History of England 1-6

Entry into the ERM, touted by Major among others as a cure for inflation, had by 1992 done nothing to ease the recession of the late Eighties. If anything, it seemed to have accelerated it. One million lost their jobs. A new and virulent strain of poverty appeared, one which struck the previously affluent, and with it arrived a new term, ‘negative equity’, with houses suddenly worth less than the mortgages taken out to pay for them. Moreover, the high interest rate that Britain was forced to adopt brought the country back to the unhappy days of the Seventies; British exports became once more uncompetitive. Still, inflation appeared again to be shackled, as Major had prophesied. But even here, an objection could be raised. At a dinner hosted by Andrew Neil, the editor of the Sunday Times, Major crowed his triumph as the prime minister who had ended the threat of inflation. At this, one of the journalists present asked, ‘What’s the point of having low inflation if the economy is not just on its knees, but on its back?’ In one form or another, the question would be repeated in the months to come.

On the Continent, within the quiet confines of the Bundesbank, troubling events had also begun to unfold. East Germany was now within the capitalist pale of the West, but the cost of its inclusion was climbing ever higher. The Bundesbank was independent of the German state and could take decisions as it saw fit. In the summer of 1992, it raised interest rates. Helmut Schlesinger, the Bundesbank president, felt bound to act according to ‘what is necessary at home’. In Britain, the effect was instant. High interest rates hit the housing market, and ‘For Sale’ boards sprang up like nettles. By late summer, currency traders began to sell pounds and buy Deutschmarks, with the result that sterling sank to the lowest level permitted within the ERM. Once again, a British chancellor was caught in a web of irreconcilable priorities, but despite his private misgivings, Norman Lamont publicly rejected the possibility either of devaluation or of exit.

Chancellor Kohl had sent Major a letter in which he indicated that he would also like to see German interest rates lowered. Major had high hopes. Lamont was altogether less sanguine. At a meeting of national and EC finance ministers in Bath, Lamont was met by protesters demanding that Britain leave the ERM. Neither he nor his continental colleagues were reassured. There was much to be discussed, not least the vulnerable state of many currencies within the EC. For the continentals, however, the meeting was to be a cordial affair, in which delicate matters might be raised, but not quarrelled over. Lamont, however, was desperate, and was not disposed to be diplomatic. The French finance minister recalled his questioning as ‘without introduction and without conclusion: quick, brutal, cutting’. Four times Lamont asked Schlesinger whether he would not lower interest rates. Schlesinger, a financial grandee unaccustomed to being berated like a scullion, recalled: ‘One cannot be treated as an employee … one cannot accept it. I thought, “He is not my master … I must bring this exercise to an end.”’ In an obvious snub, he switched to Bavarian dialect in an aside to Waigel, the German finance minister, saying: ‘I think I should go now.’ It was all Waigel could do to restrain him from marching off. Lamont left empty-handed.

Worse was to follow. On 11 September, in Rome, the value of the imperilled Italian lira plummeted. Speaking on the telephone to John Major, Giuliano Amato, the warm and expansive Italian premier, had a chilling message for his British counterpart: once the traders have finished with us, they will come for you. But Major refused to devalue, just as he refused any suggestion of leaving the ERM. He was confident that his policy would survive. From Germany came the signs of a faint thaw, as Schlesinger offered to lower interest rates, should the currencies that were struggling agree to ‘realign’. This, for Major, was out of the question. For Italy, however, there was no escape, and the lira was devalued by 7 per cent. Surely this would satisfy the Germans? The response was a token 0.3 per cent cut in interest rates. European solidarity appeared to be fraying by the week. For all the public assurances offered by Major and Lamont, banks, pension funds and international companies had no doubt that the pound would depreciate. The result was one of those tragically self-fulfilling prophecies that haunt international finance, a world in which perception is often the principal reality.