and flowed in accordance with the likelihood or otherwise of our joining the ERM. We had no alternative anchor for economic policy. One after another, the possibilities had been knocked away. Following the boom of the late 1980s, the monetarist orthodoxy and the Medium Term Financial Strategy had lost credibility. The money-supply targets were no longer credible; we could hardly shadow the deutschmark as Nigel had done – even he had abandoned this approach. We examined credit controls only to confirm their uselessness. I considered giving the Bank of England independence over interest rate policy, as Nigel had wished to do, and as Gordon Brown has since done. I dismissed the idea because I believed the person responsible for monetary policy should be answerable for it in the House of Commons.
If we let the exchange rate float freely, it was clear that the value of the pound would fall and push up inflation. If that happened, our choices would be bleak. We could raise interest rates, or we could raise taxes. Neither appealed. We were dangerously fettered. I knew that we had to re-establish economic credibility if we were to bring down inflation – and win the next general election, which, as we were now in mid-term, was already on the horizon. The ERM, with its emphasis on exchange rate stability, was no panacea, but it looked to me like the best – if not the only – way forward. Each morning at Number 11, I woke up between 4 and 5 a.m. and lay awake wondering how sterling would perform that day. Each hour I received market reports. The foreign exchange screen became a focal point of the day. A pfennig up or down influenced thinking far too much. I knew this could not go on.
The Prime Minister was as frustrated as I was over rising inflation and sky-high interest rates. No prime minister likes these twin horrors, and Margaret Thatcher was no exception. She feared the impact they had on her natural constituency of homeowners and small businesses, but she had no policy to combat them. Perversely, she opposed policies necessary to bring inflation down – whether higher interest rates, or exchange rate management, or tax increases. She knew what she disliked, but had no coherent strategy for achieving what she wanted – a strong pound and low interest rates. This, however, was a horse and carriage that did not go well together. Economic management was adrift.
Margaret Thatcher was always a mixture of shrewd political calculation and emotional responses. When her political judgement was to the fore, she recognised that we might have little choice but to join the ERM. But when her emotions took over, she tried to delay our joining. As emotion battled with judgement, policy-making was often two steps forward and one back. It was very debilitating, and my year as chancellor was to be peppered with reassuring briefings and statements, confirming that the Prime Minister really did agree with her own government’s policies. Her deepest hostility was to a single currency and the political implications of surrendering monetary authority. Her opposition to sharing authority in the ERM, though acute, was less, and could, I sensed, be overcome by her wish for a stable economic environment. But not easily – especially as the powerful voices of Nicholas Ridley and Alan Walters still urged her not to yield. She was also intransigent because she felt she had been bounced into a commitment to join the ERM by Geoffrey Howe and Nigel Lawson before the Madrid summit. She would never forgive this.
In early February 1990, Nick Ridley learned that I was warming to the ERM. He did not approve, and sought to buttress the Prime Minister’s opposition. He put to her the argument that German reunification, which she strongly opposed but which was now a certainty, provided a good excuse for abandoning our undertaking to join the ERM. The Prime Minister was very fond of Nick and agreed with him that Germany was dangerously powerful, but she did not fall for his argument, and stuck to her existing position. Nor did she encourage him to hope that she would change her mind, although he went away with a sense that he could raise their shared doubts in Cabinet, but not in public, unless they were cleared directly with her.
By early March, when inflation had risen above 8 per cent, I was convinced that entry to the ERM was a sensible option. I asked for a checklist to be established of how close we were to the Madrid criteria for entry. I recognised that if we went in, we could not do so at the expense of the Prime Minister’s credibility. We had to be able to argue that her conditions had been met. The March assessment of this was encouraging, but there was still a long way to go. I also commissioned papers on the risks of early entry, as well as the advantages. If we were to go in, I had to be convinced it was right, and that I could advocate entry to the Prime Minister, in good faith, and defend it with conviction.
Discussion about European policy came increasingly to dominate my discussions not only with Margaret, but with Douglas Hurd. My working relationship with Douglas had always been very easy. We had begun meeting regularly at Mijanou’s restaurant in Ebury Street for lunch when he was home secretary and I was first at the Treasury as chief secretary. When Douglas became foreign secretary, we met at his official residence in Carlton Gardens for breakfast, where Judy Hurd would fend off the children while we talked.
Douglas looked instinctively towards improving our European relationships, rather than simply using them for domestic advantage. We both believed the Prime Minister needed to be coaxed, and not browbeaten. We knew she could not afford to lose another chancellor or a foreign secretary but we never considered playing that card. We wished to convince her of the merits of entry into the ERM, and we believed persuasion and logic would achieve what an ultimatum would not. Nevertheless, Nick Ridley, remembering the Howe – Lawson axis, was deeply suspicious of us, and thought that our breakfasts were ‘mysterious’. The only real mystery was how we managed to do any work as Douglas’s children got ready for school.
On 29 March 1990, my forty-seventh birthday, I set about the task of talking round the Prime Minister. I knew it would not be straightforward, but I now saw entry as inevitable. Douglas agreed with me that Margaret would have to be persuaded on economic grounds. With his wry sense of humour, he joked that Napoleon had conquered most of Europe, so getting the Prime Minister to enter a small part of it should not be too difficult.
My first discussion with her launched the process, but resulted in a stand-off. I was fortunate in that so far as the ERM was concerned, I was far closer to her thinking than Nigel Lawson had been. I argued that we should not publish a future date for joining, since that would put us at the complete mercy of the markets. I also argued that we should enter within wide bands for rate fluctuation, and not confined in a narrow straitjacket. She agreed. I also made it clear that the pound was very vulnerable, and that the foreign exchange markets were getting used to high interest rates to sustain it. This was dangerous, and had a real impact on Margaret, who wished to reduce interest rates as soon as possible.
At this meeting
