Downing Street Years - Margaret Thatcher [435]
By now there was some evidence that the economy might be growing at a rate too strong to be sustainable. The monetary figures were ambiguous, but the PSBR looked as if it would turn out much lower than expected at the time of the budget. 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 as people spent less and saved more in order to make up for the decline in the value of their shares.
I was in the United States when I learnt about the Stock Market collapse. I had flown from the Commonwealth Conference at Vancouver to Dallas, where I was to stay with Mark and the family. As it happens 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. The same effect can have several causes. 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-today charge.
Of course, as the months pass and people look back at what has been happening questions begin to be asked. Nigel, who is nobody’s fool, must have recognized that this would happen. Indeed, he presumably intended it. Had all gone well, it would have been taken as proof that we could enter the ERM at about DM3 with no adverse consequences. He would have been able to overturn my veto on entry under circumstances in which it was almost impossible for me to reimpose it. To some extent, indeed, this is what happened, though he did not actually force us into the ERM. Once the financial markets have become convinced that a particular policy — in this case shadowing the deutschmark at a particular parity — is the central guarantee of financial stability, the effect of moving away from this approach is profoundly destabilizing. That is why, when I discovered what was happening, I found we had already forfeited some of our freedom of action.
Extraordinarily enough, I only learnt 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 there was no getting away from the fact that 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 did not want to raise this matter with Nigel until I was