Downing Street Years - Margaret Thatcher [432]
At my seminar Nigel did not argue that it would be right to enter the ERM under current circumstances. But he repeated the general argument in favour of joining which he had put to me earlier. Perhaps the most significant intervention, however, was that of Geoffrey Howe who had now been converted to the Foreign Office’s departmental enthusiasm for the ERM and thought that we should be looking for an appropriate opportunity to join — though he too did not think the circumstances at the moment were right. In the course of the discussion it became clear that we would need to build up foreign exchange reserves if we wanted to be in a position to enter. I agreed that the Treasury and the Bank of England should consider how this should be done. But since no one was arguing for immediate entry, there was no other decision to take. The meeting ended amicably enough.
During the summer of 1985 I started to become concerned about the inflation prospect. I was uneasy for a number of reasons. £M3 was rising rather fast. Property prices were increasing, always a dangerous sign. The ‘bill mountain’ was worrying too — not because it suggested anything about inflation (indeed the overfunding which led to it was in part the result of the Bank’s attempt to control £M3). Rather, since we had decided against a policy of overfunding as far back as 1981, the fact that it had been resumed on such a scale without authorization did not increase my confidence in the way policy in general was being implemented.
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, who believed that MO was the best indicator, reckoned that monetary policy was sufficiently tight, as did the rest of my advisers. Essentially, these tricky questions are always a matter of judgement. 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. The subject seemed to be becoming something of an idée fixe. Nigel even sent me a paper envisaging what would happen if we were in the ERM in the run-up to a general election which the financial markets thought that we might lose. In such circumstances, he argued, we would need to announce our temporary cessation from operating the system coupled with an undertaking that on our return to office after the election we would immediately resume at the same parity as before. In itself, of course, this was an example of the perils of committing oneself to fixed parities irrespective of outside events.
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