BY ANDREW GIBSON
Today, the 16th September, marks the thirtieth anniversary of the pound sterling’s suspension from the Exchange Rate Mechanism (ERM), an event that broke the credibility of the Major Government, emboldened the intellectual self-confidence of British Eurosceptics, and taught important lessons about the folly of large-scale state interventions in the economy.
The episode also revealed John Major’s unattractive, low cunning.
ERM membership was essentially foisted on the fag end of the Thatcher Government, with a sceptical PM weakened by Lawson’s resignation and Cabinet splits. The depth of her Foreign Secretary’s (Hurd’s) Europhilia could be guessed; Chancellor John Major’s profound ideological commitment to all things “euro” was, carefully, much less advertised.
Within the ERM, sterling could fluctuate 6% either side of the joining rate of one pound to DM 2.95.
By 1992, with the Major Government re-elected, strains were starting to show, not just in the UK but in many ERM and ERM adjacent economies. The UK economy was weak, negative equity was rife, and interest rates needed to be cut. In contrast, in the anchor economy, Germany, monetary conditions were loose following a generous reunification settlement and interest rates needed to be raised.
The key point is that exchange rates are simply a price; the price of one currency expressed in terms of another. If politicians intervene to “fix” prices, a glut or surplus will eventually arise, as economic actors respond to the artificial, administered price level. After all, if one had to sell bread at 10p a loaf, who would bake bread?
The heavily Europhile Major Cabinet dismissed this argument, made strongly at the time by free market economists. The Cabinet had its eyes on a bigger prize; greater EU centralisation. For example, to join a mooted single currency, as many ministers wanted to do, national currencies had to be in the narrow band (2.25% around the parity) for at least two years.
The Chancellor, Norman Lamont, was sceptical of the policy which he had inherited, but tried to make it work. He assessed, surely correctly, that the Major Cabinet would not suspend ERM membership unless forced to by external forces.
That forcing came on 16 September 1992.
The UK Government had to buy sterling within the prescribed tram lines. Speculators could simply buy sterling cheaply overnight in non-European markets, then sell it to the UK at the official minimum rate for an immediate profit. The UK was losing money rapidly.
On the morning of the sixteenth, Lamont raised interest rates two percentage points to 12% to see if sterling could be propped up. The move had zero effect; Lamont knew the game was up.
Not so the euro-zealot PM. Lamont requested a meeting but was fobbed off and left waiting in a corridor. With an eye on his personal interests, Major instead summoned the Political Big Beasts; Clarke, Heseltine, and Hurd. If the Government’s central economic policy were to be killed off, Major would ensure that his putative rivals’ hands would be dipped in the blood.
As the Europhiles faffed around and sought to dodge the inevitable, the UK continued to leak hundreds of millions of pounds.
In a final, forlorn effort, it was agreed to raise interest rates to 15%, effective Thursday. The move failed to impress the markets, and ERM membership was suspended late on the Wednesday.
The markets had bucked the interventionists.
The protagonists naturally spend much time on this matter in their respective autobiographies.
Lamont’s is by far the best account, as he understood the issues, did not really support the inherited policy, and set the UK on a sounder footing post-ERM, taking steps towards an independent central bank. Completely in character, Major sacked Lamont once his, Major’s, own position was more secure.
Major’s autobiography will fascinate those with an interest in buck passing, self-delusion, and the impact of guilt upon memory.
The Opposition parties supported the ERM policy. Like the Tory Europhiles, once the policy collapsed they affected to believe we should have joined at a different rate. This is ignorant. When you interfere with a market price, raising or cutting it by decree, whatever rate you choose will eventually become unbearably inappropriate, as wants, needs, technologies, substitutes, and a host of other factors change.
Have we learnt our lesson?
In an era where ministers impose energy price caps, central bankers devalue the currency through over supply, and politicians cap capriciously the bonuses of successful financial traders, it is difficult to argue that we have kicked the damaging habit of seeking to buck the market.
Andrew Gibson worked in Investor Relations in Tokyo for five years. He now works in corporate communications. He tweets at @AndrewGibsonMBA .