The Foreign Exchange was like a bloodless rerun of the Battle of the Somme: the British tactics were ineffective, the strategy hopeless and the casualties enormous. The pound was made to walk across no man's land under heavy machine-gun fire, and each successive wave of reserves was thrown in and wiped out. The generals did not know what they were doing, or why.
The battle was bound to be lost, and at 7:30 last night the Treasury admitted defeat. If the pound had been maintained at its previous value by a base rate of 15 per cent - which means a real interest rate of more than 11 per cent - the depression, bad as it is, would have been turned into a slump. Already, it had seemed probable that next year would see a further fall in output. Given the shock to confidence of yesterday's two base rate rises, and the continuation of interest rates at or near this level, any hope of recovery or even standstill would have been destroyed. There would have been wholesale bankruptcies, a mass increase in unemployment, a collapse of the housing market, economic catastrophe.
Fortunately, the market is much stronger than the Government; it has much more money and much more intelligence. The market applied irresistible force against the proposition that the pound ought to maintain its minimum fixed rate inside the exchange rate mechanism. The Government mistakenly believed that the market could be beaten, and was taught the lesson that it could not.
The economic evidence is that the market was always the better judge of reality. Britain has suffered a longer period of depression even than in the Thirties. Despite the depression, and despite real interest rates that were destructively high before yesterday's rises, Britain has a large balance of payments deficit. The deficit that would be caused by a recovery would obviously be much higher. The market saw that the ERM rate for the pound was not sustainable, and demanded a lower rate at which interest rates could be reduced and recovery made possible.
The management of the crisis was inept. Never before has the base rate had to be put up twice in one day, itself a confession of gross miscalculation. Many people could have forecast that 12 per cent would not be enough to reassure the market and 15 per cent would be regarded as panic. To have inadequacy and panic inside a few hours is ridiculous. It sends the clearest possible message of loss of control. Thank goodness the 15 per cent rate will not now be applied, but why do we need 12 per cent if we are trying to discover the right market value for the pound?
The policy was questionable from the beginning. In October 1990 Britain joined the ERM at the very moment we were moving into recession and Germany was facing the new burdens of unification. Even then, the rate looked too high. In practice, the ERM has been a strait- jacket that has forced Britain to keep interest rates during a world depression much too high for much too long. Even the decision to increase rates to 12 per cent sacrifices the real welfare of the economy to a policy already doomed to failure. It will not prevent inflation - the surest way to cause higher inflation is to deepen the slump now. The 15 per cent rate was, of course, economic lunacy.
The ERM is not the first fixed-rate system the world has tried, nor the first to break down. It has always had the disadvantage that it was only a regional system, with other and stronger currencies floating beside it. That created its own strains and discrepancies. However, it became increasingly plain this year that the anchor currency, the mark, was no longer strong enough to hold it, and that the dominant country, Germany, put the ERM relatively low in its priorities.
This week it was two German actions that precipitated events. The first was the niggardly quarter per cent cut in the Lombard rate. That showed that Germany was not concerned to make a reality of the probably inadequate realignment of the weekend. The second was the interview in the Wall Street Journal with Helmut Schlesinger, the president of the Bundesbank, which made it clear that he expected some further realignment. No fixed-rate system will work without a strong anchor and a determined and discreet Central Bank. The ERM no longer has either.
The best course now would be to allow the pound to find its own level at an appropriate interest rate, not 12 per cent, not 10 per cent, but probably closer to 6 per cent. The greatest problem facing Britain is the length and severity of the recession, which is a social and political evil. It has been made much worse by the overhang of the mortgage debt and the continued fall in the housing market. As money supply figures are rising too slowly, a recovery in mortgage lending is needed if normal economic growth is to resume.
Even their lower interest rates have not produced strong recoveries in the United States or Japan, but our high interest rates have made the British depression much worse than it would otherwise have been. Perhaps the 12 per cent rate is only intended to cover the immediate aftermath of suspension from the ERM. As anything but the rate for a few days, 12 per cent is obviously much too high.
Britain certainly should not try to go back into the ERM. Fixed rates are hard to operate and hard to maintain; we have failed to win market acceptance in this system. The ERM was intended to give us stability. In fact, when we shadowed it in the late Eighties, it gave us high inflation and when we joined it in 1990 it gave us prolonged depression. Floating rates are not perfect. But in the Thirties and in most of the Eighties, floating rates allowed Britain strong recovery and an improving competitive performance. They put on us the responsibility for our own monetary policy which we should never have abandoned. British monetary policy is more likely than German to meet Britain's needs. At present the priority must be to prevent the depression destroying homes, jobs and businesses.
Last night's devaluation is a defeat for the economic and European policy of the Government, which has been backed to the end by the leaders of the Labour and Liberal Democrat parties. The ERM and Maastricht have been the centre of that policy, yet withdrawal from the ERM makes the Maastricht policy of a single currency meaningless. For Britain, the ERM has ended in disaster and heavy loss. No doubt Norman Lamont and John Major will both consider their responsibilities for these serious errors of policy. It is only fair to the Chancellor to observe that the policy was initiated and maintained by the Prime Minister, who took direct personal responsibility for it.
This is not however a moment when the assessment of blame is the most important issue. The exchange market has forced the Government to set the British people free from the shackles of the ERM. The right course now is to float the pound, cut interest rates, and get Britain back to work.Reuse content