Margaret Thatcher: The Autobiography (106 page)

As always, the prospect of privatization meant that the finances of the industry were subject to searching scrutiny, and what came to light was extremely unwelcome. For environmental reasons and to ensure security of supply, I felt it was essential to keep up the development of nuclear power. But in the autumn of 1988 the figures for the cost of decommissioning the now ageing power stations were suddenly revised sharply upwards by the Department of Energy. These had been consistently underestimated or perhaps even concealed. And the more closely the figures were scrutinized the higher they appeared. By the summer of 1989 the whole prospect for privatizing the main generating company which would have the nuclear power stations started to look in jeopardy. So I agreed that the older Magnox power stations should remain under government control. This was one of Cecil’s last actions at Energy and it fell to his successor, John Wakeham, to deal with the rest of the nuclear problem.

Alan Walters had been urging from the previous autumn that all the nuclear power stations should be removed from the privatization. As so often, he turned out to be right. The figures for decommissioning the other power stations started to look uncertain and then to escalate, just as those for Magnox had done. John Wakeham recommended and I agreed that all nuclear power in England and Wales should be retained in state control. One consequence of this was that Walter Marshall, who naturally wanted to retain the nuclear provinces in his empire, decided to resign, about which I was very sad. But the other consequence was that privatization
could now proceed, as it did, with great success, to the benefit of customers, shareholders and the Exchequer.

The result of Cecil Parkinson’s ingenious reorganization of that industry on competitive lines is that Britain now has perhaps the most efficient electricity supply industry in the world. And as a result of the transparency required by privatization we also became the first country in the world to investigate the full costs of nuclear power – and then to make proper financial provision for them.

There was still much I would have liked to do. But by the time I left office, the state-owned sector of industry had been reduced by some 60 per cent. Around one in four of the population owned shares. Over six hundred thousand jobs had passed from the public to the private sector. It constituted the greatest shift of ownership and power away from the state to individuals and their families in any country outside the former communist bloc. Indeed, Britain set a worldwide trend in privatization. Some £400 billion of assets have been or are being privatized worldwide. And privatization is not only one of Britain’s most successful exports: it has re-established our reputation as a nation of innovators and entrepreneurs. Not a bad record for something we were constantly told was ‘just not on’.

Monetary policy, interest rates and the exchange rate

A
CORRECT ECONOMIC POLICY
depends crucially upon a correct judgement of what activities properly fall to the state and what to people. After a long struggle during my first term, from 1979 to 1983, like-minded ministers and I had largely converted the Cabinet, the Conservative Party and opinion in the worlds of finance, business and even the media to a more restrictive view of what the state’s role in the economy should be. Moreover, as regards the regulatory framework within which business could run its affairs, there was a general understanding that lower taxes, fewer controls and less interference should be the goal. But as regards setting the overall financial framework there was less common ground. Whereas Nigel Lawson and I agreed strongly about the role of the state in general, we came sharply to differ about monetary and exchange rate policy.

Our success in bringing down inflation in our first term from a rate of 10 per cent (and rising) to under 4 per cent (and falling) had been achieved by controlling the money supply. ‘Monetarism’ – or the belief that inflation is a monetary phenomenon, i.e., ‘too much money chasing too few goods’ – had been buttressed by a fiscal policy which reduced government borrowing, freeing resources for private investment and getting the interest rate down. This combined approach had been expressed through the Medium Term Financial Strategy – in large measure Nigel Lawson’s brainchild. Its implementation depended heavily on monitoring the monetary indicators. These, as I have noted, were often distorted, confusing and volatile. So, before the end of Geoffrey Howe’s Chancellorship, the value of the pound against
other currencies – the exchange rate – was also being taken into account.

It is important to understand what the relationship between the exchange rate and the money supply is – and what it is not. First consider the effect of an increase in the exchange rate; that is, one pound sterling is worth more in foreign currency. Because most import and export prices are fixed in foreign currencies, the sterling prices of these tradeable goods will fall. But this only applies to goods and services which are readily imported and exported, like oil or textiles. Many of the goods and services that comprise our national income are not of this sort: for example, we cannot export our houses or the services provided in our restaurants. The prices of these things are not directly affected by the exchange rate, and the indirect effect – passed on via wages – will be limited. What does more or less determine the prices of houses and other ‘non-tradeables’, however, is the money supply.

If the money supply rises too fast, the prices of non-tradeable domestic goods will rise accordingly, and a strong pound will not prevent that. But the interaction of a strong pound and a loose money supply causes the export sector to be depressed, resources to flow to houses, restaurants and the like. The balance of trade will then go into larger and larger deficits, which have to be financed by borrowing from foreigners. This kind of distortion just cannot last. Either the exchange rate has to come down, or monetary growth has to be curtailed, or both.

This result is of the utmost importance. Either one chooses to hold an exchange rate to a particular level, whatever monetary policy is needed to maintain that rate. Or one sets a monetary target, allowing the exchange rate to be determined by market forces. It is, therefore, quite impossible to control both the exchange rate
and
monetary policy.

A free exchange rate, however, is fundamentally
influenced
by monetary policy. The reason is simple. If a lot more pounds are put into circulation, then the value of the pound will tend to fall – just as a glut of strawberries will cause their value to go down. So a falling pound may indicate that monetary policy has been too loose.

But it may not. There are many factors other than the money supply which have a great influence on a free exchange rate. The most important of these are international capital flows. If a country reforms its tax, regulatory and trade union arrangements so that its after-tax rate of return on capital rises well above that of other countries, then there will be a net inflow of capital and its currency will be in considerable demand. Under
a free exchange rate, it would appreciate. But this would not be a sign of monetary stringency: indeed, as in Britain in 1987 to mid-1988, a high exchange rate may well be associated with a considerable monetary expansion.

It follows from this that if the exchange rate becomes an objective in itself, ‘monetarism’ itself has been abandoned.

The only effective way to control inflation is by using interest rates to control the money supply. If, on the contrary, you set interest rates in order to stick at a particular exchange rate you are steering by a different and potentially more wayward star. As we have now seen twice – once when, during my time, Nigel shadowed the deutschmark outside the ERM and interest rates stayed too low; once when, under John Major, we tried to hold to an unrealistic parity inside the ERM and interest rates stayed too high – the result of plotting a course by this particular star is that you steer straight onto the reefs.

These questions went to the very heart of economic policy, which itself lies at the heart of democratic politics. But there was an even more important issue which was raised first by argument about whether sterling should join the ERM and then, in a more acute form, about whether we should accept European Community proposals for Economic and Monetary Union (EMU). This was the issue of sovereignty. Sterling’s participation in the ERM was seen partly as proof that we were ‘good Europeans’. But it was also seen as a way of abdicating control over our own monetary policy, in order to have it determined by the German Bundesbank. This was what was meant when people said we would gain credibility for our policies if we were ‘anchored’ to the deutschmark. Actually, if the tide changes and you
are
anchored, the only option to letting out more chain as your ship rises is to sink by the bows; and in an ERM where revaluations were ever more frowned upon there was no more chain to let out. Which leads on to EMU.

EMU – which involves the loss of the power to issue your own currency and acceptance of one European currency, one central bank and one set of interest rates – means the end of a country’s economic independence and thus the increasing irrelevance of its parliamentary democracy. Control of its economy is transferred from the elected government, answerable to Parliament and the electorate, to unaccountable supranational institutions. In our opposition to EMU, Nigel Lawson and I were at one. But, alas, by his pursuit of a policy that allowed British inflation to rise, which itself almost certainly flowed from his passionate wish to take
sterling into the ERM, Nigel so undermined confidence in my government that EMU was brought that much nearer.

I made Nigel Lawson Chancellor in 1983. At this time the exchange rate was just one factor being taken into account in order to assess monetary conditions. It was the monetary aggregates which were crucial. The wider measure of money – £M3 – which we had originally chosen in the MTFS had become heavily distorted. A large proportion of it was in reality a form of savings, invested for the interest it earned. In Nigel’s first budget (1984) he set out different target ranges for narrow as well as broad money. The former – Mo – had been moving upward a good deal more slowly and this was taken into account in plotting the future course. But at this stage M3 and Mo were formally given equal importance in the conduct of policy. Other monetary indicators, including the exchange rate, were also taken into account. Our critics, who had until now denounced our policy as a rigid adherence to a statistical formula, began to denounce our rootless and arbitrary pragmatism. And indeed this was to mark the beginning of a process by which the clarity of the MTFS became muddied. This in turn, I suspect, caused Nigel, as the years went by, to search with increasing desperation for an alternative standard which he finally thought he had found in the exchange rate.

Events in January 1985 brought the ERM back into discussion. The dollar was soaring and there was intense pressure on sterling. I agreed with Nigel that our interest rates should be raised sharply. I also agreed with Nigel’s view that there should be co-ordinated international intervention in the exchange rates to achieve greater stability, and I sent a message to this effect to President Reagan. This policy was formalized by Nigel and other Finance ministers under the so-called ‘Plaza Agreement’ in September. In retrospect, I believe that this was a mistake. The Plaza Agreement gave Finance ministers – Nigel above all perhaps – the mistaken idea that they had it in their power to defy the markets indefinitely. This was to have serious consequences for all of us.

Sterling’s problems prompted Nigel to raise with me in February the issue of the ERM. He said that in his view controlling inflation required acceptance of a financial discipline which could be provided either by monetary targets or by a fixed exchange rate. New factors, argued Nigel, favoured the ERM. First, it was proving difficult to get financial markets to understand what the Government’s policy towards the exchange rate really was: the ERM would provide much clearer rules of the game. There
was also a political consideration. Many Conservative MPs were in favour of joining. Entry into the ERM would also move the focus of attention away from the value of the pound against the dollar – where, of course, the problem at this particular moment lay. Finally, £M3 was becoming increasingly suspect as a monetary indicator because its control depended increasingly on ‘overfunding’, with the resulting rise in the so-called ‘bill mountain’.
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I was not convinced on any of these counts, with the possible exception of the last. But I agreed that there should be a seminar involving the Treasury, the Bank of England and the Foreign Office to discuss it all.

Alan Walters could not attend the seminar and let me have his views separately. He put his finger on the key issue. Would membership of the ERM reduce the speculative pressure on sterling? In fact, it would probably make it worse. That was the lesson to be drawn from what had happened to other ERM currencies.

At my seminar Nigel 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, like Nigel, did not think the circumstances at the moment were right. 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 and the meeting ended amicably enough.

During the summer of 1985 I started to become concerned about the inflation prospect. £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.