In the final episode on Britain’s 1992 currency crisis, Neil and Jonathan look at the consequences of Black Wednesday with Jonathan Portes, Sir Paul Tucker, both of whom had ringside seats in the Treasury and Bank of England respectively, and economic historian Duncan Weldon.
Presented by Jonathan Ford and Neil Collins.
With Duncan Weldon and Jonathan Portes.
Produced and edited by Nick Hilton for Podot.
Additional editing by Ewan Cameron.
Sponsored by Briefcase.News
Jonathan Ford 00:06
Hello and welcome to a long time in finance with Jonathan Ford and Neil Collins, in partnership with briefcase dot news, the service that brings intelligent curation and analysis to your media monitoring.
So hello, this is the final part of our three-part series on Black Wednesday, the crisis that led to Sterling’s devaluation and exit from Europe’s Exchange Rate Mechanism 30 years ago. In the last episode, we dealt with the day itself, and we got to the point where Chancellor Norman Lamont had run up the white flag, the UK suspended its membership of the ERM and the pound slumped. We talked a bit about this shambolic way the day ended with no one telling the country or indeed the markets, what was going on. Nobody really knew what could happen next, could we you go back into the ERM at a lower rate, or are we out for good? And unsurprisingly, the press is unimpressed. And this is when Sun Editor Kelvin Mackenzie tells John Major who is unwise enough to phone him up that evening that he has an enormous bucket of shit on his desk that he’s going to pour over Majors head the following morning, prompting the immortal reply, Oh, you are such a wag Kelvin. But what was the mood like in The Telegraph that evening?
Neil Collins 01:25
Well, not quite the same as the main news desk of the Sun. Nobody was, nobody had any idea what was going on. And we spent the day rewriting the main story as events overtook events. I mean, going from 10% to 12% was a pretty serious move, right with the first interest rate rise. And that shook the markets, obviously, the market and government stocks had a very nasty day. And then when it was raised to 15%, rather than going up, Sterling went down. And rather than going down stock prices shot up, because everybody knew at that point that game was up.
Jonathan Ford 02:11
I remember from my – I was working in a bank then and the only thing I really remember about that day is the second rate rise. There was a moment of silence, I think, because everyone absorbed what the news was coming across their screens. And then there was a sort o laughter and everyone said – Well, yeah, that’s the end of that, then. I think that was a decisive moment.
Neil Collins 02:31
It was sort of widely, almost universal. You know, this is a joke. It was the end of the line.
Jonathan Ford 02:36
So let’s talk a bit about the fallout from the joke. I guess the first thing that becomes clear is that we’re not going to go back into the ERM in a hurry. As Norman Lamont (still the chancellor) has told the press that he’s singing in the bath about leaving the ERM which is not what you generally do. It’s a matter of enormous regret.
Neil Collins 02:53
No, quite. I mean, also, there was no possibility of us going back in. Because the first question would be asked is what is the rate? Nobody would be able to agree.
Jonathan Ford 03:03
Right. But in the first episode, we talked about why the government had originally wanted to get into the ERM. The reason was they wanted some sort of anchor to their monetary policy, something which was independent of the mind of Mrs. Thatcher or John Major, which would force interest rates to rise in a credible way of inflation sparked up which is why of course they joined the ERM, but ERM has failed. So a new mechanism is needed, I guess. And here we talk to Duncan Weldon, economic historian about the search and how they found a new monetary anchor in New Zealand of all places.
Duncan Weldon 03:42
Yeah, Britain sort of stumbles almost by accident into a different sort of macroeconomic policy setup; we’re out of ERM, we need something, we look around the world, the New Zealanders have recently started inflation targeting – seems like an idea worth copying. So you know, we sort of follow the Reserve Bank of New Zealand into picking an inflation target in 1992.
Neil Collins 04:03
Yes, that was Don Black at the New Zealand. He was a great guy and I’ve met him. Yes, he’s very sensible, and had the opportunity to impose a sensible policy. I think he was the forerunner of essentially the independent central bank philosophy.
Jonathan Ford 04:24
This sort of gets around your sort of dilemma that you identified, Neil, which is you can never solve all three problems at the same time. You can’t have your exchange rate in the right place, your interest rates in the right place for domestic monetary policy and whatever the third one was.
Neil Collins 04:41
Well, the two key ones are control of interest rates and control of your currency in an open economy, you cannot do both simultaneously.
Jonathan Ford 04:51
Right. So when we move to what’s called inflation targeting, Britain moves away from the idea of controlling its exchange rate and focuses purely on setting the right rate for monetary conditions to hold down inflation. The question then is who’s going to be in charge of doing it? The UK as we heard in an earlier episode flirted with the idea, has flirted with the idea, under Nigel Lawson, Chancellor in the 1980s of giving the control of interest rates to the Bank of England and Lamont now floats the idea again, but Major says no. The reason he does that, this is immediately after the ERM exit, is interesting. According to the biography of Jeremy Hayood – late Cabinet Secretary – Jeremy Heywood was, of course, Lamont’s private secretary and John Major was worried that to make the Bank of England independent, might be seen as a sign that the UK wants to go into the euro.
Neil Collins 05:43
Yes, I think that that may have some truth in it. But I suspect the underlying question was, no politician likes giving up power. And that’s what it would mean.
Jonathan Ford 05:56
And Britain is very, very set in its way. So for years and years, politicians have always rubber-stamped or set interest rate movements. And they continue to do so under the new inflation-targeting regime. But there’s one change, which is the Bank of England gives advice to the chancellor. And that advice is made public, which is a big step.
Neil Collins 06:17
I think. I think it’s an important step. Yes, it’s the maximum amount of control that the politicians could bear to give up at that time.
Jonathan Ford 06:25
And increasingly, it gives the bank a big saying in what happens. And as Jonathan Portes, who was a Treasury official at the time, said to us, it’s become pretty clear where inflation targeting is headed.
Jonathan Portes 06:38
I mean, as a counterfactual history is difficult. But I think it’s almost inconceivable that under any, whoever was in power from 1997 to 2002, wouldn’t have made the bank independent. It was obviously coming, I think.
Jonathan Ford 06:53
And then when Tony Blair comes in, in 1997, almost the first act of his Chancellor literally within days, Gordon Brown, is to give the bank the power to set interest rates.
Neil Collins 07:03
It’s an extraordinary moment, he raises interest rates on day two or day three, and then says, over to you now. And people are so stunned by this, they can hardly believe it. And actually, I suspect he could hardly believe it either. Because two days later, he took away some of the powers that the bank had in terms of running the markets in government debt.
Jonathan Ford 07:30
It was a very big moment, and it rather silences the conservatives, I think. So there’s a technocratic fix at the end of all this for the era of inflation targeting, independent bank in the long run. But what about the political fallout from the whole ERM catastrophe?
Neil Collins 07:45
Catastrophe is the word for the Tories. Because even though the next election was five years away, people didn’t forget. And when it came to it, Major was comprehensively thumped in the polls, and Tony Blair, became Prime Minister.
Jonathan Ford 08:04
I think, total chaos on the day. And we heard in the last episode, this sort of sense that there was nobody at home towards the end of Black Wednesday, after which the Conservatives don’t win another election outright until 2015.
Neil Collins 08:17
Some legacy, I would say.
Jonathan Ford 08:18
Well done major. Anyway, as for the personnel, well, Lamont loses his job pretty quickly. As you said, Max Hastings told him he would.
Neil Collins 08:29
Yeah, he lasted a few months. But really, he deserved to lose it, even though he now claims he never really liked the ERM, and was only going along because he was obeying the Prime Minister’s diktat. But if he felt that strongly about it, he should have resigned, had he done so of course, he would have been vindicated and probably now have a reputation which was a good deal higher than the one he actually has now.
Jonathan Ford 09:00
Where he clearly falls down as he doesn’t have the courage of his own convictions politically to make a stand. And therefore you get swept away with the rest of them.
Neil Collins 09:09
I mean, to be fair to him, I suspect he was the only voice in Cabinet who was voicing serious doubts about ERM because if you look at the other big beasts there, like Clark and Heseltine, they were very keen on further integration with Europe and this was a step in the right direction.
Jonathan Ford 09:28
You look back and it is fascinating that the people who essentially urged the ship to steam straight into the iceberg survive with their political careers seemingly undamaged, and the one conspicuous casualty is the one person who was at least falteringly suggesting that they may turn the wheel a few notches to starboard to get out of the way of the onrushing chunk of ice. I think we should also talk a bit about John Major here. I think he comes out of it really badly on this. Basically he is the absolute architect have this policy failure. His manoeuvring as we get closer and closer to disaster is clearly all about trying to spread the blame, wriggle out of responsibility himself. I think there’s a judgement we want to reach about John Major, which is, it’s short term, he spreads the blame, and he survives. But in the long term, I think it’s bad for his reputation.
Neil Collins 10:19
I don’t think he really understood the magnitude of the decision to join the ERM in the first place. And he didn’t have the understanding, to see that it was bound to end in tears. And he brought no opposition to his view that this was the right thing to do. And that, if it’s not hurting, it’s not working. And that was more or less what he was saying. And he was backed by the fact that he just won an election against the odds. So this reinforced his own conviction that this was the right thing to do.
Jonathan Ford 10:57
Because what you’re saying is, you’re saying that Major is a good example of politics, coming into collusion with economics, I think, economic facts. And in the end, I basically thought… he thought he could talk his way out of a crisis. But when the economic realities were so clearly arranged against him, he couldn’t!
Neil Collins 11:18
I would say that the exit from the ERM marked a sea change in the basic attitude of the Conservative parliamentary party.
Jonathan Ford 11:28
We did talk to Duncan Weldon about this. And I think that’s right. And this is what he said.
Duncan Weldon 11:33
Yeah I mean, I think certainly, you know, there’s a sea change in the attitude to Europe in the Conservative Party, and that’s partially a sort of Maastricht and the changing nature of the European Community becoming the European Union. And it’s partially this negative association with what happened on Black Wednesday. A really big sea change, you know, your younger generation of Conservative MPs in the early 90s, become distinctly more Euroskeptic in the 90s. And, you know, those are the people that go on to play a very important role in the party, in the last decade or so. (inaudible) I think there is a sense of swell that you’re after Black Wednesday it becomes an almost settled opinion amongst politicians in both major parties amongst top treasury, civil servants, and amongst Bank of England types, that a floating exchange rate is, is better for Britain, we’ve had two really big falls in sterling in the last 20 years, you know, after 2009, again, after the 2016 Brexit referendum, perhaps a third one happening at the moment. But amidst all of those, there’s now no serious voice in sort of, you know, technocratic British circles, saying, what we need is a fixed exchange rate.
Jonathan Ford 12:46
That raises a very interesting point, which is about the reaction to Black Wednesday, because at the time, and you’ll probably remember better than I do, there’s a huge shock that this sort of George Soros and, you know, the gnomes of Zurich have suddenly reappeared. But this time they administered a terrific beating to the Bank of England. And how can this possibly be the right state of affairs that this great institution should be embarrassed like this?
Neil Collins 13:12
Well, because they were defending the indefensible is, well, that’s the obvious reason. Although Soros is the man who is most closely connected with the fiasco. It’s worth remembering at the time that the dollar was very weak. A pound bought almost $2, which was clearly a rate which was absurdly out of kilter. And a lot of people, real investors, actual people who read the telegraph bought dollars.
Jonathan Ford 13:46
Our newspapers are available listeners…
Neil Collins 13:49
We urged the readers to buy dollars, because it was so obvious that that rate was wrong. And the reason why it was wrong was that the dollar was weak against the Deutsche Mark. But the pound was weak against the Deutsche Mark as well. So they were both going in the wrong direction. This was an opportunity that was clearly never going to recur. And that also added to the pressure on the Bank of England because the bank had to provide the Deutsche Marks to satisfy the sellers of sterling. And those buyers of Deutsche Marks could easily convert them into dollars and get a very nice rate.
Jonathan Ford 14:28
I’m very impressed that the reason (inaudible). The other point I think the other point to make about this, though, is that if we think about why, as Duncan said, no one really believes in a fixed exchange rate after 1992 in the UK, it’s partly because they’ve kind of suddenly twigged that Mrs. Thatcher might really be onto something, that you can’t buck the market in a world where the Markets have become very, very deep oceans of capital, which can be assembled by people like George Soros, who can borrow billions and billions and billions. And the Bank of England is never going to have zillions of reserves to range against this enormous battering ram. And so basically, it’s kind of this idea that intervention can stop, a barbarian style assault on the Bank of England is decided it’s not going to, you know, we’re not going to go there. Again, we’re not going to make those mistakes, again.
Neil Collins 15:31
Because the capital markets, as a force in the world economy, had grown dramatically and have continued to do so.
Jonathan Ford 15:40
So what Britain learns from the ERM debacle is no more fixed currency regimes. And the Conservative Party basically forms a view about the whole question. And I think the Treasury as well, that integration into the single currency, which is still in theoretic possibility in 1992. That kind of bar goes up sharply against the idea of taking Sterling out of the Exchange Rate Mechanism, which is a relatively loose form of fixed currency and putting it into the kind of Iron Maiden of the euro. And I think that that sort of aversion, which takes place after we leave the ERM means that by 1997, even though theoretically, Blair is still talking about, he has hopes that we will join the euro. Everyone in the establishment is now very sceptical. Well, that’s a good idea.
Neil Collins 16:30
I’m not sure, I would entirely go along with that. I think it was more that Blair was very keen. If he hadn’t been sandbagged by Brown and Ed Balls, with his five conditions to join the euro, which he knew at the time were incapable of being fulfilled, we might well have found ourselves in because Blair, was so dominant in terms of political clout, he could have said, well, you either join the euro, or I’m going to fire you. And I think it betrayed Blair’s lack of understanding of markets and economics that he really thought this was a political project, which could be achieved.
Jonathan Ford 17:14
Can I ask you one question? What were the five conditions? You can’t, okay, we’ll move on.
Neil Collins 17:23
Nor can anybody else.
Jonathan Ford 17:25
I think there’s one about there to be an R in the month. But so Britain doesn’t want to join the euro, even though Tony Blair definitely does. But it’s worth also talking about whether the EU might have thought they’d dodged a bullet when we dropped out of the ERM and had a second thoughts about ever joining their single currency project. Because I mean, we talked to Jonathan Porter – imagine what would have happened had we gone in 1999. And then 2008, the great financial crunch had happened when we were inside. And this is what he had to say.
Jonathan Porter 17:58
I think the Eurozone got lucky in the sense that it’s quite possible that if we’d been in the euro in 2008, we would have had to withdraw, and that would have blown up the entire currency. Right?
Neil Collins 18:10
I agree entirely with that comment.
Jonathan Ford 18:12
Yeah. So I think it is a kind of sliding doors moment where Britain basically could have gone in one direction in the autumn of 1992. And basically decides to go a different way, which is into a much more semi-detached relationship with the EU where we’re not in a number of the major kind of signature projects, of which obviously, the Euro is the biggest one, that process leads to us being on the outside, if you like, of a more rapidly integrating central block, that certainly starts to lead down the winding path that leads towards Brexit.
Neil Collins 18:44
Yes, semi-detached, I think is a very good expression here, because over many centuries, that has essentially been Britain’s attitude towards Europe.
Jonathan Ford 18:56
Anyway, ironically, you know, despite all the political carnage after we leave the ERM, the UK economy then thrives in a way which you know, normally would help the government in power, but in this case, doesn’t. Interest rates come down and this remarkable recovery really starts which lasts the whole way through the 1990s. The UK sort of stumbled as Duncan Weldon said into a, a kind of macroeconomic framework, inflation targeting, that really seems to work. Which means, of course, that the economy Tony Blair, inherits in 1997 is vastly stronger than the one that Major started out with in 1990. And that, I think, leads to one last assessment to make which is on the government’s own handling of the crisis, which did very much to fix John Major and his merry men, in public minds as being so useless. Here we got Jonathan Porter has explained to us the problem of how governments get trapped in their own brilliant policy ideas.
Jonathan Porter 19:51
The government as a whole has a real problem with scenario planning because your policy is by definition the right policy, right? Because if it weren’t the right policy, we wouldn’t be doing it. That’s why we’re doing it. It’s because it’s the right policy, so how can it turn out to be the wrong policy? So the Treasury can make a plan for an asteroid hitting Newcastle because you know, we don’t have a policy on asteroids hitting Newcastle it – it’s unlikely to happen. But you know, it might happen. And so it’s reasonable to make a plan for it. If we can’t make a plan for the possibility that this policy, which is a wonderful policy and will succeed, because it’s our policy, will actually turn out to be a really crap policy that leads to total disaster. So the Treasury had absolutely you know, there was no plan at all, or a Black Wednesday, nobody had done any contingency planning any war gaming, there wasn’t some sort of stumbling to be pulled off the shelf, or any of that. And that was partly one of the reasons why it was such a complete mess in the days leading up to it and the day itself, because there was no plan at all.
Neil Collins 20:58
I think that’s a real insight into the way governments actually do work, that you are not allowed to consider things which are banned or outlawed in the manifesto, you cannot, as a civil servant, have a plan B, if the manifesto says here is plan A and this is what we’re going to do. That exposes a really central weakness in our political governance. Yeah.
Jonathan Ford 21:28
It’s interesting, though, isn’t it? Because if you think about the two Prime Ministers who most obviously fallen into this trap of having a brilliant idea, which then fails, one, obviously being John Major with the ERM, the other, I would say would be David Cameron with his renegotiation of terms of membership of the EU, where he refuses to countenance any possible scenario planning into what might happen if the public doesn’t agree with him. And in both those cases, the political price paid by the leader who got caught out was very high, Major, basically got totally swept away. Cameron has to leave Downing Street in his socks the following morning, pretty much, after the referendum. So you think that there is quite a strong political incentive to try to avoid getting caught in these awful situations?
Neil Collins 22:19
I suppose it’s because if there is a plan B being hatched as a contingency, the political correspondents who have got their teeth well into the side of the political machine would say, ah, did you realise that there’s a contingency plan for, I don’t know, nuclear disarmament, or variable rates of income tax in Scotland and England or something which is off the scale as far as the government is concerned, but is a possibility.
Jonathan Ford 22:54
The reality is, as a politician, you do not want to get yourself, box yourself in, to a vulnerable position where the only possible salvation you have is other people. And in the case of both Cameron and Major, the other people were probably the Germans – have to be relied on to pull your chestnuts out of the fire because I think you find that quite obviously, those other people often have their own interests, which don’t square with your political ones. So that’s it for Black Wednesday. I think it’s a major watershed, Britain solves its monetary dilemma, sets a firm mandate; 2% inflation is the limit. Where are we now?
Neil Collins 23:36
Just under 10? Okay, as we speak.
Jonathan Ford 23:39
So and we’ve got a bit of a sterling crisis as well. But fortunately, we’re not in a fixed currency regime. That’s the main thing.
Neil Collins 23:45
Quite. So there’s no question of trying to defend the pounds’ rate against anything else, the euro or the dollar. The inflation regime worked pretty well during the benign decade after the financial crisis of 2008, to the point where people got very complacent about it. And people believed that inflation was a problem of the past. And of course, in the UK economy, it never is a problem of the past. And we see now what can happen and how quickly things can get very bad indeed. And also, it shows the limits of giving the Bank of England independence, so-called, because it is quite clear that there are severe limits as to what the bank can really do in terms of raising interest rates.
Jonathan Ford 24:38
Hang on, heresy alert, are you suggesting we go back to the political setting of interest rates?
Neil Collins 24:43
I don’t think you can ever get away from it. In reality, I think you can give the bank a considerable degree of independence. And in the normal way, it can act independently and raise interest rates because that is the acid test always – every politician likes to cut interest rates and every politician hates raising them. But looking at the way the Bank of England has behaved in the last year or so, they completely failed to see the inflation problems coming. Either they were asleep at the switch, or they were got at by the politicians and persuaded somehow to keep interest rates at the absurdly low levels that we got used to.
Jonathan Ford 25:26
Well, the one lesson from 1992 is you can’t ignore economic realities forever!
Neil Collins 25:32
Let’s hope. Let’s hope that the Prime Minister and the Governor of the Bank between them have grasped this truth.
Jonathan Ford 25:39
Amen to that.
Neil Collins 25:44
That was a long time in finance with Jonathan Ford and Neil Collins, editing and production by Nick Hilton, and our sponsorship partner is briefcase dot news. Join us again next week.